| **UNITED STATES**                      |
|----------------------------------------|
| **SECURITIES AND EXCHANGE COMMISSION** |
| **WASHINGTON, D.C. 20549**             |

Form 10-K

| **[X]**            |   | Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934     |
|--------------------|--------|------------------------------------------------------------------------------------------|
|                    |        | For the fiscal year ended December 31, 2006                                              |
| or                 |
| **[  ]** |        | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
|                    |        | For the transition period from ___________ to ___________                                |

**Commission File Number 1-31300EXPRESSJET HOLDINGS, INC.***(Exact name of registrant as specified in its charter)*

| **Delaware** (*State or other jurisdiction of incorporation or organization)*                              | **         ** | **76-0517977***(I.R.S. Employer Identification No.)* |
|------------------------------------------------------------------------------------------------------------|------------------------------------------------------------|------------------------------------------------------|
|                                                                                                            |                                                            |                                                      |
| **700 North Sam Houston Parkway West, Suite 200 Houston, Texas***(Address of principal executive offices)* |                                                            | **77067***(Zip Code)*                                |
|                                                                                                            |                                                            | **  **                                     |
| 832-353-1000*(Registrant's telephone number, including area code)*                                         |

| Securities registered pursuant to Section 12(b) of the Act:                                                                                                                                                                                                                                                                                                                                                   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Title of eachclass:                                                                | Name of each exchange on which registered: |
| Common Stock, $.01 par value                                                                                                                                                                                                                                                                                                                                                                                  | New York Stock Exchange |
| Preferred Stock Purchase Rights                                                                                                                                                                                                                                                                                                                                                                               | New York Stock Exchange |
| Securities registered pursuant to section 12(g) of the Act:  None                                                                                                                                                                                                                                                                                                                         |

            Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. **[  ]** Yes **[X]** No

            Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. **[  ]** Yes **[X]** No

            Indicate by check mark whetherregistrant (1) has filed all reports required to be filed by Section13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or by such shorter period that the registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.**[X]** Yes  **[  ]** No

            Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 or Regulation S-K (§ 229,405 of this chapter) is not contained herein,and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. **[X]**

            Indicate by check mark whetherthe registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. **[  ]** Largeaccelerated filer  **[X]** Accelerated filer   **[  ]** Non-accelerated filer

            Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the Act).**[  ]** Yes  **[X]** No

            The aggregate market value of thevoting and non-voting common equity held by non-affiliates of the registrant was $372.9 million as of June 30, 2006.

            As of February 17, 2006,54,208,153 shares of common stock were outstanding.

| **DOCUMENTS INCORPORATED BY REFERENCE** |
|-----------------------------------------|

            Information called for by PartIII of Form 10-K is incorporated by reference to the Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed withthe Commissions within 120 days after December 31, 2006.

----

**TABLE OF CONTENTS**

|          |   | Part I                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |        | Page |
|----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------|
| Item 1.  |        | Business                                                                                                                                 |   | 2    |
|          |        | Forward-Looking Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |        | 2    |
|          |        | Our Company                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |        | 3    |
|          |        | Business Strategy                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |        | 3    |
|          |        | Capacity Purchase and Other Agreements with Continental Airlines                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |        | 4    |
|          |        | Aircraft Fleet                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |        | 15   |
|          |        | Competitors                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |        | 17   |
|          |        | Industry                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |        | 18   |
|          |        | Industry Regulation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |        | 18   |
|          |        | Employees                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |        | 19   |
| Item 1A. |        | Risk Factors                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |        | 20   |
| Item 1B. |        | Unresolved Staff Comments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |        | 26   |
| Item 2.  |        | Properties                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |        | 26   |
|          |        | Flight Equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |        | 26   |
|          |        | Facilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |        | 26   |
| Item 3.  |        | Legal Proceedings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |        | 27   |
| Item 4.  |        | Submission of Matters to a Vote of Security Holders                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |        | 28   |
|          |        | PART II                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |        |      |
| Item 5.  |        | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |        | 28   |
| Item 6.  |        | Selected Financial Data                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |        | 30   |
| Item 7.  |        | Management's Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |        | 33   |
|          |        | Executive Summary                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |        | 33   |
|          |        | Results of Operations and Analysis                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |        | 41   |
|          |        | Liquidity and Capital Commitments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |        | 46   |
| Item 7A. |        | Quantitative and Qualitative Disclosure About Market Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |        | 52   |
|          |        | Aircraft Fuel                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |        | 52   |
|          |        | Interest Rates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |        | 52   |
| Item 8.  |        | Financial Statements and Supplementary Data                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |        | 53   |
|          |        | Report of Management                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |        | 54   |
|          |        | Report of Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |        | 55   |
|          |        | Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |        | 56   |
|          |        | Consolidated Statements of Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |        | 58   |
|          |        | Consolidated Balance Sheets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |        | 59   |
|          |        |   Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |        | 59   |
|          |        |   Liabilities and Stockholders' Equity (Deficit)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |        | 60   |
|          |        | Consolidated Statements of Cash Flows                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |        | 61   |
|          |        | Consolidated Statements of Stockholders' Equity (Deficit)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |        | 62   |
|          |        | Notes to Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |        | 63   |
| Item 9.  |        | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |        | 90   |
| Item 9A. |        | Controls and Procedures                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |        | 90   |
| Item 9B. |        | Other Information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |        | 91   |
|          |        | PART III                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |        |      |
| Item 10. |        | Directors and Executive Officers of the Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |        | 92   |
| Item 11. |        | Executive Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |        | 92   |
| Item 12. |        | Security Ownership of Certain Beneficial Owners and Management                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |        | 92   |
| Item 13. |        | Certain Relationships and Related Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |        | 92   |
| Item 14. |        | Principal Accounting Fees and Services                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |        | 92   |
|          |        | PART IV                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |        |      |
| Item 15. |        | Exhibits, Financial Statements Schedules                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |        | 93   |
|          |        | Signatures                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |        | 98   |
|          |        | Index to Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |        | 101  |

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Table of Contents

**PART I**

**Item 1. Business**

****

           ExpressJetHoldings, Inc. (“Holdings”) has strategic investments in the air transportation industry.  Our principal asset isall of the issued and outstanding shares of stock of XJT Holdings, Inc., the sole stockholder of ExpressJet Airlines, Inc.(referred to in this report as “Airlines” and, together with Holdings, as ExpressJet, “we” or“us”). Airlines operates over 200 aircraft for Continental Airlines, Inc. (“Continental”) as ContinentalExpress, and operates a number of aircraft through its Corporate Aviation division in charter service. Additionally, Airlines plansto begin flying scheduled point-to-point service under the ExpressJet brand in April 2007 and plans to fly 10 aircraft on behalf ofa major network carrier beginning in the second quarter of 2007.  Airlines is one of the largest regional airlines in theworld, based on 2006 available seat miles, the number of regional jets in its fleet and passengers flown.  We also invest inother entities that permit us to leverage the management experience, efficiencies and economies of scale present in oursubsidiaries.

            Our website address is*www.expressjet.com*.  In addition to other information, you may view the following materials on our website, free ofcharge:

|           | •  | our reports and other filings with the Securities and Exchange Commission ("SEC"), which areavailable as soon as reasonably practicable after we file them with, or furnish them to, the SEC; |
|--------------------------------------------------------|--------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                        | •  | the Corporate Governance Guidelines adopted by our board of directors establishing the generalpolicies by which the board operates;                                                           |
|                                                        | •  | the charters of the principal standing committees of our board:  Audit, Human Resources,and  Nominating and Corporate Governance; and                                               |
|                                                        | •  | the Principles of Conduct, which is our code of business conduct and ethics applicable to all of ourdirectors and employees.                                                                  |

            Stockholders can print a copy ofthe foregoing materials from our website or may request a copy from the Secretary of the company by writing to the address on thecover of this report.

            As described in the Principles ofConduct, we have established means for our employees to report concerns of questionable accounting, auditing and other businesspractices to our Director of Internal Audit and to our Corporate Compliance Officer.  One way for our employees to reportconcerns is through the following email address: *xjtinternalaudit@expressjet.com. * Persons desiring to communicate withthe independent members of our board of directors may also do so through this email address.

            On May 9, 2006, our ChiefExecutive Officer certified to the New York Stock Exchange ("NYSE") that he was not aware of any violation by the company of theNYSE's corporate governance listing standards.  In addition, our Chief Executive Officer and Chief Financial Officer have madethe certifications required under Section 302 of the Sarbanes-Oxley Act, which are included as exhibits to this report.

**Forward-Looking Statements**

            This report containsforward-looking statements.  Statements in the "Business “Risk Factor,” "Properties" and "Management's Discussionand Analysis of Financial Condition and Results of Operation" sections of this report, together with other statements includingwords such as "believes," "intends," "plans," "anticipates, “estimates," "projects," "expects" or similar expressionsrepresent forward-looking statements that are based on management's expectations in light of facts known by management on the datethis report was filed with the SEC.  Specifically, statements regarding our future results of operations, operating costs,business prospects, growth and capital expenditures, including plans with respect to our fleet, are forward-lookingstatements.  These statements reflect our plans and assumptions about future events and are subject to uncertainties, many ofwhich are outside our control.  Important factors that could cause actual results to differ materially from the expectationsexpressed or implied in the forward-looking statements include known and unknown risks.  Some of the known risks that couldsignificantly impact our revenues, operating results and capacity include, but are not limited to: our continued dependence onContinental for the majority of our revenue; our capacity purchase agreement (the “Continental CPA”) with Continentalcould be terminated; the results of our arbitration with Continental over the 2007 rates to be

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charged under the Continental CPA may have an adverse effect on our results; potential loss ofaccess to our aircraft, facilities and regulatory authorizations, as well as any airport-related services that Continentalcurrently provides to us; our new operations may be less profitable than our historical results; competitive responses to ourbranded entry into new markets; certain tax matters; our reliance on technology and third party service providers; flightdisruptions as a result of operational matters; regulatory developments and costs, including the costs and other effects ofenhanced security measures and other possible regulatory requirements; and competition and industry conditions.  For furtherdiscussions of these risks, please see "Item 1A - Risk Factors" beginning on page 20.  The statements in this report are madeas of February 22, 2007, and the events described in the forward-looking statements might not occur or might occur to a materiallydifferent extent than described in this report.  We undertake no duty to update or revise any of forward-looking statements,whether as a result of new information, future events or otherwise.

****

**Our Company**

            Holdings was incorporated inDelaware in August 1996.  We have strategic investments in the air transportation industry.  Our principal asset is allof the issued and outstanding shares of stock of XJT Holdings, Inc., the sole stockholder of Airlines.  Airlines is one of thelargest regional airlines in the world, based on 2006 available seat miles, number of regional jets and passengerstransported.  

            Airlines currently operates afleet of 274 aircraft.  During substantially all of 2006, the entire fleet operated on behalf of Continental as ContinentalExpress pursuant to the Continental CPA and we received substantially all of our revenue under that agreement.  In December2006, Continental began releasing 69 aircraft (25% of our fleet) from that agreement.  We redeployed two of these aircraft tocharter service in 2006; the other 67 are being removed from Continental service during the first six months of 2007 and will bedeployed in branded flying, charter service, or a capacity purchase agreement with a major network carrier. Branded flying, underthe name “ExpressJet” will provide regularly scheduled air service to West, Midwest and Southeast destinations in theUnited States commencing service on April 2, 2007.  We will continue to operate the remaining 205 aircraft under theContinental CPA.

            As of December 31, 2006 under theContinental CPA, we averaged over 1,300 daily departures, offering scheduled passenger service to over 150 destinations in NorthAmerica, Mexico and the Caribbean.  Our available seat miles grew at a compounded annual rate of 18.8% from 4.7 billion in2000 to 13.2 billion in 2006.  We generated $1.7 billion of revenue and $92.6 million of net income for the year endedDecember 31, 2006.  Please refer to our consolidated financial statements included in this report for information regardingour revenue and net income for each of the last three fiscal years and total assets as of the end of the last two years.

            During 2005, we announced thatour wholly owned subsidiary, ExpressJet Services, LLC (“ExpressJet Services”), and Airlines’ Training Servicesdivision received third-party repair and training certificates, respectively, from the Federal Aviation Administration(“FAA”). We expanded ExpressJet Services during 2006 to include our wholly owned subsidiaries American Composites LLCand InTech Aerospace Services, and Saltillo Jet Center, a majority owned subsidiary.  Please see Item 7.“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Executive Summary”and Item 8. “Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 1– Summary of Accounting Policies” for a description of our investments and our current accounting treatment for theseentities.

            After Continental’sownership of our common stock fell below 10% in April 2005, we redeemed the sole share of our Special Voting Preferred Stock, whichwas held by Continental. The redemption terminated Continental’s right to elect a director to our board of directors. The Continental CPA provided Continental the right to nominate a director to our board, but Continental relinquished this right inOctober 2005.  In January 2007, Continental sold all but 625 shares of our common stock.  

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**Business Strategy**

****

            We seek to enhance stockholdervalue by providing consistently efficient, customer focused and reliable regional jet service.  This service, coupled withopportunities arising from the competitive strengths we have developed, positions us as a leading provider of regional jetservices.  We believe that our focus on cost, customers and reliability has both strengthened Continental and will createopportunities for our growth in other areas.  

            Our commitment to customerservice and reliability has served us well doing business as Continental Express, and our Empresa Brasileira de Aeronautica S.A.(“Embraer”) ERJ-145XR aircraft enable Continental to serve more distant markets with demand for non-stop service tomajor metropolitan areas such as Houston, New York/Newark, Los Angeles and Cleveland.

            Our cost structure, measured on aper-seat mile basis, remains highly competitive to aircraft of much larger configurations.  Comparisons from publiclyavailable data indicate that our direct operating costs on a per available seat mile basis for maintenance, flight operations,market fuel rates and aircraft ownership reflect economics better than many 100+ seat aircraft operated by major airlines.  Webelieve that the capability and operating economics of our aircraft will provide us strategic opportunities in the foreseeablefuture.  Airlines currently operates a fleet of 274 aircraft.  During substantially all of 2006, the entire fleetoperated on behalf of Continental, as Continental Express, pursuant to the Continental CPA and we received substantially all of ourrevenue under that agreement. In December 2006, Continental began releasing 69 aircraft from that agreement.  We will continueto operate the remaining 205 aircraft under the Continental CPA.  

            During 2006, we finalized ourplans for the 69 aircraft being released from the Continental CPA beginning December 28, 2006.  The new Corporate Aviationdivision is expected to operate a total of 15 aircraft by June 2007, providing distinctive travel solutions for corporations,aircraft brokers, hospitality companies, sports teams, schools and others.  The aircraft are being flown under Airlines’operating certificate issued by the FAA. The aircraft are configured with 50 redesigned seats for enhanced passenger comfort, andeach seat includes XM Satellite radio with over 100 channels of audio entertainment.  In addition to the basic service,customized flight service options will give customers an opportunity to create a unique flight experience.

            We currently plan to use 44aircraft to launch branded services in markets that are sized appropriately for these aircraft and typically do not have directflight options today.  Service to 24 cities in the West, Midwest and Southeast United States is scheduled to begin in Apriland May 2007.  Product features will include redesigned seats for enhanced passenger comfort, free XM Satellite radio,advanced seat assignments with no middle seats, valet carry-on baggage service and complimentary snacks and meals on longer haulflights.

