Continental posts profit, but expects Q4, full-year loss; warns 2007 debt obligations will be a challenge

By Rebecca Melvin

Princeton, N.J., Oct. 19 - Despite a price spike that lifted fuel oil to its No. 1 expense item, Continental Airlines Inc. reported a third-quarter profit amid solid demand, especially for its international flights.

But the carrier said it expects to post a fourth quarter and full-year 2005 loss, and it warned of an impending liquidity crunch that will really hit by 2007, and which was behind Continental's move to price a spot offering of common stock on the heels of its earnings report late Tuesday.

The equity offering was aimed at helping to further strengthen liquidity - and existing liquidity is sufficient through 2006, said Larry Kellner, Continental's chairman and chief executive.

But beyond that, 2007 presents challenges given current market conditions, Kellner told analysts and investors during a conference call on Thursday.

The company faces $937 million in debt maturities in 2007, including its 4.5% convertibles, which brought proceeds of $175 million when issued.

Asked during the Q&A portion of the conference call whether, in light of this crunch, Continental will be back in the capital markets in the next 12 months, Kellner said he would not comment on potential capital market transactions.

Neither would company officials offer more details on the common stock offering.

The stock sale raised $204 million, and as of Dec. 31, Continental said it expects to have $1.6 billion of unrestricted cash and short-term investment, which includes proceeds from the 18 million share offering and an overallotment option of 2.7 million shares. The stock was sold at a price of $11.35.

Continental will also have $6 billion in debt, includes $5.7 billion of long-term debt and $593 million of current maturities due in the next 12 months.

As announced late Tuesday, third-quarter earnings totaled $61 million, or 80 cents a share. Excluding a $3 million charge, the company earned $64 million, or 83 cents a share. In the same quarter last year, Continental lost $18 million, or 29 cents a share.

Analysts expected a profit of 27 cents, with a range of 10 cents to 50 cents a share, according to Thomson First Call.

Fuel becomes biggest cost

Fuel oil rose to become Continental's single largest expense, surpassing wages and salaries for the first time, Continental Airlines president Jeff Smisek said during the conference call.

Including regional operations, fuel costs increased $340 million in the third quarter to a total $684 million, with the average cost $1.8799 a gallon, up 57% year over year, Smisek said.

The carrier's "relentless focus on controlling costs" was overwhelmed by the continually rising price of fuel that set a new record at well over $120 a barrel for Gulf Coast fuel oil, Smisek said.

Those costs are expected to go even higher in the fourth quarter, and are behind Continental's projected losses for 2005, Smisek said.

Fourth quarter fuel is expected to cost $2.05 a gallon, up 48% year over year, he said.

The Houston-based carrier said that its pension contribution year to date stands at $304 million, which matches the objective for the year.

During the third quarter, Continental began mediation with its flight attendants in an effort to reach an agreement for pay and benefit reductions and work rule changes. In addition, the company's field service employees rejected representation sought by the Transport Workers Union of America.

In terms of its flight attendants pension and benefit reduction plans, company officials offered no further details other than to say that they desire quick timing, but would not sacrifice corporate culture.

"We won't sacrifice the right agreement for speed," Kellner said.

The quarter's severe weather, including the two hurricanes that pounded the Gulf Coast, resulted in the cancellation of 1,272 mainline Continental flights.

When asked if the bankruptcy filings last month of competitors Delta Air Lines Inc. and Northwest Airlines Corp. were viewed as a positive, because those carriers will be cutting capacity, or negative, because they are cutting costs, Kellner said that "as in all things it's complex."

Competitiveness through growth

The announced future capacity cuts haven't influenced the market yet, he said, but at the margin that's a good thing. As far as looking at more cost efficient competitors in the future, he said that Continental will get more competitive too, but it has no intention of going back to its labor groups for more cutbacks. It will become more competitive through growth, he said.

Third-quarter passenger revenue rose 15.3% to a record $2.8 billion, on a 7% increase in passengers, largely the result of continued expansion into international markets and higher fares.

Passenger revenue in its domestic market was $1.22 billion, by far the single largest part, and representing a 7.6% increase. But trans-Atlantic totaled $545 million, which was up 25.7%; Latin America was $285 million, which was up 12.7%; and the Pacific was at $222 million, up 30%, but representing a 0.6% decrease in terms of revenue per available seat mile, or RASM.

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