Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This quarterly report on Form 10-Q contains forward-looking statements that are not limited to historical facts, but reflect our current beliefs, expectations or intentions regarding future events. All forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. For examples of such risks and uncertainties, please see the risk factors set forth in Part II, Item 1A. "Risk Factors" and elsewhere in this Form 10-Q, in our Annual Report on Form 10-K for the year ended December 31, 2008 (the "2008 Form 10-K") and in our reports and registration statements filed from time to time with the Securities and Exchange Commission ("SEC"), which identify important matters such as the significant volatility in the cost of aircraft fuel, our transition to a new global alliance, the consequences of our high leverage and other significant capital commitments, our high labor and pension costs, delays in scheduled aircraft deliveries, service interruptions at one of our hub airports, disruptions to the operations of our regional operators, disruptions in our computer systems, and industry conditions, including the recession in the U.S. and global economies, the airline pricing environment, terrorist attacks, regulatory matters, excessive taxation, industry consolidation, the availability and cost of insurance, public health threats and the seasonal nature of the airline business. We undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this report, except as required by applicable law.

OVERVIEW

We are a major United States air carrier engaged in the business of transporting passengers, cargo and mail. We are the world's fifth largest airline as measured by the number of scheduled miles flown by revenue passengers in 2008. Including our wholly-owned subsidiary, Continental Micronesia, Inc. ("CMI"), and regional flights operated on our behalf under capacity purchase agreements with other carriers, we operate more than 2,300 daily departures. As of June 30, 2009, we served 119 domestic and 120 international destinations and offered additional connecting service through alliances with domestic and foreign carriers.

General information about us can be found on our website, continental.com. Electronic copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC.

Second Quarter Financial Highlights

· We recorded a net loss of $213 million in the second quarter of 2009.

· Passenger revenue decreased 24.2% during the second quarter of 2009 as compared to the second quarter of 2008 primarily due to lower fares and less high yield business traffic attributable to the global recession. We estimate that the outbreak of the H1N1 flu virus reduced passenger revenue by approximately $50 million during the quarter.

· We recorded an operating loss of $154 million during the second quarter of 2009 as compared to an operating loss of $71 million in the second quarter of 2008, due primarily to significantly reduced passenger revenue offset in part by lower fuel expenses.

· Unrestricted cash, cash equivalents and short-term investments totaled $2.8 billion at June 30, 2009.

Second Quarter Operational Highlights

· Consolidated traffic decreased 6.4% and capacity decreased 7.8% during the second quarter of 2009 as compared to the second quarter of 2008, resulting in a consolidated load factor of 82.7% for the second quarter of 2009.

· We recorded a U.S. Department of Transportation ("DOT") on-time arrival rate of 78.7% and a mainline segment completion factor of 99.6% for the second quarter of 2009, compared to a DOT on-time arrival rate of 73.1% and a mainline segment completion factor of 99.5% for the second quarter of 2008.

· We placed one new Boeing 737-900ER aircraft into service and removed four Boeing 737-500 aircraft from service.

Outlook

The severe global economic recession has significantly diminished the demand for air travel and disrupted the global capital markets, resulting in a difficult financial environment for U.S. network carriers. In addition, we have significant long-term debt and capital lease obligations and future commitments for capital expenditures, including the acquisition of aircraft and related spare engines. To meet these obligations, we must access the global markets for capital and/or achieve and sustain profitability. Although access to the troubled capital markets has improved over the past several months, as evidenced by our recent financing transactions, we cannot give any assurances due to the economic environment that we will be able to obtain additional financing or otherwise access the markets for capital in the future on acceptable terms (or at all). Moreover, continuing declines in our passenger and cargo revenues are hindering our ability to achieve and sustain profitability and, given the losses we incurred during the first six months of 2009, under current market conditions we expect to incur a significant loss for the full year 2009.

Economic Conditions. The airline industry is highly cyclical, and the level of demand for air travel is correlated to the strength of the U.S. and global economies. The current recession in the U.S. and global economies has had a significant negative impact on the demand for air carrier services. Seven major U.S. carriers have reported a combined 9.5% decrease in traffic, as measured by miles flown by revenue passengers during the first half of 2009 as compared to the first half of 2008. The decline in demand has disproportionately reduced the volume of high yield traffic, as many business travelers are either curtailing their travel or purchasing lower yield economy tickets.

The global economic recession has severely disrupted the global capital markets, resulting in a diminished availability of financing and higher cost for financing that is obtainable. If economic conditions again worsen or these markets experience further disruptions, we may be unable to obtain financing on acceptable terms (or at all) to refinance certain maturing debt we would normally expect to refinance and to satisfy future capital commitments.

Fuel Costs. We benefited from significantly lower fuel costs during the first half of 2009. Our average consolidated (mainline and regional) jet fuel price per gallon including related taxes decreased to $1.95 in the first half of 2009 from $3.14 in the first half of 2008. However, the continued volatility in jet fuel prices, which ranged from $1.12 per gallon to $1.90 per gallon in the first six months of 2009, continues to impair our ability to achieve and sustain profitability. If fuel prices rise significantly from their current levels, we may be unable to raise fares or other fees sufficiently in the current financial environment to offset fully our increased costs.