**Capacity Purchase and Other Agreements with ContinentalAirlines**

**           *General.***  We currently derive substantially all of our revenue from the Continental CPA.  Under thisagreement, Airlines operates flights on behalf of Continental as Continental Express.  Continental controls and is responsiblefor scheduling, pricing and managing seat inventories and is entitled to all revenue associated with the operation of theaircraft.  We also have various other agreements with Continental that govern our relationship.

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            Under the Continental CPA, somemarketing-related costs normally associated with operating an airline are borne by Continental.  These costsinclude:

|           | •  | reservations andsales;                                                                                                            |
|--------------------------------------------------------|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                        | •  | commissions;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                        | •  | advertising;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                        | •  | revenue accounting;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                        | •  | fare and tariff filings; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                        | •  | food and beverage service.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

            On December 28, 2005, Continentalnotified us that it would withdraw 69 aircraft from the capacity purchase agreement between December 2006 and June 2007.  Wesubsequently decided to retain all 69 aircraft.  As of February 21, 2007, we have transitioned 21 aircraft fromContinental.  Additionally, on February 22, 2007, we agreed with Continental to defer the transition date for three ERJ-145XRaircraft from the first half of June to August 28, 2007.  Until then, these aircraft will remain as covered aircraft under theterms of the Continental CPA.

**           *Payment.***  Under the Continental CPA, Airlines is entitled to payment for each block hour that Continentalschedules it to fly.  Payment is based on a formula designed to provide Airlines with a target operating margin of 10% beforetaking into account variations in certain costs and expenses that are generally within our control.  The agreement providesthat the original cost components used in this formula remained in place until December 31, 2004, after which, new rates began tobe established annually using the same methodology.  We have exposure for most labor costs and some maintenance and generaladministrative expenses if the actual costs are higher than those reflected in Airlines’ estimated block hour rates.

            ***2001-2004****.*  A quarterly reconciliation payment was to be made by Continental to Airlines, or by Airlines to Continental, if theoperating margin calculated, as described below (the "prevailing margin") was not between 8.5% and 11.5% in any fiscalquarter.  When the prevailing margin exceeded 11.5%, Airlines paid Continental an amount sufficient to reduce the margin to11.5%.  If the prevailing margin was less than 8.5%, Continental would have paid Airlines an amount sufficient to raise themargin to 8.5%.  Certain items were excluded from the calculation of the prevailing margin, including:

|           | •  | actual labor costs that differed from those reflected in Airlines’ block hourrates;                                                                             |
|--------------------------------------------------------|--------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                        | •  | performance incentive payments, including payments from controllable cancellation performance(cancellations other than weather or air traffic control cancellations); |
|                                                        | •  | litigation costs outside the normal course of business; and                                                                                                           |
|                                                        | •  | other costs that were not included in Airlines’ block hour rates (or covered by anyadjustments to them) and were not reasonable and customary in the industry.  |

            During 2001 to 2004, thequarterly prevailing margins, before any reconciliation payments, were never below 8.5%. 

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            The table below describes howvariations between Airlines’ actual costs and estimated costs, as determined in the block hour rates, were treated under theContinental CPA through 2004.

| **Fully reconciled costs:** reconciliation payment, including 10% margin, to the fullextent actual costs differed from estimated costs.                                                                                                                                                                                                                                                                                                                                                                                     |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|  • Fuel and into-plane expenses(1)  • Aircraft rent  • Terminal facility rent  • On-time bonuses and 401(k) company match     under current plans  • Taxes (other than income taxes)  • Passenger liability insurance  • Hull insurance  • War risk insurance  • Landing fees                                                                                    |  • Ground handling services  • Administrative services provided by     Continental  • Third-party security and screening expenses  • Substantially all regional jet engine expenses    under current long-term third-party contracts  • Depreciation and amortization(2)  • Pilot training volumes  • Glycol, de-icing, snow removal  • International navigational fees  • Pilot soft time(3) |
| **Costs within the margin band:** if actual expenses in this category were sufficiently different from estimates used inthe block hour rates so that the prevailing margin (calculated to exclude the impact of unreconciled costs, to the extent theydiffered from Airlines’ estimated costs, and other items(4)) was less than 8.5% or greater than 11.5%, then areconciliation payment was to be made by Continental or Airlines to the other so that this prevailing margin would be 8.5% or11.5%, as applicable. |
|  • Maintenance, materials and repairs not     included above  • Passenger services                                                                                                                                                                                                                                                                                                                                                                                        |  • Other rental expenses  • Other operating expenses |
| **Unreconciled costs:** no reconciliation payment was made for actual results that differed from estimated costs.                                                                                                                                                                                                                                                                                                                                                                                                           |
|  • Wages and salaries  • Benefits not included above                                                                                                                                                                                                                                                                                                                                                                                                                                          |  • Corporate headquarter rent costs |

| (1)   | Under our fuel purchase agreement with Continental, fuel and fuel tax expense were reconciled to thelower of the actual costs or the agreed-upon caps.  Since 2003, our caps on fuel and fuel taxes have been 66.0 cents and 5.2cents per gallon, respectively.  For 2002, the caps on fuel and fuel taxes were 61.1 cents and 5.2 cents per gallon,respectively, and for 2001, the caps were 80.9 cents and 5.6 cents per gallon, respectively.  If the fuel agreement withContinental were not in place, Airlines’ fuel cost, including related taxes, would have been $1.23 per gallon for the yearending December 31, 2004. |
|-----------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)   | Depreciation was reconciled for assets and capital projects accounted for in the Continental CPA orthose approved by Continental outside of the agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (3)   | Pilot soft time reconciliation ended March 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (4)   | In addition to the unreconciled costs listed above, the prevailing margins used to calculateAirlines’ quarterly reconciliation payments did not take into account any performance incentive payments, including paymentsfrom controllable cancellation performance (cancellations other than weather or air traffic control cancellations), litigationcosts outside the normal course of business and other costs that were not included in Airlines’ block hour rates (or coveredby adjustments to them) and were not reasonable or customary in the industry.                                                                          |

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            In addition, to the extent thatAirlines’ rate of controllable cancellations (such as those due to maintenance or crew availability) was lower than itshistorical benchmarks, Airlines was entitled to incentive payments; conversely, Airlines would have had to pay Continental if itscontrollable cancellations were above historical benchmarks.  Because these incentive benchmarks were based on historicalfive-year rolling averages of monthly controllable cancellations, lower controllable cancellations that resulted in higherincentive payments in the near term reduced Airlines’ opportunity to earn incentive payments in the future.  Also,because Airlines used monthly rolling averages, its opportunity to earn these payments in any particular fiscal quarter wasaffected by monthly variations in historical controllable cancellation rates.  Airlines was also entitled to receive a smallper-passenger fee and incentive payments for certain on-time departure and baggage handling performance.

            ***2005 Rate Negotiation andAmendment.***  As part of the 2005 rate negotiation, we agreed to cap Airlines’ prevailing margin at 10.0%. Airlines also began including previously unreconciled costs, as discussed previously, within the margin band, although it is notreimbursed if these costs are higher and cause its prevailing margin to fall below the 8.5% margin floor.  In addition,Airlines is still entitled to receive incentive payments from Continental if its rate of controllable cancellations is lower thanits historical benchmark, but is not required to pay Continental a penalty for controllable cancellations unless the rate risesabove 0.5%.  Airlines continues to receive a small per-passenger fee and incentive payments for certain on-time departure andbaggage handling performance.

            The table below describes howvariations between Airlines’ actual costs and estimated costs, as determined in the block hour rates, have been treated underthe Continental CPA since January 1, 2005.

| **Fully reconciled costs:** reconciliation payment, including 10% margin, to the fullextent actual costs differ from estimated costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|  • Fuel and into-plane expenses(1)  • Aircraft rent  • Terminal facility rent  • On-time bonuses and 401(k) company     match under current plans  • Taxes (other than income taxes)  • Passenger liability insurance  • Hull insurance  • War risk insurance  • Landing fees  • Ground handling services                                                                                                                                            |  • Administrative services provided by     Continental  • Third-party security and screening    expenses  • Substantially all regional jet engine    expenses under current long-term    third-party contracts  • Depreciation and amortization(2)  • Glycol, de-icing, snow removal  • International navigational fees |
| **Costs within the margin band:** if actual expenses in this category are sufficiently different from estimates used in theblock hour rates so that the prevailing margin is less than 8.5% or greater than 10.0%, then a reconciliation payment is made byeither Continental or Airlines to the other so that this prevailing margin will be 8.5% or 10.0%, as applicable.  If theprevailing margin is less than 8.5% due to impact of certain costs, as described below, or if the prevailing margin is above 10.0%due to other items(3), no reconciliation payments would be made from either Continental or Airlines. |
|  • Maintenance, materials and repairs not     included above  • Passenger services                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | • Other rental expenses • Other operating expenses |

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| (1)   | Under our fuel purchase agreement with Continental, fuel and fuel tax expense are reconciled to thelower of the actual costs or the agreed-upon caps of 66.0 cents per gallon and 5.2 cents per gallon, respectively, based onAirlines’ fuel purchase agreement with Continental.  If the fuel purchase agreement with Continental were not in place,the fuel cost, including related taxes, would have been $1.80 and $2.04 per gallon for the years ended December 31, 2005 and 2006,respectively. |
|-----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)   | Depreciation is reconciled for assets and capital projects accounted for in the Continental CPA orthose approved by Continental outside of the agreement.                                                                                                                                                                                                                                                                                                                                                       |
| (3)   | The prevailing margin used to calculate the reconciliation payment does not take into accountperformance incentive payments, including payments from controllable cancellation performance, litigation costs above a historicalbenchmark and other costs that are not included in the block hour rates (or covered by adjustments to them) or that are notreasonable and customary in the industry.                                                                                                             |

            In 2006, the fully reconciledcosts and costs within the margin band under the Continental CPA represented approximately 63% and 35% of total operating costs,respectively.  In 2005, the fully reconciled costs and costs within the margin band under the Continental CPA representedapproximately 64% and 36% of total operating costs, respectively.

            Certain costs that wereunreconciled under the Continental CPA prior to 2005 now require Airlines to make a reconciliation payment to Continental if thedifferences cause the prevailing margin to be greater than 10.0%.  However, if the differences cause the prevailing margin tobe less than 8.5%, they remain unreconciled.  These costs are:

|           | •  | wages and salaries;and                                                                                                       |
|--------------------------------------------------------|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                        | •  | benefits not included in the table above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

***            2006 RateSetting.***  Pursuant to the terms of the Continental CPA, the 2006 scheduled block hour rates werefinalized in April 2006 to be consistent with the 2005 rates. 

***            2007 RateSetting.***  We began 2007 rate discussions with Continental in September 2006. Although theContinental CPA contemplates a November 1 deadline for setting the rates, the parties agreed to extend the deadline.  However,in January, ExpressJet and Continental were unable to agree on new rates for 2007 and agreed to submit their disagreements tobinding arbitration in accordance with the terms of the agreement.

            In the arbitration, each partyhas selected one arbitrator, and those two arbitrators will select the third arbitrator to complete the panel.  TheContinental CPA sets forth procedures and a schedule that will likely result in a hearing and the issuance of a final decision bylate in the second or early in the third quarter of 2007.  ExpressJet will continue to be paid under the 2006 block hour ratesduring the arbitration process and expects the decision setting the revised rates to be retroactive to January 1, 2007.

****

**            *Scope of Agreement andExclusive Arrangement.***  At December 31, 2006, the Continental CPA covered 272 of Airlines’ existing fleetof 274 aircraft.  By June 30, 2007, 205 of Airlines’ aircraft will be covered by the agreement.  The agreementallowed us to be Continental’s exclusive regional jet service provider at Newark’s Liberty International,Houston’s Bush Intercontinental and Cleveland’s Hopkins International airports through December 31, 2006. 

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            The Continental CPA permits us tofly under our own code or on behalf of other airlines.  However, the agreement states that:

|           | •  | at Continental’s hubs, we may only fly for Continental;                                                                                                                                                                                                                   |
|--------------------------------------------------------|--------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                        | •  | at any other airport where Continental, its subsidiaries and other regional jets operating underContinental’s code as their primary code operate an average of more than 50 flights daily (although currently there are nosuch airports), we may only fly for Continental; and |
|                                                        | •  | we cannot operate any of our aircraft subject to the agreement or use our passenger-related airportfacilities employed under the agreement for other carriers or for flights under our own code.                                                                                     |

            Because our license fromContinental to use the Continental Express name and other trademarks is non-exclusive, Continental is not prohibited from flyingits own planes or permitting other airlines to operate under the Continental Express name.

            The Continental CPA also providesthat Continental has the right to withdraw a limited number of our regional jets covered by the agreement under certaincircumstances upon 12 months notice.  On December 28, 2005, Continental gave us a withdrawal notice with respect to 69aircraft, the maximum number that it could withdraw at that time.  Under the terms of the agreement, Continental cannotwithdraw additional aircraft until December 28, 2009 unless the agreement is terminated early, which Continental can do at any timeupon twelve months’ notice.

            So long as scheduled flightsunder the Continental CPA represent at least 50% of all our scheduled flights, or at least 200 of our aircraft are covered by theagreement, we are required to allocate our crews, maintenance personnel, facilities and other resources on a priority basis toscheduled flights under the agreement above all of our other flights and aircraft.

**            *Code-Sharing andMarketing.***  The Continental CPA authorizes us to use Continental’s two-letter flight designator code(CO*) to identify Airlines’ flights operated as Continental Express in the central reservation system, to paint our aircraftwith its branding and to market and advertise our status as being a part of the Continental route system.  The agreement alsogives us a non-exclusive license to fly under the Continental Express name.  Passengers on Continental Express flights canearn rewards under Continental’s OnePass frequent flyer program.  We do not pay fees with respect to these services.

**            *AircraftFinancing.***  Airlines currently leases or subleases all of its existing aircraft from Continental.  Underthe Continental CPA, Continental is required to purchase or lease from Embraer or its designee aircraft to be flown under theagreement, participate in the financing and to lease or sublease these aircraft to us.  Aircraft withdrawn from theContinental CPA become “Uncovered Aircraft” as defined in the agreement, and the agreement contains a provision for theinterest rate implicit in calculating the scheduled lease payments we make to Continental under the relevant leases or subleases toautomatically increase by 200 basis points.

            The 100 ERJ-145XR aircraft thatwe have options to purchase would also be Uncovered Aircraft since Continental has declined to include them under the ContinentalCPA.  These option aircraft may be exercised for other types of aircraft within the ERJ-145 line of aircraft, which includethe ERJ-135, ERJ-145 and ERJ-145XR (“ERJ-145 Family”).  While we retain the right to exercise these options, wewould have to finance our acquisition of these aircraft independently. 

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            Continental has the right toterminate, at any time, any Uncovered Aircraft sublease and take possession of the aircraft so long as it provides us a replacementaircraft and we can obtain financing reasonably satisfactory to us.  If we do not obtain such financing, Continental cannotrequire us to take the replacement aircraft.

            Continental does not have anyobligation to finance, arrange to finance or participate in the financing of any aircraft acquired outside the ContinentalCPA.

**            *Airport Facilities, Slotsand Route Authorities*.**  Most of the airport facilities that Airlines uses as Continental Express are leasedfrom airport authorities by Continental.  Under Airlines’ master facility and ground handling agreement withContinental, Airlines is entitled to use these facilities to fulfill its obligations under the Continental CPA.  However, weare generally not entitled to use airport terminal facilities leased by Continental to service other carriers or operate flightsunder our own code without Continental’s approval.  Further, we must use those facilities that are non-terminalfacilities on a priority basis to support the scheduled flights that Airlines flies on behalf of Continental so long as thoseflights constitute at least 50% of our total scheduled flights or at least 200 of our aircraft are covered by the ContinentalCPA.

            All terminal facility rents atContinental’s hub airports are borne by Continental, and Airlines pays for incremental rent at other Continental-managedlocations.  Additional rent can be incurred at Continental-managed locations when Airlines operates all flights during aquarter.  At locations Airlines manages, rent is allocated between Continental and Airlines based on the number of eachcarrier’s respective passengers. 

            Continental is generallyresponsible for all capital and start-up costs for airport terminal facilities at its hub airports and at any other facilitieswhere it elects to provide ground handling services to Airlines.  If Continental elects to provide ground handling services atany facility where Airlines previously did so, Continental will reimburse Airlines for most of the capital and start-up costsAirlines incurred at that facility.  We are generally responsible for capital and start-up costs associated with airportterminal facilities where Airlines flies and any non-terminal facilities not regularly used by Continental.  If Airlines exitsa market at the direction of Continental (and we do not re-enter that market within six months flying under our own code or that ofan airline other than Continental), Continental will reimburse us for certain losses incurred in connection with the closure of therelated facility. If the Continental CPA is terminated, we may be required to vacate the terminal facilities (or all facilities ifthe termination results from our material breach of the agreement) that are subleased to Airlines by Continental, and to usecommercially reasonable efforts to assign to Continental or its designee any of the facility leases in our name.

            In addition, there are provisionsin the Continental CPA that require us to use commercially reasonable efforts to transfer, subject to applicable laws, toContinental or its designee any of our airport take-off or landing slots, route authorities or other regulatory authorizations usedfor Airlines’ scheduled flights under the agreement.

**            *GroundHandling.*****  Airlines provides ground handling and other support services, including baggage handling,station operations, ticketing, gate access and other passenger, aircraft and traffic servicing functions for Continental at severalof our airport locations.  In exchange, Continental pays us an amount equal to Airlines’ incremental cost for providingthese services.  Continental provides the same services for Airlines at its stations, including its hub airports.  Thecost for these services is based on the number of scheduled aircraft and the rates stipulated in the Continental CPA. Effective January 1, 2007, Airlines also provides ground handling and other support services at fixed rates, inclusive of a margin,at 15 Continental/Continental Express stations.

**            *Most FavoredNations.***  So long as Continental is our largest customer, if we enter into a capacity purchase or economicallysimilar agreement with another major airline (defined as any airline with annual revenues greater than $500 million, prior toadjustment for inflation since 2000) to provide regional airline service for more than 10 aircraft on terms and conditions thatare, in the aggregate, less favorable to us than those in the Continental CPA, the agreement has a provision that may allowContinental to amend its agreement with us to conform to the terms and conditions of our new agreement.

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            ***Change ofControl.***  So long as Continental is our largest customer, if we experience a change of control without its consent,there are provisions in the Continental CPA that may cause Airlines’ block hour rates to be reduced by an amountapproximately equal to the operating margin built into those rates.  Under the agreement, a change of control of our companyis defined as:

|           | •  | our merger or consolidation with a major airline, i.e., an airline other than Continental or itssubsidiaries that had more than $500 million of revenue, adjusted for inflation since 2000, (or, if we are the surviving entity, $1billion of revenue) during the most recently completed fiscal year;                 |
|--------------------------------------------------------|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                        | •  | the acquisition by a major airline, or group of major airlines acting in concert, of more than 10%of our capital stock or voting rights;                                                                                                                                                                               |
|                                                        | •  | the acquisition by any other entity, or group of entities acting in concert, other than Continentaland its subsidiaries or passive investors, of more than 25% of our capital stock or voting rights, unless such entity or groupreduces its ownership to below this threshold within 30 days of the acquisition; |
|                                                        | •  | our acquisition of more than 10% of the capital stock of an airline (other than Continental or itssubsidiaries) that had more than $1 billion of revenue during the most recently completed fiscal year;                                                                                                               |
|                                                        | •  | our acquisition of airline assets that generated more than $500 million, prior to adjustment forinflation since 2000, of revenue during the most recently completed fiscal year;                                                                                                                                       |
|                                                        | •  | our merger or consolidation with another entity following which our stockholders own less than amajority of the voting securities of the surviving entity;                                                                                                                                                             |
|                                                        | •  | the sale or other disposition of all or substantially all of our airline assets to a majorairline;                                                                                                                                                                                                                     |
|                                                        | •  | our liquidation or dissolution, in connection with which we cease operations as an aircarrier;                                                                                                                                                                                                                         |
|                                                        | •  | a majority of our directors are neither our current directors or individuals nominated by a majorityof our board of directors; or                                                                                                                                                                                      |
|                                                        | •  | our entering into definitive agreements relating to the foregoing matters.                                                                                                                                                                                                                                             |

            ***LaborDisruption.***  Upon the occurrence of a union-authorized labor strike, the Continental CPA provides that:

|                                | •  | Airlines will be compensated only for the flights it completes, and will not be compensated for anycontrollable or uncontrollable cancellations regardless of its historical cancellation rates;                                                                                                                                                                                                                        |
|--------------------------------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                | •  | on each of the 2nd, 15th, 30th, 45th, 60th and 75th days of the strike, Continental will be entitledto terminate Airlines’ leases or subleases for, and take immediate possession of, up to 20 of Airlines’ aircraftcovered by the agreement, up to a maximum of 120 aircraft if the strike extends to the 75th day;                                                                                        |
|       | •  | we will be required to provide to Continental or its designee, for the duration of the strike and180 days thereafter, at market rates, first-priority access to all of our flight simulators, hangars, training and otherfacilities and inventory to the extent necessary to enable Continental or their designee to operate any aircraft of whichContinental takes possession as a result of the strike; and |
|                                | •  | if the strike continues for 90 days or more, Continental is entitled to terminate the agreementfor cause, cancel Airlines’ leases or subleases and take immediate possession of all of the aircraft covered by theagreement.                                                                                                                                                                                 |

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            In addition, a labor disruptionother than a union-authorized strike may cause us to be in material breach of the Continental CPA.  Under the agreement,whenever Airlines fails to complete at least 90% of its aggregate scheduled flights (based on available seat miles) in threeconsecutive calendar months or at least 75% of its aggregate scheduled flights (based on available seat miles) in any 45-day period(in each case, excluding flights cancelled due to union-authorized labor strikes, weather, air traffic control or non-carrierspecific airworthiness directives or regulatory orders), we will be deemed to be in material breach of the agreement.  A labordisruption other than a union-authorized strike could cause Airlines to fail to meet these completion requirements and, as aresult, cause us to be in material breach of the agreement.  See further discussions below regarding remedies for breach ofthe agreement by either Continental or us.

            ***Term and Termination ofAgreement and Remedies for Breach*.**  The Continental CPA is scheduled to expire on December 31, 2010. Continental has the option to extend the term of the agreement with 24 months’ notice for up to four additionalfive-year terms through December 31, 2030.

            Continental may terminate theagreement at any time with 12 months’ notice, or for cause without notice.  “Cause” is definedas:

|          | •  | our bankruptcy;                                                                                                                                                                 |
|--------------------------------------------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                  | •  | suspension or revocation of Airlines’ authority to operate as a scheduled airline;                                                                                        |
|                                                  | •  | cessation of Airlines’ operations as a scheduled airline, other than as a result of aunion-authorized labor strike or any temporary cessation not to exceed 14 days; |
|                                                  | •  | a union-authorized labor strike that continues for 90 days; or                                                                                                                  |
|                                                  | •  | our intentional or willful material breach that substantially deprives Continental of the benefitsof the agreement, which is not cured within 90 days of notice of the breach.  |

            Continental may also terminatethe agreement at any time upon our material breach that does not constitute cause, but continues uncured for 90 days after wereceive notice of the breach.  If we materially breach the agreement (including for cause) and, for breaches other than cause,fail to cure the breach within 60 days after we receive notice of the breach, we will have to pay Continental an amount equalto the expected margin contained in the block hour rates for scheduled flights from the 60th day (or immediately, without receiptof any notice, if the breach is for cause) until the breach is cured.  In addition, Continental may terminate the agreementimmediately without notice or giving us an opportunity to cure if it makes a reasonable and good faith determination, usingrecognized standards of safety, that there is a material safety concern with our operation of any flights under the ContinentalCPA.

            If Continental materiallybreaches the agreement and fails to cure the breach within 60 days after we notify it of the breach, we will be entitled toobtain our payments directly from Airline Clearing House, Inc. from the 60th day for the duration of the default.  Inaddition, Continental and we are each entitled to seek damages in arbitration and to reach equitable remedies.

**            *Disposition of Aircraftupon Early Termination.***  If Continental terminates the Continental CPA for cause, it will also have the rightat that time to terminate Airlines’ leases or subleases for aircraft covered by the agreement and take possession of theseaircraft.  If Continental terminates the agreement for any reason other than for cause, we have the option to cancel all orany number of our leases or subleases with Continental for aircraft covered by the agreement at the time of termination. However, if Airlines terminates any of these subleases, it will lose access to the subject aircraft, which would reduce the size ofour fleet and affect our future ability to generate revenue.  If Airlines elects not to terminate these leases or subleases,the agreement contains a provision for the interest rate implicit in calculating the scheduled lease payments we make toContinental under the relevant leases or subleases to automatically increase by 200 basis points.

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**

**            *Amendment of Embraer andRolls Royce Contracts.***  We are prohibited, without Continental’s consent, from amending Airlines’aircraft purchase agreements with Embraer for the current 274 aircraft to change the pricing, financing or leasing arrangements,number or delivery schedule of firm order or option aircraft subject to the agreements, or to make any other changes that may beexpected to adversely affect Continental’s rights under the Continental CPA or our ability to perform our obligations underthe agreement.  We have also agreed to consent to any amendment of Airlines’ Embraer aircraft purchase agreements thatreduces the financing or other obligations of Continental, provided that the amendment does not increase Airlines’obligations under these agreements.  We are also prohibited, without Continental’s consent, from amending ourpower-by-the-hour agreement with Rolls Royce Corporation (“Rolls Royce”) in any manner that adversely affectsContinental’s or our engine maintenance costs for the aircraft subject to the Continental CPA.  With Continental’sconsent, we agreed to a five-year extension of our agreement with Rolls Royce and expanded the scope of its coverage in 2003 and2004, respectively.

**           *Indemnification***.  In general, we have agreed to indemnify Continental and it has agreed to indemnify us forany damages caused by any breaches of our respective obligations under the Continental CPA or caused by our respective actions orinactions under the agreement.

            ***BoardDesignee***.  In October 2005, Continental relinquished its right under the Continental CPA tonominate a director to our board.

**            *Other Agreements withContinental.***  In connection with the Continental CPA, we also entered into an administrative servicesagreement, under which Continental provides us with services such as information technology support, transaction processing,insurance and risk management and treasury administrative services, corporate real estate and environmental affairs.  During2006, we began to transition some of these services away from Continental and to perform them independently. These transitionedservices include some information technology support, accounts payable, payroll, and treasury administrative services. Airlines also has a fuel purchasing agreement with Continental, under which Continental manages all of Airlines’ fuelpurchasing requirements under the Continental CPA.  Continental charges us for these services and the cost is included in theblock hour rate pricing arrangement in the agreement.  Beginning in 2007, our administrative services agreement withContinental is limited to technology and other back-office infrastructure as necessary to support our Continental Expressflying. 

            In addition, we have a taxagreement with Continental that provides, among other things, for our payment of all or a significant portion of the tax benefitswe realize as a result of an internal reorganization performed before our initial public offering in 2002.  Since our initialpublic offering, we have made net payments of approximately $123.7 million to Continental under the tax agreement and could payContinental as much as an additional $234.4 million through 2017.  See Item 8.  "Financial Statements and SupplementaryData – Notes to Consolidated Financial Statements – Note 7" for a detailed discussion of our income taxes and our taxagreement with Continental.

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**Branded Flying**

****

***            Route Structure andScheduling.***  Our branded flying will focus on providing nonstop service to cities that are underserved by othercarriers.  Beginning in the second quarter of 2007, we plan to initialize service to 24 cities located in the West, Midwestand Southeast United States that are typically less congested than other major cities.  We plan to fly over 200 dailydepartures to eliminate connections and minimize delays and total trip time.  California’s LA/Ontario InternationalAirport will be the busiest city for us, followed by San Diego, California; Austin, Texas; Sacramento, California; and San Antonio,Texas. 

**BRANDED ROUTE SYSTEM**

***            ProductAmenities.***  We offer a distinct product to meet the needs of both business and leisure travelers. Our customerswill fly on young jets with advanced seat assignments and no middle seats.  We will also provide valet carry-on baggageservice as a convenience in order to save time the customers would otherwise spend loading bags in the overhead bin or waiting atbaggage claim.  Our leather seats have been redesigned for additional passenger comfort including memory foam cushions andover a 100 channels of complimentary XM Satellite radio.  We will serve complimentary, recognized brand-name snacks, and fullmeal options will be available for longer haul flights.   
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****

***           Marketing. *** We are using the following methods for airline ticket distribution:  

        

• 

Airline’s website, www.xjet.com.  It is less expensive to sell through this directchannel and, as a result, we continue to promote and encourage the use of our online capabilities.

• 

The four principal global distribution systems, Sabre, Worldspan, Galileo and Amadeus, so that ourtickets can be sold through traditional travel agencies and online sites such as Orbitz, Travelocity and Expedia.

• 

Telephone reservation call centers.

            We will provide anelectronic ticketing, or E-Ticket, product eliminating the need to print and process a paper ticket.  E-Tickets providereal-time customer and revenue information and are a vital part of our distribution strategy.  We will have self-servicekiosks at all airports throughout our system to expedite the check-in process for our customers. 

****

**           ** We offer a range ofcompetitive fares that are distinguished by restrictions on use, such as time of day and day of the week, length of stay andminimum advance booking period.  Other ticketing or passenger service fees, such as ticketing change fees, unaccompanied minorand excess baggage, will be consistent with or less than those charged by most United States carriers.

****

            We are in the process oflaunching a new frequent flyer program called JetSet.  It will be a simple fly-and-redeem travel program for members with thepossible future addition of other cash-value rewards and partner participation.  We also intend to launch a travel agencyincentive program.

****

**            CorporateAviation. ** Our new Corporate Aviation division is expected to operate a total of 15 aircraft by June 2007,providing distinctive travel solutions for corporations, aircraft brokers, hospitality companies, sports teams, schools andothers.  The aircraft are being flown under Airlines’ operating certificate issued by the FAA. The aircraft areconfigured with 50 redesigned seats for enhanced passenger comfort, and each seat includes XM Satellite radio with over 100channels of audio entertainment.  In addition to the basic service, customized flight service options will give customers anopportunity to create a unique flight experience. 