In response to high fuel prices during the first half of 2008 and to address the risk of further escalations in fuel prices, most of the major network carriers (including us) continued to enter into fuel hedging arrangements, including collars which minimize the up-front costs. However, the precipitous decline in oil prices during the second half of 2008 resulted in significant costs to us and to those other carriers with hedging arrangements obligating them to make payments to the counterparties to the extent that the price of crude falls below a specified level. Our hedge contracts for the first six months of 2009, which were largely entered into before oil prices fell, resulted in $0.42 per gallon of additional fuel expense during the first half of 2009. We have significantly fewer hedge contracts outstanding related to the third and fourth quarters of 2009, and have hedged none of our fuel requirements beyond 2009.

Based on our expected fuel consumption in 2009, a one dollar change in the price of a barrel of crude oil would change our annual fuel expense by approximately $40 million, before considering refining margins and the impact of our fuel hedging program. We believe that our modern, fuel-efficient fleet continues to provide us with a competitive advantage relative to our peers and a permanent hedge against rising fuel prices.

New Revenue-Generating and Cost Saving Measures. In response to the significant decline in revenue, we are implementing a number of measures to raise revenues and reduce costs that are designed to achieve approximately $100 million in annual benefits when fully implemented in 2010. These measures include eliminating approximately 1,700 positions across the company, including management and clerical positions. This is in addition to the previously announced elimination of 500 reservation agent positions and special company offered leaves of absence extended for 700 flight attendants. We are offering employees voluntary programs to minimize the number of involuntary furloughs and reductions in force. We are also increasing domestic checked baggage fees by $5 for customers who do not prepay those fees online, effective immediately for travel August 19, 2009 and beyond, and increasing the telephone reservation booking service fee by $5 effective immediately.

Capacity. Our long-term target remains to grow our mainline capacity between 5% and 7% annually. However, because of the current adverse economic conditions, we have reduced our capacity significantly and rescheduled aircraft deliveries, and we do not anticipate returning to significant capacity growth until the level of demand for air travel and economic conditions improve sufficiently to justify such growth. By early January 2010, we expect to remove all of our remaining Boeing 737-300 aircraft and nine additional Boeing 737-500 aircraft from service.

Our future ability to grow our capacity could be adversely impacted by manufacturer delays in aircraft deliveries. In June 2009, Boeing announced an additional delay to its 787 aircraft program. Boeing has not yet provided an updated 787 delivery schedule. Prior to this delay, we expected the first of our 25 Boeing 787 aircraft to be delivered in 2011 instead of the first half of 2009 as originally scheduled.

Star Alliance. In 2008, we entered into framework agreements with United, Lufthansa and Air Canada, each a member of Star Alliance, pursuant to which we plan to develop an extensive code-share relationship and reciprocity of frequent flier programs, elite customer recognition and airport lounge use with these other airlines. We plan to implement these relationships and join United, Lufthansa and Air Canada (and other member airlines) in Star Alliance as promptly as practicable following our exit from SkyTeam. We will exit SkyTeam effective with our last flight on October 24, 2009.

On July 23, 2008, we filed an application with the DOT to join United and a group of eight other carriers within Star Alliance that already hold antitrust immunity, which the DOT approved on July 10, 2009. Final approval by the DOT of this application enables us, United and these other immunized Star Alliance carriers to work closely together to deliver highly competitive international flight schedules, fares and service and provides competitive balance to antitrust-immunized carriers in SkyTeam. Additionally, we, United, Lufthansa and Air Canada have received final DOT approval to establish a trans-Atlantic joint venture to create a more efficient and comprehensive trans-Atlantic network for our respective customers, offering those customers more service, scheduling and pricing options and establishing a framework for similar joint ventures in other regions of the world. The DOT's approval of antitrust immunity is subject to certain conditions and limitations that are not expected to diminish materially the benefits of our participation in Star Alliance or the trans-Atlantic joint venture. In addition, we are seeking a modification to our existing pilot collective bargaining agreement, which would permit us to engage in a joint venture with a domestic air carrier.

Labor Costs. Our ability to achieve and sustain profitability also depends on continuing our efforts to implement and maintain a more competitive cost structure. The collective bargaining agreements with our pilots, mechanics and certain other work groups became amendable in December 2008. On July 6, 2009, our flight simulator technicians ratified a new four-year collective bargaining agreement with us. We are meeting with representatives of the applicable unions representing our other unionized workgroups to engage in bargaining for amended collective bargaining agreements with a goal of reaching agreements that are fair to us and to our employees. We cannot predict the outcome of our ongoing negotiations with our unionized workgroups, although significant increases in the pay and benefits resulting from new collective bargaining agreements could have a material adverse effect on us.

Management Changes. On July 16, 2009, we announced that Larry Kellner, our chairman and chief executive officer, will leave effective December 31, 2009 to head a new private equity firm. Jeff Smisek, our president and chief operating officer and a member of our board of directors, will become chairman and chief executive officer effective January 1, 2010.

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RESULTS OF OPERATIONS

The following discussion provides an analysis of our results of operations and reasons for material changes therein for the three and six months ended June 30, 2009 as compared to the corresponding periods in 2008. As further discussed in the notes to our consolidated financial statements, our consolidated financial statements for the three and six months ended June 30, 2008 have been adjusted for the retrospective application of FSP APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)," and for certain reclassifications related to fuel and related taxes on flights operated for us by other operators under capital purchase agreements.

Comparison of Three Months Ended June 30, 2009 to Three Months Ended June 30, 2008