**Aircraft Fleet**

            ***Our Fleet.***  Weoperate a fleet of 274 aircraft which includes Embraer ERJ-135, ERJ-145 and ERJ-145XR aircraft.

            The Continental CPA provides forthe continuation of our 274 Embraer regional jets’ sublease.  On December 28, 2005, Continental notified us of itsintent to withdraw 69 aircraft, or 25% of the capacity currently under the agreement. As of December 31, 2006, two aircraft werewithdrawn.  The additional aircraft are being withdrawn as follows: 

**WithdrawalMonth                 **

**Aircraft Withdrawn**

**ERJ-145XR**

**ERJ-145LR**

  

  

  

January 2007

10

5

5

February 2007

12

8

4

March 2007

12

8

4

April 2007

12

8

4

May 2007

15

10

5

June  2007 (1)

6

4

2

**Total**

**67**

**43**

**24**

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            (1) On February 22,2007 we agreed with Continental to defer the transition date for three ERJ-145XR aircraft from the first half of June to August 28,2007.  Until then, these aircraft will remain as covered aircraft under the terms of the Continental CPA.

            During 2007, our aircraft aregoing to be deployed as follows:

                                                                                               

**Aircraft Allocation**

Continental Express

205

Branded Flying

44

Corporate Aviation

15

Major Network Carrier

10

**Total Aircraft**

**274**

            Continental could withdraw 51additional aircraft beginning December 28, 2009, with 12 months’ prior notice.  In addition, Continental can terminatethe Continental CPA at anytime with 12 months’ notice, under which withdrawal would be limited to 15 aircraft per month. Ifwe return the aircraft to Continental, it would incur costs associated with terminating the leases or subleases under the terms ofthe agreement. 

            The operational capability of theERJ-135 and ERJ-145 is 1,100 miles.  The ERJ-145XR, with a 1,600 mile range, continues to create opportunities for us toexpand Continental’s network and our branded network more economically to cities that are the right size for ouraircraft.  Each of our aircraft is equipped with advanced technology and certifications that aid our operation in challengingweather conditions, as well as allowing for more cost-effective operations at higher flight levels. 

            The aircraft dedicated to theContinental CPA offer a seamless jet service experience to Continental’s passengers.  The planes feature overheadbaggage compartments, under-seat baggage storage, leather seating, lavatories, in-flight meal and beverage service capabilities andjet-bridge loading in most locations. 

            Aircraft dedicated to brandedflying and corporate charters have redesigned seats for enhanced comfort and feature complimentary XM Satellite radio with over 100channels of entertainment. 

            We have options for 100 ERJ-145XRaircraft that may be exercised for other types of aircraft within the ERJ-145 Family.  During 2005, Continental declined theright to exercise any of these options.  Continental is not required to participate in the financing for any option aircraftthat we acquire.  We currently have no firm orders for additional aircraft.

            ***Maintenance ofAircraft.***  We maintain our aircraft using primarily our own trained and FAA-certified personnel and facilities. We emphasize routine maintenance in addition to inspection of our aircraft engines and airframes at intervals required by theFAA.  We perform line and heavy maintenance at our facilities in Burlington, Vermont; Cleveland, Ohio; Houston, Texas;Knoxville, Tennessee; Richmond, Virginia; Louisville, Kentucky; Shreveport, Louisiana and Newark, New Jersey.  In connectionwith our reduction in flying under the Continental CPA, we anticipate closing Burlington and Louisville during thesecond quarter of 2007.  With the commencement of branded flying, we expect to open an additional major maintenancebase at LA/Ontario International Airport in California during the second quarter of 2007.  Other maintenance bases are beingevaluated based on our operations outside of the Continental CPA.  Exact locations have not been identified.  We alsoperform line maintenance at our satellite maintenance stations.  We maintain an inventory of aircraft spare parts to ensurethe reliability of our operations and utilize a computerized tracking system to increase maintenance efficiency and avoid excessinventory of spare parts.

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            We have a power-by-the-houragreement with Rolls Royce to maintain the engines on our aircraft through April 2015.  Under the agreement, we are charged afixed rate based on flight hours incurred during a month.  The rates are subject to annual revisions based on specific laborand materials indices.  We also have power-by-the-hour agreements with other vendors to cover various components and systemson the aircraft, such as auxiliary power units, avionics, environmental controls, tires, wheels and brakes.  For 2006,approximately 70% of our maintenance, materials and repairs cost consisted of power-by-the-hour expenses.  We believe thatthese agreements, coupled with our ongoing maintenance program, reduce the likelihood of unexpected maintenance expense during theaircraft lease terms.

**

            In 2005, ExpressJet Services, ourrepair and overhaul subsidiary, received a repair station certificate from the FAA enabling it to provide services to thirdparties.  We expanded ExpressJet Services during 2006 to include our wholly owned subsidiaries American Composites, LLC andInTech Aerospace Services, and Saltillo Jet Center, a majority owned subsidiary.  ExpressJet Services is the North Americanpartner to three major European original equipment manufacturers and provides composite, sheet metal, paint, interior, includingseat refurbishment, and thrust reverser repairs throughout five facilities in the United States.  We believe ExpressJetServices allows us to pursue a strategy that leverages our expertise in aircraft reliability.

**Competitors**

            Currently our competitors includeMesa Airlines, Mesaba Airlines, Pinnacle Airlines, Republic Airways and SkyWest Airlines, including Atlantic SoutheastAirlines.  We also compete with other airlines, such as American Eagle, Comair and Horizon Airlines, which are wholly ownedsubsidiaries of major airline holding companies.  The challenges for airlines operating regional jets at either the fixed feeor revenue-sharing arrangements are not only the dependence on the financial health of their partners, but also the ability tomaintain reliable and seamless operations with an effective cost structure in order to better compete as their partners willcontinue to bid out such flying in order to save money for their overall network.

            Due to the variations among thecontracts under which regional airlines operate, cost comparisons between regional airlines are extremely difficult.  Webelieve that Airlines is one of the most cost-efficient providers of regional jet service due to the efficiencies it realizes byoperating a single fleet type, the economies of scale it achieves as one the world’s largest regional airlines and its launchcustomer status for the Embraer ERJ-145 family.

            We also believe that Airlinesprovides one of the highest levels of customer service in the regional industry as evidenced by its top-tier performance in theDepartment of Transportation (“DOT”) monthly surveys on customer complaints, mishandled bags and on-timeoperations.  In terms of reliability, Airlines accomplished a controllable completion factor, which excludes weather and airtraffic control cancellations, of 99.8% for the year ended December 31, 2006 versus our benchmark used for incentive paymentcalculations under the Continental CPA of 99.7%.  Our strong operational performance resulted in receipt of $2.1 million inincentive payments from Continental in 2006.

            As we launch into branded flyingand corporate aviation, our competitors will expand beyond these carriers and include traditional major and low-costcarriers.  However, we believe that our focus on customer service, costs and operational reliability will continue to allow usto properly differentiate ourselves from our competitors. 
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**Industry**

            The United States airlineindustry has been very competitive since it was deregulated in 1978, and various business models have been developed to offercommercial air service.  The industry has traditionally been led by airlines, such as American Airlines, United Air Lines,Delta Air Lines and Continental, which schedule flight service to most major U.S. cities, numerous smaller U.S. cities, and citiesthroughout the world via a hub-and-spoke model.  Other airlines, such as Southwest Airlines and JetBlue Airways, offerscheduled flights to many of the same domestic markets, but at lower prices and with fewer amenities to travelers; they havecompeted effectively in the U.S. market due to their lower cost structures.  Another group, including ExpressJet, MesaAirlines, Republic Airways and SkyWest Airlines, has evolved to provide feeder service to the hub-and-spoke network orpoint-to-point service for smaller and medium-sized airports through fixed-fee or revenue-sharing agreements.  The developmentof the regional jets operated by this group has been enhanced during recent years, allowing them to connect markets in the UnitedStates, Mexico and Canada more economically than with larger aircraft.

            Airlines’ strategiestypically include:

        

• 

lowering operating costs;

• 

broadening their networks to spread fixed costs over more flights;

• 

focusing on business travelers, who historically have paid higher fares;

• 

maintaining capacity and market share against other carriers; and

• 

bringing additional connecting traffic into their networks through new alliances.

**

Airlines have faced unprecedented challenges over the last few years, including the war in Iraq,under-funded defined benefit pension plans, airlines emerging from bankruptcy protection with lower cost structures and higher cashbalances, and highly volatile fuel prices.  Two additional items added pressure to the airlines: the Internet as adistribution system and lower-cost carriers.  The Internet allows passengers to instantaneously compare all of the network andexpansion of low cost airlines’ pricing, largely eliminating lucrative travel agent and corporate contracts, which resultedin higher revenue premiums to larger airlines. 

**Industry Regulation**

            We operate under a certificate ofpublic convenience and necessity issued by the DOT.  This certificate may be altered, amended, modified or suspended by theDOT if public convenience and necessity so require.  The DOT has jurisdiction to prohibit certain unfair or anti-competitivepractices, determine carrier fitness to serve and mandate certain conditions of carriage.  The DOT can bring proceedings forthe enforcement of its regulations under applicable federal statutes, which proceedings may result in civil penalties, revocationof certificate authority or criminal sanctions.

            We also operate under an aircarrier operating certificate issued by the FAA which may be amended, modified, suspended or revoked if safety in air commerce orair transportation and the public interest so require.  The FAA regulates airlines, primarily in the areas of flightoperations, maintenance, ground facilities and other technical matters.  Under these regulations, we have established, and theFAA has approved, a maintenance program for the aircraft that Airlines operates, which provides for the ongoing maintenance ofthese aircraft, ranging from frequent routine inspections to major overhauls.

            Associated with the FAA’ssafety responsibility is its program to ensure compliance with rules regulating the transportation of hazardous materials.  Wehave policies against accepting most hazardous materials or other dangerous goods for commercial transportation.  Ouremployees are trained in the recognition of hazardous materials and dangerous goods through an FAA-approved training course. We may ship aircraft and other parts and equipment, some of which may be classified as hazardous materials, on our aircraft orusing the services of third-party carriers. Our employees who prepare our company aircraftparts for shipment are trained and certified as dangerous goods shippers. In acting in the capacity of a shipper or carrier of hazardous materials, we must comply with applicableregulations.  The FAA enforces its hazardous material regulations by the imposition of civil penalties, which can besubstantial.

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            Based on conditions in theindustry, or as a result of Congressional directives or statutes, the DOT and the FAA from time to time propose and adopt newregulations or amend existing regulations that may impose additional regulatory burdens and costs on us.  Imposition of newlaws and regulations on air carriers could increase our cost of operation or limit our operating discretion.

            The Aviation and TransportationSecurity Act of 2001 (“the ATSA”) federalized substantially all aspects of civil aviation security and created theTransportation Security Administration (“TSA”) under the Department of Homeland Security.  The implementation ofthe requirements of the ATSA and other security laws and regulations has resulted in increased costs for airlines and passengers,as well as delays and disruptions in air travel.  The TSA has issued regulations implementing the ATSA, including arequirement that we adopt an air carrier security program.  Failure to comply with TSA rules or with our security program mayresult in the imposition of substantial civil penalties. All security screeners at airports are either federal employees orcontractors hired directly by the TSA, and other significant elements of airline and airport security are overseen by federalemployees, including federal security managers, federal law enforcement officers, federal air marshals and federal securityscreeners.  The law mandated improved flight deck security, deployment of federal air marshals onboard flights, improvedairport perimeter access security, airline crew security training, enhanced security screening of passengers, baggage, cargo, mail,employees and vendors, enhanced training and qualifications of security screening personnel, additional provision of passenger andcargo data to the U.S. Bureau of Customs and Border Protection and enhanced airline employee background checks.

            The law also requires thatchecked baggage be screened by explosives detection systems, which has required significant equipment acquisition by the governmentand the implementation of facility and baggage process changes.  Further implementation of the requirements of the ATSA andother security laws and regulations have resulted in increased costs for airlines and passengers, delays and disruptions to airtravel and reduced demand.  The TSA has issued regulations implementing the ATSA, including requirement for air carriersecurity programs and substantial civil penalties for violations. Under The Arming Pilots Against Terrorism Act, the TSA hasestablished a program to arm volunteer pilots of air carriers to protect aircraft.  The TSA is currently testing a new“Secure Flight” passenger screening program with the assistance of U.S. airlines.

            In the maintenance of ouraircraft and ground equipment, we handle and use many materials that are classified as hazardous.  The EnvironmentalProtection Agency and similar local agencies have jurisdiction over the handling and processing of these materials.  We arealso subject to the oversight of the Occupational Safety and Health Administration concerning employee safety and healthmatters.  We are subject to the Federal Communications Commission’s jurisdiction regarding the use of radio frequencies.Federal law establishes maximum aircraft noise and emissions limits.  All of our aircraft comply with currently applicablefederal noise and emissions regulations.  Federal law generally preempts airports from imposing unreasonable local noise rulesthat restrict air carrier operations.  However, under certain circumstances, airport operators may implement reasonable andnondiscriminatory local noise abatement procedures, which could impact our ability to serve certain airports, particularly inoff-peak hours.

**Employees**

            As of December 31, 2006, we hadapproximately 7,300 employees, comprised of approximately 2,600 pilots and instructor pilots, 1,300 flight attendants, 1,200customer service personnel, 1,000 mechanics and 300 other maintenance personnel, 80 dispatchers and 800 supervisors, management andsupport personnel.

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            Labor costs are a significantcomponent of airline expenses and can substantially impact our results.  While there can be no assurance that our generallygood labor relations and high labor productivity will continue, a crucial component of our business strategy is the preservation ofgood relations with our employees, approximately 70% of whom are represented by unions.

            The following table, as ofDecember 31, 2006, reflects our principal collective bargaining agreements and their respective dates when they becomeamendable:

**Employee Group**

**Approximate Number of Employees**

**Representing Union**

**Contract Amendable Date**

  

  

  

Pilots and Instructors

2,600

Air Line Pilots Association, International

December 2010

Mechanics

1,000

International Brotherhood of Teamsters

August 2009

Flight Attendants

1,300

International Association of Machinists and Aerospace Workers

August 2010

Dispatchers

80

Transport Workers Union of America

July 2009

            Our other employees are notcovered by collective bargaining agreements.    

****

**Item 1A.  Risk Factors**

**Factors that May Affect our Future Operating Results and Financial Condition**

            Our results of operations andfinancial condition may vary materially from those we anticipate, estimate or project due to risks arising in four keyareas:

        

• 

our reliance on Continental Airlines for the majority of our revenue;

• 

our ability to profitably redeploy the 69 aircraft being removed from the ContinentalCPA;

• 

rising costs and the highly competitive nature of the airline industry; and

• 

regulation and other factors

******

***We remain dependent on Continental for the majority of our revenue***

            In December 2006, we redeployedtwo of the aircraft being withdrawn from the Continental CPA; the other 67 will be removed from Continental service during thefirst six months of 2007.  The 69 aircraft represent 25% of our current fleet.  We will continue to operate the remaining205 under the Continental CPA and so rely heavily on the financial and operational stability of Continental. 

            Although Continental has recentlyreturned to profitability, the domestic airline environment in the United States continues to be extremely challenging for allcarriers. For the year ended December 31, 2006, Continental reported net income of $343 million and has indicated that its ownbusiness and financial results are subject to a number of risk factors, many of which are uncontrollable, including low-costcompetitors, the low-fare environment, higher fuel prices, pension liability, terrorist attacks and adverse regulatoryrulings.

            We cannot predict the futureimpact of these factors on Continental.  Furthermore, high fuel prices, the long-term impact of the changes in fare structures(most importantly in relation to business fares), booking patterns, low-cost competitor growth, customers’ direct booking onthe internet, competitor bankruptcies that reduce their cost structures, and other changes in the industry cannot be predicted atthis time, but could have a material adverse effect on both Continental’s and our financial condition, liquidity and resultsof operations.

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            Airlines and Continental wereunable to agree on rates for 2007 under the Continental CPA and have submitted our disagreements to binding arbitration inaccordance with the agreement’s terms.  The agreement sets forth procedures and a schedule that will likely result in ahearing and issuance of a final decision by the arbitration panel in the late second or early third quarter of 2007.  We canprovide no assurance that the arbitration panel will resolve the disputes entirely, or at all, in our favor.

            Airlines will continue to be paidunder the 2006 block hour rates during the arbitration process, and expects the decision setting the revised rates to beretroactive to January 1, 2007.  If the arbitration panel were to issue a decision that is wholly or partially adverse toAirlines, then Airlines could have a significant liability to Continental for overpayments that Continental would have made sinceJanuary 1, and Airlines could receive significantly smaller payments from Continental for the remainder of 2007.  The finalarbitration decision could also significantly affect future payments for the remaining term of the Continental CPA.  Inaddition, the arbitration may be disruptive to our ongoing relationship with Continental and divert management’s attentionand resources from our operations and other business activities.  One or more of these results could have a material adverseeffect on our results of operations, liquidity and financial position.

***Our Continental CPA could be terminated***

            Although Continental cannotreduce the aircraft we fly under the Continental CPA again prior to December 28, 2009, Continental can terminate the agreement atany time with 12 months’ notice.  If the agreement were terminated, our revenue from Continental would be effectivelyeliminated after the pertinent wind-down period and we would incur significant losses unless we were able to profitably redeploythe other 205 aircraft.  We cannot be certain that we would be able to do so or, if we did, that the alternative businesswould be as profitable as the Continental CPA.

            Although the Continental CPA isscheduled to terminate on December 31, 2010, in addition to its right to terminate the agreement at any time upon 12 months’notice, Continental can also terminate the agreement:

        

• 

for cause, as described in “—Continental CPA  and Other Agreements,” at anytime without giving us notice or an opportunity to cure;

• 

at any time upon our material breach that does not constitute cause, including our failure tocomplete a specified percentage of our scheduled flights, if the breach continues for 90 days after we receive notice of thebreach; and

• 

at any time, without giving us notice or an opportunity to cure, if Continental reasonably and ingood faith determines, using recognized standards of safety, that there is a material safety concern with our operation of anyflights under the agreement.

***We could lose access to our aircraft, facilities and regulatory authorizations, as well as anyairport related services that Continental currently provides to us***

            We currently lease or subleaseall of our aircraft from Continental. If Continental terminated the Continental CPA for cause, it would have the right to terminateour leases and subleases for aircraft covered by the agreement at the time of termination.  Additionally, ifContinental’s financial condition deteriorated and it filed for bankruptcy protection, it would have the ability to rejectthe leases or subleases on our aircraft.  There can be no assurance that Continental will have sufficient liquidity to fundits future operations and other financial obligations, especially in the event additional adverse factors beyond its control occur,such as terrorist attacks, adverse regulatory rulings or higher fuel prices.****

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            Additionally, if the ContinentalCPA were terminated for any reason, we could lose access to some or substantially all of our airport facilities and other servicesthat Continental currently provides to us, as well as our take-off and landing slots and route authorities.  Continentalleases most of the airport facilities that we use.  We could be required to vacate the terminal facilities (or all facilitiesif the termination results from our material breach of the Continental CPA) that are subleased to us by Continental, and to usecommercially reasonable efforts to assign to Continental or its designee any lease in our name where we fly for Continental. Consequently, to offer airline services in the same markets, we would have to arrange to use the same or other airport facilities,take-off or landing slots, route authorities and other regulatory authorizations used for scheduled flights at potentially higherrates.  We cannot provide any assurance that we would be able to gain appropriate access to airport facilities, slots or otherauthorizations, or would not incur a significant increase in our costs to do so.

***Our new operations may be less profitable than our historical results***

******

            As discussed above, we arecurrently redeploying aircraft from the Continental CPA to branded flying, charter flying and capacity purchase flying for a majornetwork carrier.  Our operating results under these new operations is likely to be lower than under the Continental CPA, andit is possible that industry conditions, competition, miscalculation or failure to execute our plans will result in losses. Currently, our redeployment and these risks relate only to 25% of our fleet; however, if the Continental CPA were terminated, ourfleet could be significantly reduced or these risks could extend across our entire fleet. The risks affecting our diversificationinclude:

        

• 

our ability to create the infrastructure necessary to support new operations;

• 

our ability to obtain and finance any expansion at acceptable rates of return;

• 

our ability to create brand recognition

• 

the condition of the U.S. economy; and

• 

unanticipated competitive responses from other air carriers.

            As we expand anddevelop our diversification, we will need to successfully develop markets that are new for us and increase the markets weserve.  For the first time, we are operating our own distribution, reservations and ticketing functions.  We have notpreviously had responsibility for route planning, scheduling, pricing, marketing, advertising, sales, revenue management or revenueaccounting functions.  Additionally, we may be unable to acquire space at or the right to serve some airports that would bedesirable or to do so at an appropriate cost.  The costs of entering new markets or our inability to effectively manage ourgrowth could negatively impact our results of operations and financial condition.

***Competitive responses to our branded entry into new markets could make ourservice there unprofitable***

            The airlineindustry is highly competitive.  Barriers to entry are low, and a number of airlines have failed over the years.  Subjectto the availability of space, and in some cases the right to serve certain airports, we will have the right to serve most U.S.airports.  However, most airports already have some combination of legacy, regional and low-cost carriers and we cannotpredict with certainty the competitive response we might face in a given market from airlines that are already there or from otherairlines that may choose to serve a market once we begin service.  Carriers with comparatively larger fleets and more capitalwill have greater flexibility to increase frequencies into a market or to reduce fares.  They may also enjoy established brandrecognition or have marketing alliances that we do not, which enable them to compete more effectively.
******
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******

***We may not be successful in retaining qualified personnel to maintain the current level ofcustomer service and reliability and to execute our diversification plans***

            Wage rates, in general, areincreasing.  Therefore, our employees may elect to seek other employment opportunities, thereby increasing our recruiting andtraining costs.  We cannot guarantee that we will be able to find qualified personnel to fill our vacancies.  As ourworkforce matures, we may not be able to cover the resulting higher wage rates if competition or other conditions do not permit usto achieve sufficient revenues.  Approximately 70% of our employees are covered by collective bargaining agreements.  Adeterioration in our labor relationships could significantly impact our operations and results.

**

***We may be responsible for additional taxes as a result of our tax agreement withContinental***

            We have a tax agreement withContinental that provides, among other things, for our payment to Continental of all or a significant portion of the tax benefitswe realize as a result of an internal reorganization done prior to our initial public offering in 2002.  Since that time, wehave made net payments of approximately $123.7 million to Continental under the agreement and could pay Continental as much as anadditional $234.4 million through 2017.  See Item 8. “Financial Statements and Supplementary Data – Notes toConsolidated Financial Statements – Note 7” for a detailed discussion of our income taxes and the tax agreement. If it were determined, as a result of an income tax audit or examination, that a significant amount of these tax benefits shouldnot have been available, thus requiring us to pay additional taxes, interest and penalties to one or more tax authorities, and ifat that time Continental were unable to indemnify us for these amounts as contemplated in the tax agreement, then we could beresponsible for such tax payments, interest and penalties.

***We may be unable to obtain all of the parts or related support services we expect from Embraerto operate our aircraft***

******

            We operate a single fleet typeproduced by a single manufacturer; consequently, our operations could be materially adversely affected by:

        

• 

Embraer’s inability to provide sufficient parts or related support services on a timely basisespecially in light of its announcement to cease the production of our current fleet type;

• 

the issuance of FAA directives restricting or prohibiting the use of Embraer regional jets orparts;

• 

unscheduled or unanticipated maintenance requirements; or

• 

force majeure events that prevent Embraer from performing under the lease agreement.

Conversely, if we choose to operate another aircraft type in the future, we will not have themaintenance expertise we have acquired with our current fleet, training costs would increase, and parts and inventory costs wouldrise.

***Maintenance costs will likely increase as the average age of our fleetincreases***

            Similar to other air carriers inour industry, as the average age of our fleet increases, our aircraft maintenance costs will likely increase.  We emphasizeroutine maintenance, in addition to the inspection of our aircraft engines and airframes at intervals required by the FAA.  Weperform line and heavy maintenance at our maintenance facilities and satellite stations located throughout the Midwest and Easternparts of the United States.

            Additionally, we have a“power-by-the-hour” agreement with Rolls Royce to maintain the engines on our aircraft through April 2015.  Underthe agreement, we are charged a fixed rate based on flight hours incurred during a month.  The rates are subject to annualrevisions based on specified labor and material indices.  We also have power-by-the-hour agreements with other vendors tocover various components and systems on our aircraft, and will continue to evaluate and implement similar agreements when the termsare favorable. 

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            However, our average maintenancecosts could increase and adversely impact our results of operations in the event that we have to address any new FAA or Embraermaintenance directives.  We are not aware of any such directives at this time that will adversely affect our maintenancecosts.

***Reductions in insurance coverage or increases in rates could adversely impactour operations and financial results***

            The terroristattacks of 2001 led to a significant increase in insurance premiums, as well as a decrease in the coverage available to commercialair carriers. We carry insurance for public liability, passenger liability, property damage and damage to our aircraft.  TheHomeland Security Act of 2002 currently requires the federal government to provide third party, passenger, and hull war-riskinsurance coverage to commercial air carriers through August 31, 2007.  If any of our insurance programs terminated, theCompany would likely face a material increase in the cost of war-risk insurance.

******

***Our cost structure may not be competitive with some of our competitors***

            Because we do not control our ownflight schedule under the Continental CPA, only 44% of our costs related to Airlines are controlled by us.  All other costsare driven by the flight schedule determined by Continental, Continental’s own cost structure or factors that are outside ourcontrol, or in some instances even Continental’s control (such as aircraft rent, fuel, insurance, property taxes,etc.).  As a significant portion of our costs are allocated and/or inherited from Continental, we may not be able torestructure our costs effectively to compete with low-cost or other carriers.

***Our business is subject to extensive government regulation and we may incur additional coststo comply with such regulations***

            Our business is subject toextensive government regulation.  As evidenced by the enactment of the ATSA, airlines are subject to extensive regulatory andlegal compliance requirements that can or may result in significant costs.  The FAA and other governmental agencies such asthe EPA from time to time issue directives and other regulations relating to the maintenance and operation of aircraft that requiresignificant expenditures.  Some requirements cover, among other things, retirement of older aircraft, security measures,collision avoidance systems, potable water standards, noise abatement and other environmental concerns, commuter aircraft safetyand increased inspections and maintenance procedures conducted on older aircraft.

            We expect to continue incurringexpenses to comply with these regulations.  In addition, if any of these regulations caused us to cancel flights, theresulting reduction in our revenue from performance penalties would not be taken into account in any reconciliation payment madeunder the Continental CPA to maintain our operating margin within a specified range.

            Additional laws, regulations,taxes and airport rates and charges are proposed from time to time that could significantly increase the cost of airline operationsor reduce revenue.  Such laws, taxes and regulations have affected all facets of our operations from security at airports,restrictions on landing, take-off, routes, restrictions on international routes, which can change suddenly depending on the currentarrangements between the United States and the foreign governments, and increases in landing fees and other airport facilitycharges.  We cannot be certain that current laws or regulations, or laws or regulations enacted in the future, will notadversely affect us.
**
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**

***We may be adversely affected by factors beyond our control, including weather conditions andthe availability and cost of fuel***

            Generally, revenue for airlinesdepends on the number of passengers carried, the fare paid by each passenger and service factors, such as timeliness of departureand arrival.  During periods of fog, icy conditions, storms, hurricanes or other adverse weather conditions, flights may becancelled or significantly delayed.  Under the Continental CPA, we are substantially protected against cancellations due toweather or air traffic control.  However, when we operate our aircraft for other airlines, we may not, and when operatingunder our own brand, we will not, be protected against weather or air traffic control cancellations, which could adversely affectour operating results and our financial condition.

            In addition, in operating ouraircraft for other airlines and in branded flying, we could be exposed to the volatility of fuel prices.  Both the cost andavailability of fuel are subject to various economic and political factors and events occurring throughout the world. Significant changes or extended periods of high fuel cost or fuel supply disruptions would materially affect our operatingresults.  Our ability to pass on increased fuel costs through fare increases will be limited by several factors, includingeconomic and competitive conditions.  Additionally, under the Continental CPA, if the unavailability of fuel caused us tocancel flights, our incentive revenue would be reduced.  The cost and availability of adequate supplies of fuel could have amaterial adverse effect on our operating results and our financial condition in the future.

***Our reliance on technology could be harmful in the event of systemfailure***

            Like other aircarriers, we rely heavily on automated systems and technology to operate our business, including computerized airline reservations,flight operations and telecommunications. Any disruptions in these systems due to internal failures of technology or externalinterruptions, such as power outages, could result in the loss of critical data and have an adverse effect on our results ofoperations. 

***Our operations and financial condition could be adversely affected as a result of an aviationaccident***

            An accident or incident involvingone of our aircraft could involve repair or replacement of a damaged aircraft and its consequential temporary or permanent lossfrom service, as well as significant potential claims of injured passengers and others.  We are required by the DOT to carryliability insurance.  In the event of an accident, our liability insurance may not be adequate and we may be forced to bearsubstantial losses from the accident.  Substantial claims resulting from an accident in excess of our related insurancecoverage would harm operational and financial results.  Moreover, any aircraft accident or incident, even if fully insured,could create a public perception that we are less safe or reliable than other airlines.

***Our reliance on third party service providers could adversely affect our operationsif they failed to perform their functions***

            Our reliance upon others toprovide essential services on behalf of our operations may limit our ability to control the efficiency and timeliness of contractservices. We have entered into agreements with contractors to provide various facilities and services required for our operations,including fuel supply and delivery, aircraft maintenance, services and ground facilities, and expect to enter into additionalsimilar agreements in the future. These agreements are subject to termination after notice.  Any material problems with theefficiency and timeliness of our automated or contract services could have a material adverse effect on our business, financialcondition and results of operations.

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**Item 1B.  Unresolved Staff Comments**

            We do not have any unresolvedcomments from the SEC’s staff as of the date of this filing.

****

**Item 2.  Properties**

**Flight Equipment**

            As shown in the following table,our operating fleet consisted of 274 regional jets at December 31, 2006. 

**Type**

**Total Leased Aircraft**

**Options**

**Seats in Standard Configuration**

  

  

  

  

ERJ-145XR                             

104

100

50

ERJ-145

140

—

50

ERJ-135

30

—

37

Total

274

100

            During 2006, we put 8 newERJ-145XR aircraft into service.  Our options for the 100 ERJ-145XR aircraft may be exercised for some other types of aircraftwithin the ERJ-145 Family.  During 2005, Continental declined the right to exercise any of these options.  Continental isnot required to participate in the financing for any option aircraft that we acquire. 

**Facilities**

            ***Airports.***  Welease all of our airport facilities either directly with the airport authorities or in some cases, through arrangements withContinental Airlines, on a net-rental basis.  Our largest operational centers are at Houston’s George BushIntercontinental Airport, which is approximately 155,000 square feet, with 31 gates in Terminal B, Cleveland’s HopkinsInternational Airport, of which we have approximately 106,000 square feet and 12 gates in Terminal D as well as numerous jetwaysand gates at Continental’s Terminal C, and Newark Liberty International Airport, where we operate out of Continental’sTerminal C2 with up to 24 passenger loading bridges.  In addition, we have leased approximately 14,000 square feet of terminalspace and 3 gates at LA/Ontario International Airport.  

****

***            Corporate Offices andOther.***  Our Houston headquarters building is comprised of executive, administrative and SOCC departments,occupying approximately 42,000 square feet.  ExpressJet also occupies a second building that consists of 18,000 square feetfor executive and administrative staff, as well as 50,000 square feet of production and warehouse space for our InTech Aerospacesubsidiary, for use in its aircraft refurbishment business.  The two facilities are leased directly by us.  Additionally,we lease a 57,000 square foot Training Center containing numerous simulators, training devices and corresponding training andadministrative staff.

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***            MaintenanceFacilities.***  In addition to our airport passenger facilities, ExpressJet currently maintains eight majormaintenance facilities (hangars/shops) in Houston, Cleveland, Newark, Knoxville, Shreveport, Burlington, Louisville and Richmond aswell as seven satellite line maintenance facilities in other cities.  In connection with the reduction of flying under theContinental CPA, we anticipate closing Burlington and Louisville in the second quarter of 2007.  Continental Airlines is theprimary sublessor for these facilities with the exception of the Houston maintenance hangar, the Knoxville hangar and shopfacilities, the Shreveport hangar and facility and the Corpus Christi and Lake Charles satellite maintenance station, which welease directly.  However, with the commencement of branded flying, we anticipate leasing an additional maintenance base ofapproximately 36,000 square feet at LA/Ontario International Airport in the second quarter of 2007.  ExpressJet has two othermaintenance facilities, a Miami maintenance shop and the Saltillo aircraft painting facility, which we own.  The facility inMiami consists of approximately 74,000 square feet which we lease to our American Composites subsidiary for use in its aircraftrepair and maintenance business.  The operation in Saltillo, Mexico is an aircraft painting facility that consists ofapproximately 96,000 square feet of hangar space and 3,000 square feet of administrative space.  We lease this facility to ourpartner Saltillo Jet Center, S. de R.L. de C.V. for use in its aircraft painting business.

            We are responsible formaintenance, taxes, insurance and other facility-related expenses and services at these facilities.  In addition, at each ofContinental's three domestic hubs and many other locations, our passenger and baggage handling space is provided by Continental onvarying terms dependent on the prevailing practice at each airport.  If the Continental CPA were terminated, we might berequired to vacate the terminal facilities (or all facilities if the termination resulted from our material breach of theagreement) that are subleased to us by Continental, and to use commercially reasonable efforts to transfer to Continental or itsdesignee any lease in our name.  See Item 1. "Business - Capacity Purchase and Other Agreements with Continental Airlines -Airport Facilities, Slots and Route Authorities."  For a period of five years following the termination of the agreement, ifwe wanted to transfer our interests in any of our facilities used to fulfill our obligations under the agreement, Continental wouldneed to consent to the transfer (where Continental is the sublessor) and has a right of first refusal to acquire our interests inthose facilities that we lease from parties other than Continental.

**Item 3.  Legal Proceedings**

            We are a defendant in variouslawsuits arising in the ordinary course of our business.  While the outcome of these lawsuits and proceedings cannot bepredicted with certainty and could have a material adverse effect on our financial position, results of operations or cash flows,we believe that the ultimate disposition of these suits will not have a material adverse effect on our financial position, resultsof operations or cash flows.

****

**Continental CPA Arbitration**

            In September 2006, Airlines begandiscussions with Continental to adjust the scheduled block hour rates for 2007 under the Continental CPA.  Although theagreement contemplates a November 1 deadline for setting the rates each year, the parties extended that deadline in an attempt toreach agreement.  In January 2007, the parties submitted their disagreements to binding arbitration in accordance with theterms of the agreement, which provides that it will be conducted pursuant to the Federal Arbitration Act.  Each party hasselected******one arbitrator, and those two will select a third arbitrator to complete the panel.  The agreement setsforth procedures and a schedule that will likely result in a hearing and issuance of a final decision by late in the second orearly in the third quarter of 2007.  Airlines will continue to be paid under the 2006 block hour rates during the arbitrationprocess, and expects the decision setting the revised rates to be retroactive to January 1, 2007.  We do not intend to issueany reports on the progress of the arbitration until the panel issues its final decision.  We cannot predict the outcome ofthe arbitration.  If decided adversely to us, the arbitration could have a material adverse effect on our results ofoperations, liquidity and financial position.  See Item 1A. “Risk Factors.”
****
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**Environmental Proceedings**

            We are and may from time to timebecome involved in environmental matters, including the investigation and/or remediation of environmental conditions at propertieswe use or were previously used by us.  We are not, however, currently subject to any environmental cleanup orders imposed byregulatory authorities, nor do we have any active investigations or remediation at this time.

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

            Not applicable.

**PART II**

**Item 5.  Market for Registrant's Common Equity, Related StockholderMatters and Issuer Purchases of Equity Securities**

            Our common stock trades on theNYSE.  The table below shows the high and low sales prices for our common stock as reported on the NYSE composite tape for theperiods indicated.

                                                 

**Common Stock**
****
**High**

**Low**
********
**2006**

  First Quarter

$

8.52

$

6.70

  Second Quarter

$

7.55

$

5.01

  Third Quarter

$

7.40

$

5.96

  Fourth Quarter

$

8.97

$

6.36

** **

**2005**

 

 

  First Quarter

$

13.01

$

10.58

  Second Quarter

$

11.69

$

8.45

  Third Quarter

$

10.46

$

8.40

  Fourth Quarter

$

10.97

$

7.61

            As of February 21, 2007, therewere approximately 20 holders of record of our common stock.

            We have not paid any cashdividends on our common stock and have no current plans to do so.

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**Performance Graph**

            The following graph compares thecumulative total return on our common stock with the cumulative total returns (assuming reinvestment of dividends) of the AmericanStock Exchange Airline Industry Index, the Russell 2000 Index and the New York Stock Exchange Composite Index as if $100 wereinvested in our common stock and each of those indices on April 18, 2002. 

**4/18/02**

**12/31/02**

**12/31/03**

**12/31/04**

**12/31/05**

**12/31/06**

**                                                                                    **
************************
ExpressJet Holdings, Inc.

$

100.00

 

$

64.06

 

$

93.75

 

$

80.50

 

$

50.56

 

$

50.63

American Stock Exchange Airline Industry Index

100.00

38.77

61.33

60.04

54.40

58.26

Russell 2000 Index

100.00

73.87

107.39

125.65

129.82

151.89

New York Stock Exchange Composite Index

100.00

79.75

102.72

115.64

123.67

145.77

            Our certificate of incorporationprovides that no shares of capital stock may be voted by or at the direction of persons who are not United States citizens unlessthey are registered on a separate stock record.  Our bylaws further provide that no shares will be registered on this foreignstock record if the amount to be registered would exceed United States foreign ownership restrictions.  United States lawcurrently limits the voting power in us (or any other U.S. airline) by persons who are not citizens of the United States to25%.

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**Issuer Purchases of Equity Securities**

**Period**

**a) Total number of shares purchased**

**(b) Average price paid per share**

**(c) Total number of shares purchased as part of publicly announced program**

**(d) Maximum value of shares that may yet be purchased under the program   (in millions)(1)**

 

October 1 to October 31,2006             

 

—

 

$

—

 

—

 

$

24.4

November 1 to November 30, 2006

166

$

7.70

—

24.4

December 1 to December 31, 2006

86

$

8.75

—

24.4

Total

252

$

—

$

24.4

(1)  

Amount shown relates to securities repurchased program.  Shares shown were withheld to satisfytax obligations arising upon the vesting of restricted stock and do not count against the program.

**Item 6.  Selected Financial Data**

            This selected financial datashould be read together with the consolidated financial statements and related notes and Item 7.  “Management’sDiscussions and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

            Airlines has operated under theContinental CPA, pursuant to which Continental pays it an amount calculated by using a formula for each scheduled block hour thatAirlines operates under the agreement.  Under the formula, the rates vary depending on the average length of the scheduledflights, the aggregate number of completed flights and the types of aircraft utilized and are otherwise subject to specifiedadjustments.  Substantially all of our revenue has been received under the agreement.

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            The following selected financialdata, excluding operating statistics, have been derived from our audited financial statements.  The financial informationincluded in this report is not necessarily indicative of our future results of operations, financial position and cash flows as wediversify from our current business model under the Continental CPA.  For a discussion of some of the key factors that couldhave an adverse effect on our results of operations, financial position and cash flows, please refer to Item 1A. “RiskFactors" beginning on page 20 of this report.

**                                                                    **

**Year Ended December 31,**
****
**2006**

**2005**

**2004**

**2003**

**2002**
********************
**(In thousands, except per share data)**

Statement of Operations Data:

Operating revenue

$

1,679,637

 

$

1,562,818

 

$

1,507,524

 

$

1,311,443

 

$

1,089,099

Operating expenses (1)

1,538,566

1,406,275

1,302,097

1,129,466

941,319

Operating income

141,071

156,543

205,427

181,977

147,780

Non-operating expense, net

5,385

(2,309

)

(7,423

)

(6,774

)

(9,174

)

Net income

92,565

97,993

122,771

108,181

84,280

Basic earnings per share (2)

1.72

1.81

2.26

1.80

1.38

Diluted earnings per share (2)

1.56

1.65

2.04

1.74

1.38

Weighted average number of shares used   in computations:

     Basic

53,864

54,117

54,220

60,026

61,068

     Diluted

61,529

61,722

61,779

63,062

61,069

(1)  

Includes government grant of $0.5 million in 2002.

(2)  

See Item 8.  “Financial Statements and Supplementary Data – Notes to ConsolidatedFinancial Statements – Note 1 – Summary of Significant Accounting Policies – (n) Earnings per Share” forthe reconciliation of the numerator and denominator of basic earnings per share to the numerator and denominator of dilutedearnings per share for the years ended December 31, 2006, 2005 and 2004.  In addition, we adopted the Emerging Issues TaskForce Issue No. 04-08 – “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” (“EITF04-08”) on December 15, 2004.  As a result, we restated our diluted earnings per share for all periods in which theconvertible notes were outstanding (since August 2003).

**                                                                    **

**As of December 31,**
****
**2006**

**2005**

**2004**

**2003**

**2002**
********************
**(In thousands)**

Balance Sheet Data:

Cash, cash equivalents and short-term   investments (including restricted cash)

$

302,860

$

236,503

$

215,151

$

193,092

$

120,930

Amounts due from Continental, net

—

4,832

—

—

17,419

Total assets

637,029

560,270

543,244

510,171

434,148

Amounts due to Continental, net

3,522

—

11,239

5,588

—

Note payable to Continental (1)

—

17,545

98,804

193,172

325,512

Other long-term debt and capital lease   obligations, including current maturities (2)

152,721

154,305

161,012

163,623

11,568

Stockholders' equity (deficit)

304,314

208,510

114,044

(10,287

)

15,302

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(1)  

See a detailed description of our note payable to Continental in Item 8.  “FinancialStatements and Supplementary Data – Notes to Consolidated Financial Statements – Note 6.”

(2)  

Beginning July 1, 2003, our Series A Cumulative Mandatorily Redeemable Preferred Stock(“Series A Preferred Stock”) was classified as long-term debt in accordance with Statement of Financial AccountingStandard No. 150 – “Accounting for Certain Financial Instruments with Characteristics of both Liabilities andEquity”.  Reclassification of the prior year financial statements was made to conform to this accounting standard. In April 2005, we redeemed this stock.

 

**                                                                             **

**Year Ended December 31,**
****
**2006**

**2005**

**2004**

**2003**

**2002**
********************
Operating Statistics:

 

 

 

 

Revenue passenger miles (millions) (1)

 

10,297

8,938

7,417

5,769

3,952

Available seat miles (millions) (2)

13,200

11,973

10,410

8,425

6,219

Passenger load factor (3)

78.0

%

74.7

%

71.3

%

68.5

%

63.5

%

Operating cost per available seat mile (cents) (4)

11.66

11.75

12.51

13.41

15.14

Block hours (5)

916,718

827,369

729,698

593,387

494,830

Operating cost per block hour (dollars) (6)

1,678

1,700

1,784

1,903

1,902

Departures

491,598

449,928

405,055

353,547

314,934

Average price per gallon of fuel, including fuel   taxes (cents) (7)

71.20

71.20

71.20

71.04

65.84

Fuel gallons consumed (millions)

319.1

295.5

262.8

215.8

164.9

Average length of aircraft flight (miles)

549

545

528

491

414

Average daily utilization of each aircraft (hours) (8)

9.24

8.87

8.51

7.79

7.63

Controllable completion factor (9)

99.8

%

99.7

%

99.9

%

99.8

%

99.9

%

Completion factor

97.9

%

97.7

%

98.4

%

98.2

%

99.0

%

Revenue passengers (thousands)

18,173

16,076

13,659

11,373

9,214

Actual aircraft in fleet at end of period

274

266

245

224

188

(1)  

Revenue passenger miles are the number of scheduled miles flown by revenue passengers.

(2)  

Available seat miles are the number of passenger seats available multiplied by the number ofscheduled miles those seats are flown.

(3)  

Passenger load factor equals revenue passenger miles divided by available seat miles.

(4)  

Operating cost per available seat mile is operating costs divided by available seatmiles. 

(5)  

Block hours are the hours from gate departure to gate arrival.

(6)  

Operating cost per block hour is operating costs divided by block hours.

(7)  

Under our fuel purchase agreement with Continental, fuel and fuel tax expense were reconciled to thelower of the actual costs or the agreed-upon caps.  Since 2003, our caps on fuel and fuel taxes have been 66.0 cents and 5.2cents per gallon, respectively.  For 2002, the agreed upon caps on fuel and fuel taxes were 61.1 cents and 5.2 cents pergallon.

(8)  

Average daily utilization of each aircraft is the average number of block hours per day that anaircraft in revenue service is operated.

(9)  

Controllable completion factor is the actual number of completed flights, plus flights cancelled dueto weather and air traffic control, divided by the number of scheduled flights.

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**Item 7.  Management's Discussion and Analysis of Financial Condition andResults of Operations**

            The information contained in thissection has been derived from our historical financial statements and should be read together with our historical financialstatements and related notes included elsewhere in this report.  The discussion below contains forward-looking statements thatinvolve risks and uncertainties.  Our actual results may differ materially from those expressed or implied in theseforward-looking statements as a result of various factors, including those described in Item 1A.  “Risk Factors”and elsewhere in this report.

****

**Executive Summary**

            ***Review of2006***

**

*           * ExpressJetHoldings, Inc. (“Holdings”) has strategic investments in the air transportation industry.  Our principal asset isall of the issued and outstanding shares of stock of XJT Holdings, Inc., the sole stockholder of ExpressJet Airlines, Inc.(“Airlines”), which currently operates as Continental Express (Holdings and Airlines are together referred to as “ExpressJet,” “we,” “us” and “our”).  Airlines is one of the largest regionalairlines in the world, based on available seat miles, the number of regional jets in its fleet and the number of passengersflown.  We also invest in other entities that permit us to leverage the management experience, efficiencies and economies ofscale present in our subsidiaries.

            Airlines currently operates afleet of 274 aircraft.  During substantially all of 2006, the entire fleet operated on behalf of Continental as ContinentalExpress pursuant to the Continental CPA, and we received substantially all of our revenue under that agreement.  In December2006, Continental began releasing 69 aircraft (25% of our fleet) from that agreement.  We redeployed two of these aircraft tocharter service in 2006; the other 67 are being removed from Continental service during the first six months of 2007 and are beingdeployed in branded flying, charter service, or a CPA arrangement with a major network carrier.   Branded flying, underthe name “ExpressJet” will provide regularly scheduled air service to West, Midwest and Southeast destinations in theUnited States commencing service on April 2, 2007.  We will continue to operate the remaining 205 aircraft under theContinental CPA.

            As of December 31, 2006 under theContinental CPA, we averaged over 1,300 daily departures, offering scheduled passenger service to over 150 destinations in NorthAmerica, Mexico and the Caribbean.  Our available seat miles have grown at a compounded annual rate of 18.8% from 4.7 billionin 2000 to 13.2 billion in 2006.  We generated $1.7 billion of revenue and $92.6 million of net income for the year endedDecember 31, 2006.  Please refer to our consolidated financial statements included in this report for information regardingour revenue and net income for each of the last three fiscal years and total assets as of the end of the last two years.

***           Fleet****. * During 2006, we accepted 8 new ERJ-145XR aircraft.  With these deliveries, we ended 2006with 104 ERJ-145XR, 140 ERJ-145 and 30 ERJ-135 aircraft.  Our ERJ-145XR aircraft provide distinct advantages that enable us topursue other strategic opportunities for the aircraft being released from the Continental CPA.  The primary advantage is theaircraft’s 1,600 mile range, which enables it to reach thinner, long-haul markets that cannot be served, nonstop, withtraditional 50-seat regional aircraft. 

***           Labor.**** * As of December 31, 2006, approximately 70% of our employees were covered by collectivebargaining agreements.  The contracts with the pilots, dispatchers, flight attendants and mechanics will become amendable inDecember 2010, July 2009, August 2010 and August 2009, respectively. 

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***            InformationTechnology****.*  During 2006, we began the implementation of our own information technology infrastructureto eliminate our dependence on Continental for information technology systems and services.  Related projects will deliver aseparate physical network with voice over IP, data centers, application platforms and software systems. Major softwareimplementations include human resource information systems, cash management, treasury, accounting, procurement, data warehousing,and other common back-office applications.  We expect the first phases of these projects to be completed during the first halfof 2007. 

            ***BusinessVentures.**** * Our consistent earnings under the Continental CPA and improving balance sheet have helped positionus for new opportunities.  We continue to seek strategic opportunities that leverage our internal strengths, such as ourtechnical, training and fleet and asset management capabilities, to develop and implement additional business strategies.  Wemade the following cash investments in 2006 (see Item 8. “Financial Statements and Supplementary Data – Notes toConsolidated Financial Statements – Note 1 – Summary of Significant Accounting Policies – (i)” for theaccounting treatment of each of the investments):

            In January 2006, we purchased anon-controlling interest in Flight Services & Systems, Inc. (“FSS”) for $4.0 million.  FSSis based in Cleveland, Ohio and provides airport services to airlines, airports and regulatory authorities.

**           **On August 31, 2006, we purchased the remaining 51% of American Composites, LLC, an aviation maintenance business in Miami,Florida, for $0.8 million in cash.  The results of operations were consolidated in our financial statements as of September 1,2006.

           During thesecond quarter of 2006, we invested $0.8 million for a 50% interest in Saltillo Jet Center, S. de R.L. deC.V. an aircraft paint facility located in Saltillo, Mexico.  We received a $0.8 million note receivable from the other 50%interest owner secured by their ownership interest.  The company has not obtained additional financing outside of the equityholders.  Pursuant to the partnership agreement and bylaws, we had the right to receive 100% of the residual returns from thecompany’s earnings until this note was fully satisfied.  We also invested $9.2 million for the construction of thehangar and office facilities from which the company conducts its operations.  During December 2006, Saltillo Jet Centerrestructured its equity ownership interest and we now own 80%.  In connection with the restructuring, we forgave the $0.8million note receivable from the other owner.

            InTech Aerospace Services, LP,American Composites and ExpressJet Services, LLC, are doing business under the name ExpressJet Services.  Under this name,these entities operate or co-invest in maintenance facilities located across the United States in Miami, Shreveport, Knoxville andHouston as well as in Saltillo, Mexico.  ExpressJet Services will provide third-party maintenance for interior and exteriorwork on the aircraft.

            ***Liquidity and FinancingActivities.***   As of December 31, 2006, we had $302.9 million in cash and short term investments, including $11.2million in restricted cash.  During 2006, we paid off the remaining balance on our note payable to Continental of $17.5million and reduced our loan agreement with Export Development Canada (“EDC”) by $0.9 million.  In addition, wemade $0.8 million in principal payments related to our capital leases.  Our cash flows from operations were sufficient tocover our capital resources and liquidity requirements during the three years ending December 31, 2006.  See discussion belowin “– Liquidity and Capital Commitments.”

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            ***Outlook for2007***

            We will continue seeking toenhance stockholder value by providing enhanced product offerings and what we believe to be the most cost-efficient and reliableregional jet service for our customers, including seeking to achieve the highest level of customer satisfaction in the regionalindustry.  In the long-run, we believe this strategy will serve us well, although we continue to be affected by the pressuresaffecting the airline industry generally. 

During 2007, we will deploy our aircraft asfollows:           

                                                                                               

**Aircraft Allocation**

Continental Express

205

Branded Flying

44

Corporate Aviation

15

Major Network Carrier

10

**Total Aircraft**

**274**

            ***ContinentalCPA.*****Beginning on December 28, 2006 and ending June 2007, 69 aircraft are being released from the ContinentalCPA.  After the release of the aircraft, we will continue to fly 205 aircraft or 75% of our total fleet under the ContinentalCPA.  However, on February 22, 2007 we agreed with Continental to defer the transition date for three ERJ-145XR aircraft fromthe first half of June to August 28, 2007.  Until then, these aircraft will remain as covered aircraft under the terms of theContinental CPA.

            We began 2007 rate discussionswith Continental last September.  Although the Continental CPA contemplates a November 1 deadline for setting the rates, theparties agreed to extend the deadline.  However, in January, ExpressJet and Continental were unable to agree on new rates for2007 and agreed to submit their disagreements to binding arbitration in accordance with the terms of the agreement.

            In the arbitration, each partyhas selected one arbitrator, and those two arbitrators will select the third arbitrator to complete the panel.  TheContinental CPA sets forth procedures and a schedule that will likely result in a hearing and the issuance of a final decision bylate in the second or early in the third quarter of 2007.  ExpressJet will continue to be paid under the 2006 block hour ratesduring the arbitration process and expects the decision setting the revised rates to be retroactive to January 1, 2007.

***            BrandedFlying.***  Our branded flying will focus on providing nonstop service to cities that are underserved by othercarriers.  Beginning in the second quarter of 2007, we plan to initialize service to 24 cities located in the West, Midwestand Southeast United States that are typically less congested than other major cities.  We plan to fly over 200 dailydepartures to eliminate connections and minimize delays and total trip time.  California’s LA/Ontario InternationalAirport will be the busiest city for us, followed by San Diego, California; Austin, Texas; Sacramento, California; and San Antonio,Texas. 

            We offer a distinct product tomeet the needs of both business and leisure travelers. Our customers will fly on young jets with advanced seat assignments and nomiddle seats.  We will also provide valet carry-on baggage service as a convenience in order to save time the customers wouldotherwise spend loading bags in the overhead bin or waiting at baggage claim.  Our leather seats have been redesigned foradditional passenger comfort including memory foam cushions and over a 100 channels of complimentary XM Satellite radio.  Wewill serve complimentary, recognized brand-name snacks, and full meal options will be available for longer haul flights.
****
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****

***           Marketing. *** We are using the following methods for airline ticket distribution:  

        

• 

Airline website, www.xjet.com.  It is less expensive to sell through this direct channel and,as a result we continue to promote and encourage use of our online capabilities.

• 

The four principal global distribution systems, Sabre, Worldspan, Galileo and Amadeus, so that ourtickets can be sold through traditional travel agencies and online sites such as Orbitz, Travelocity and Expedia.

• 

Telephone reservation call centers.

            We will provideelectronic ticketing, or E-Tickets, which will eliminate the need to print and process a paper ticket.  E-Tickets enhancecustomer and revenue information and are a vital part of our distribution strategy.   We will have self-service kiosks atall airports throughout our system to expedite the check-in process for our customers. 

****

**           ** We will offer arange of competitive fares that are distinguished by restrictions on use, such as time of day and day of the week, length of stayand minimum advance booking period.  Service fees will be consistent with or less than those charged by most United Statescarriers.

****

***           *** ExpressJetis in the process of launching a new frequent flyer program called JetSet.  It will be a simple fly-and-redeem travel programfor members with the possible future addition of other cash-value rewards and partner participation.

****

***            CorporateAviation. *** Our new Corporate Aviation division is expected to operate a total of 15 aircraft by June 2007,providing distinctive travel solutions for corporations, aircraft brokers, hospitality companies, sports teams, schools andothers.  The aircraft are being flown under Airlines’ operating certificate issued by the FAA. The aircraft areconfigured with 50 redesigned seats for enhanced passenger comfort, and each seat includes complimentary XM Satellite radio withover 100 channels of audio entertainment.  In addition to the basic service, customized flight service options give customersan opportunity to create a unique flight experience. 

******

***            Other CPAArrangements. *** During the 4th quarter 2006, we signed a memorandum of understanding with a majorU.S. carrier to operate 10 ERJ-145XR aircraft in its network under a capacity purchase agreement.  We intend to completenegotiations on this contract during first quarter 2007 with operations for this new customer beginning in the second quarter2007.

           Although webelieve that these new operations will enhance stockholder value in the long term, significant start-up costs will be incurredduring our transition period, which is likely to significantly reduce our overall profitability for 2007.  In addition, we mayexperience volatility in our quarterly results as these operations begin.
****
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****

**            *FutureCosts***

            We remain committed to providingcompetitively priced services by controlling our costs; however, we believe that our costs are likely to increase in the future dueto:

• 

transition costs associated with refurbishing and repainting the aircraft after exiting service forthe Continental CPA;

• 

relocation and additional training cost of employees for our branding flying operations;

• 

reassignment of maintenance operations;

• 

fuel costs for aircraft not  flying under the Continental CPA;

• 

distribution costs that includes schedule planning, marketing and sales related to our brandedflying and charter operations;

       

• 

changes in wages, salaries and related fringe benefit costs, including the impact of SFAS123(R) andchanges to our self-insured medical and workers compensation costs;

• 

changes in the costs of materials and outside services;

• 

changes in governmental regulations, insurance and taxes affecting air transportation and the costscharged for airport access, including new security requirements;

• 

aging of our fleet;

• 

higher aircraft ownership costs as aircraft are released from the Continental CPA or if Continentalwere to declare bankruptcy or otherwise default under the current financing arrangements;

• 

changes in the cost of services provided by Continental at fixed rates under the Continental CPA andour other agreements.  

            Due to the way in which costs arereconciled under the Continental CPA, higher costs relating to the Continental CPA may generate higher revenues in the shortterm.  However, in the long term, failure to control our costs would prevent us from remaining competitive and limit ouropportunities to attract additional partners or to take advantage of strategic opportunities as they present themselves.

**            *Critical AccountingPolicies and Estimates***

            Our consolidated financialstatements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).  Thepreparation of these financial statements requires us to make estimates and judgments that affect reported amounts and relateddisclosures.  We have identified the accounting policies and estimates below as critical to our business operations andunderstanding of our results of operations.  The SEC has defined critical accounting policies and estimates as the ones thatare most important to the presentation of a company’s financial condition and results and require the company to make itsmost difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherentlyuncertain.  For all of these estimates, we caution that future events rarely develop exactly as forecasted, and the bestestimates routinely require judgment.  The discussion below is not intended to be a comprehensive list of our accountingestimates and policies.  For a detailed discussion on the application of our accounting policies, see Item 8. “Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note1.”

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**Revenue Recognition**

*Nature of Estimates Required –* Certain amounts billed by us to Continental underthe Continental CPA are subject to our interpretation of the agreement.  Continental may dispute the amount billed and payless than the amount invoiced if it interprets the agreement differently than we do.  New rates are to be determined annually,and the rates charged in 2007 have been submitted to arbitration since we and Continental cannot agree on certain provisions of theagreement.  Until the arbitrators render their decision, we will continue to be paid under the 2006 block hour rates, duringthe arbitration process, and we expect the decision setting the revised rates to be retroactive to January 1, 2007. 

*Assumptions and Approach Used –* Our operating revenue is calculated based on our interpretation of theContinental CPA.

*Effect if Different Assumptions Used* – If our interpretation differs materially from Continental’s, ourrevenue could be materially understated or overstated.  Under the Continental CPA, a substantial portion of Airlines’costs are reconciled for differences between Airlines’ actual costs and estimated costs included in its block hour rates at a10.0% operating margin.  Under Airlines’ 2006 rates, certain costs generally controllable by Airlines are reconciled toallow it to operate within its operating margin, as defined in the agreement (“prevailing margin”) of 8.5% to10.0%.  For the fourth quarter of 2006, we rebated $0.4 million to Continental because Airlines’ prevailing marginbefore reconciliation payments exceeded 10.0%.  If Continental had successfully challenged any of our billings in the fourthquarter 2006, for example, resulting in a one percentage point increase in the prevailing margin before any reconciliation payment,our pretax income would have decreased by $4.7 million, or $0.05 per diluted earnings per common share (“DilutedEPS”).

**Wages, Salaries and Related Expenses**

*Nature of Estimates Required –* We are currently self-insured for a portion ofour healthcare costs and have a large deductible for our workers compensation liability.  Consequently, reserves for the costof claims that have not been paid or benefit costs that have been incurred but not yet reported (“IBNR”) as of a givendate are estimated.  In addition, as our collective bargaining agreements become amendable, we accrue for anticipatedretroactive pay that we estimate will be due under the new contract.  However, actual costs may differ materially from ourestimates.

*Assumptions and Approach Used –* Our estimates for these reserves are based on recommendations from actuarialprojections provided by third-party actuaries.  These estimates rely on historical claim experience, demographic data andprojection of the effects of inflation on medical costs.

*Effect if Different Assumptions Used* – If the ultimate development of these claims is significantly differentthan our estimates, the accrual for future healthcare claims could be materially overstated or understated.  As of December31, 2006, our reserve related to our healthcare cost was $2.7 million.  Our third-party actuary provided an estimated IBNRrange of $2.0 million to $3.1 million.  Had we changed our reserve to either the low end or the high end of the reserve, theimpact to our net income would have been immaterial as a result of the mechanics of the Continental CPA.  As of December 31,2006, we reserved $5.8 million for IBNR related to workers’ compensation benefits based on the advice of our workers’compensation actuary.

**Spare Parts and Supplies**

*Nature of Estimates Required–* Inventories, expendable parts and suppliesrelating to flight equipment are carried at average acquisition cost and are expensed when used.  Inventories are carried atthe lower of amortized cost or net realizable value.  The adequacy of our allowance for obsolescence requires a high degree ofjudgment.

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*Assumptions and Approach Used–* Our allowance for obsolescence related to inventory is provided over the remaininguseful life of the related aircraft, plus allowance for spare parts currently identified as excess.  Part of the calculationfor this reserve is based on historical experience.  In addition, we may reserve for additional obsolescence when currentavailable market data indicate a decline in the fair value of parts or if we deem parts as excess inventory.

*Effect if Different Assumptions Used*– As of December 31, 2006, our allowance for obsolescence related to ourspare parts and supplies was approximately $9.8 million.  If we increase the reserve by 10%, due to the mechanics of theContinental CPA, the impact on pre-tax income is immaterial.

**Aircraft and Facility Leases**

*Nature of Estimates Required–* All of our aircraft are either leased orsub-leased from Continental.  We also have airport and maintenance facility leases that are leased from airport authorities orother municipal authorities.  In order to determine the proper classification of a lease as either an operating lease or acapital lease, we must make certain estimates at the inception of the lease relating to the economic useful life and the fair valueof an asset, as well as select an appropriate discount rate to be used in discounting future lease payments.

*Assumptions and Approach Used–* The assumptions used in our lease classification analyses are based on ourinterpretation of available market data and specific contract terms.

*Effect if Different Assumptions Used*– As all our aircraft and facility leases have been classified as operatingleases, rental payments are charged to expense over the terms of the related leases.  Moreover, since operating leases are notreflected on our balance sheet, if different assumptions were used, which might cause an operating lease to be classified as acapital lease, the impact to our financial statements would be a gross-up of our property and equipment and capital leaseobligations and a charge to depreciation and amortization expense. 

**Goodwill and Intangible Assets**

*Nature of Estimates Required–* Under Statement of Financial Accounting StandardNo. 142–“Goodwill and Other Intangible Assets” (“SFAS 142”), intangible assets can have either finiteor indefinite useful lives.  As of December 31, 2006, we had intangible assets with both definite and indefinite lives. Our critical accounting estimate is related to our “Reorganization Value in Excess of Amounts Allocable to IdentifiableAssets,” which has indefinite useful life.  Under SFAS 142, goodwill and intangible assets with indefinite useful livesshould be tested at least annually for impairment.  Factors considered important when determining the impairment of reportingsegments under SFAS 142 include items affecting the cash flows of the reporting segments; the reporting segments’ operationalperformance versus market expectations; the reporting segments’ performance compared to peers within the industry; themarketplace for and identification of the intangible asset of the reporting segments; significant changes in the underlyingbusiness strategy or operational environment; material ongoing industry or economic trends; or other factors specific to the assetor reporting segments being evaluated.  Any changes in the key assumptions about the business and its prospects, or changes inmarket conditions or other externalities could result in an impairment charge.

*Assumptions and Approach Used –* For our SFAS 142 analysis, we employed a discounted cash flow approach, a marketmultiple approach and an acquisition approach.  The discounted cash flow approach considers our expected cash generationcapabilities, and the market–multiple approach and the acquisition approach analyzes similar companies or transactions withinthe industry to derive multiples for the company. * *

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*Effect if Different Assumptions Used*– Reorganization Value in Excess of Amounts Allocable to Identifiable Assetsrepresents primarily the amount that arose from Continental’s emergence from bankruptcy reorganization in 1993.  Inaddition to our annual SFAS 142 analysis at June 30, we determined a trigger event occurred during the fourth quarter 2006. In accordance with our policy, we performed a SFAS 142 impairment analysis as soon as reasonably possible after the trigger event,using the latest data available.  No impairment was identified.  If assumptions used in our analysis were changedmaterially, our intangible assets could be materially overstated.  However, based on our most current impairment test, therewould have to be a significant change in assumptions used in the calculation for an impairment to occur as of December 31,2006.

            In addition to our criticalaccounting estimates and policies described above, we made other estimates that, while not involving the same degree of judgment,are important to understanding our financial statements.  In general, we base our estimates on historical experience,information from third-party professionals and various other assumptions that we believe are reasonable under thecircumstances.  We continually evaluate our accounting policies and the estimates used to prepare our consolidated financialstatements.  Our estimates as of the date of the financial statements reflect our best judgment after giving consideration toall currently available facts and circumstances.  As such, actual results may differ significantly from these estimates andmay require adjustment in the future as additional facts become known or as circumstances change.

            We have discussed the developmentand selection of these critical accounting policies and estimates with the Audit Committee of our board of directors, and theCommittee has reviewed the disclosures presented above.

***            Recently Issued AccountingStandards***

            In September 2006, the FinancialAccounting Standards Board (“FASB”) issued FASB Statement No. 158, *Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans, an amendment of FASB Statements No 87, 88, 106 and 132(R)* (“Statement158”).  Statement 158 requires plan sponsors of post retirement benefit plans to recognize the funded status of theirpostretirement benefit plans in the statement of financial position, measure the fair value of plan assets and benefit obligationsas of the fiscal year-end statement of financial position, and provide additional disclosures.  On December 31, 2006, weadopted the recognition and disclosure principles of Statement 158.  The effect of adopting Statement 158 on our financialcondition at December 31, 2006 has been included in the accompanying consolidated financial statements.  Statement 158 did nothave an effect on the consolidated financial condition at December 31, 2005 or 2004.  Statement 158’s provisionsregarding the change in the measurement date of postretirement benefit plans are not applicable as we already use a measurementdate of December 31 for our post retirement medical plan.  See Note 10 for further discussion of the effect of adoptingStatement 158 on the consolidated financial statements.

            In June 2006,the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109" ("FIN 48"), which clarifies the accounting for uncertainty in income taxes recognized infinancial statements. FIN 48 requires the impact of a tax position to be recognized in the financial statements if that position ismore likely than not of being sustained by the taxing authority.  FIN 48 is effective for fiscal years beginning afterDecember 15, 2006.  We are currently evaluating the requirements of FIN 48; however, we do not believe that it will have amaterial effect on our consolidated financial position or results of operations.
****
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****

**Results of Operations and Analysis**

****

***Selected Financial Information***

**                                                               **

**Year Ended December 31,**
****
**2006**

**Increase/ (Decrease) 2006-2005**

**2005**

**Increase/ (Decrease) 2005-2004**

**2004**
********************
**(In thousands, except per share data and increase/decrease%’s)**

Statement of Operations Data:

Operating revenue

 

1,679,637

 

7.5

%

1,562,818

3.7

%

1,507,524

Operating expenses

1,538,566

9.4

%

1,406,275

8.0

%

1,302,097

Operating income

141,071

(9.9

)%

156,543

(23.8

)%

205,427

Non-operating expense, net

5,385

333.2

%

(2,309

)

(68.9

)%

(7,423

)

Net Income

92,565

(5.5

)%

97,933

(20.2

)%

122,771

Basic earnings per share

1.72

(5.0

)%

1.81

(19.9

)%

2.26

Diluted earnings per share

1.56

(5.5

)%

1.65

(19.1

)%

2.04

******

***Statistical Information***

**                                                                              **

**Year Ended December 31,**
****
**2006**

**Increase/ (Decrease) 2006-2005**

**2005**

**Increase/ (Decrease) 2005-2004**

**2004**
********************
Operating Statistics:

 

 

Revenue passenger miles (millions) (1)

10,297

15.2

%

 

8,938

 

20.5

%

 

7,417

Available seat miles (millions) (2)

13,200

10.2

%

11,973

15.0

%

10,410

Passenger load factor (3)

78.0

%

3.3

pts

74.7

%

3.4

pts

71.3

%

Operating cost per available seat mile (cents) (4)

11.66

(0.8

%)

11.75

(6.1

%)

12.51

Block hours (5)

916,718

10.8

%

827,369

13.4

%

729,698

Operating cost per block hour (dollars) (6)

1,678

(1.3

%)

1,700

(4.7

%)

1,784

Departures

491,598

9.3

%

449,928

11.1

%

405,055

Average price per gallon of fuel, including fuel   taxes (cents) (7)

71.20

—

71.20

—

71.20

Fuel gallons consumed (millions)

319.1

8.0

%

295.5

12.4

%

262.8

Average length of aircraft flight (miles)

549

0.7

%

545

3.2

%

528

Average daily utilization of each aircraft (hours) (8)

9.24

4.1

%

8.87

4.2

%

8.51

Controllable completion factor (9)

99.8

%

0.1

pts

99.7

%

(0.2

pts)

99.9

%

Completion factor

97.9

%

0.2

pts

97.7

%

(0.7

pts)

98.4

%

Actual aircraft in fleet at end of period

274

3.0

%

266

8.6

%

245

Revenue passengers (thousands)

18,173

13.0

%

16,076

17.7

%

13,659

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(1)  

Revenue passenger miles are the number of scheduled miles flown by revenue passengers.

(2)  

Available seat miles are the number of passenger seats available multiplied by the number ofscheduled miles those seats are flown.

(3)  

Passenger load factor equals revenue passenger miles divided by available seat miles.

(4)  

Operating cost per available seat mile is operating costs divided by available seatmiles. 

(5)  

Block hours are the hours from gate departure to gate arrival.

(6)  

Operating cost per block hour is operating costs divided by block hours. 

(7)  

Fuel cost used in calculations includes cost of fuel and related fuel tax.  Airlines incur fuelexpense and fuel tax equal to the lower of the actual cost or the agreed-upon caps of 66.0 cents and 5.2 cents per gallon,respectively, based on our fuel purchase agreement with Continental.

(8)  

Average daily utilization of each aircraft is the average number of block hours per day that anaircraft is operated.

(9)  

Controllable completion factor is the actual number of completed flights, plus flights cancelled dueto weather and air traffic control, divided by the number of scheduled flights.

            We monitor the statisticalinformation above closely to ensure that we are continually focused on our operational efficiencies and cost control.

            The following discussion providesan analysis of our results of operations and reasons for any material changes for the periods indicated.

            ***Comparison of 2006 to2005***

******

***           ****OperatingRevenue*

            Our operating income in 2006reflected an 8.4% operating margin, compared with an operating margin of 10.0% in 2005.  Our growth in operating revenue of7.5% is due to our growth in block hours of 10.8%.  Included in the operating income is approximately $3.5 million of net lossrelated to the results of operations from subsidiaries that are consolidated into our financial statements. 

            The incentive payments areprimarily based on the current controllable completion factor compared to a historical controllable completion factorbenchmark.  Because the historical rates are measured on a rolling monthly average, higher controllable completion factorsresult in higher incentive payments in the near term but reduce Airlines’ opportunity to earn incentive payments in thefuture.  Airlines’ controllable completion factor in 2006 was 99.8% and its historical benchmark completion factor was99.7% for the same period.  Beginning with the 2005 rates, Airlines is only required to pay Continental a penalty forcontrollable completion factors below 99.5% instead of using its rapidly rising historical benchmark.

            As a substantial portion ofAirlines’ costs under the Continental CPA are reconciled for differences between its actual costs and the estimated costsincluded in its block hour rates at a 10.0% operating margin, if Airlines’ prevailing margin (before any reconciliationpayments) fell outside its margin band of 8.5% to 10.0% for 2006 and 2005, Airlines’ revenue would have been adjusted tobring it back to its floor or cap.  Reconciliation payments to Continental totaled $7.3 million and $23.4 million for 2006 and2005, respectively.  The 2006 reconciliation payment was primarily driven by lower actual wages, salaries and related costsand maintenance, materials and repair expenses as compared to the estimated costs in the agreement block hour rates.  The 2005reconciliation payment was primarily driven by lower actual maintenance, materials and repair and passenger servicing expenses ascompared to the estimated costs in the block hour rates. 

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            *OperatingExpenses*

            Consistent with our growth inblock hours of 10.8% for the year ended December 31, 2006, wages, salaries and related costs increased 10.7% in 2006 over2005.  In addition, we incurred approximately $2.0 million higher employee benefit costs, such as medical coverage,workers’ compensation costs, profit sharing and 401(k) expenses in 2006. 

            Effective January 1, 2006, weadopted FASB Statement No. 123(R) using the modified-prospective transition method.  Prior to 2006, we accounted for ourstock-based compensation arrangements using the intrinsic value method in accordance with Accounting Principles Board Opinion No.25 — “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. On November4, 2005, our board of directors approved accelerating the vesting of 669,750 unvested options then held by employees, includingexecutive officers, with exercise prices greater than $11.00 per share and extended the term of 868,500 employee options that had afive-year term to seven years.  These options were and remain out of the money, and the acceleration and extension wereeffective immediately. The acceleration of vesting reduced compensation expense upon the adoption of SFAS 123R.  The reductionin compensation expense in the future, based on our implementation date of January 1, 2006, was approximately $3.1 million. The adoption of Statement 123(R) did not have a material impact on wages, salaries and related costs during 2006 nor do we believethat it will have a material affect on future periods.

              In the future, weanticipate that our wages, salaries and related costs may be affected by the following factors:

         

• 

wage increases to incentivize key personnel to remain with us as we continue implementing ourdiversification strategy including our long-term incentive plan implemented in January 2006;

• 

wage rate increases in accordance with our collective bargaining agreements as a result of higherseniority of our work force; and

• 

projected increases in health and medical benefit costs.

            The increase in our aircraft fuelexpense in 2006 was mainly due to an 8.0% increase in fuel consumption.  Consumption rose primarily due to a 10.8% increase inblock hours, which was partially offset by our jets’ more efficient fuel burn and our company’s fuel savingsinitiatives.  Our actual price of fuel, including taxes, in 2006 and 2005 was 71.2 cents per gallon.  Under theContinental CPA and related fuel purchase agreement with Continental, we incur a fuel price and fuel tax equal to the lower of theactual cost of fuel and fuel tax or the agreed-upon caps.  During 2007, fuel expense related to the aircraft not flying forContinental will be subject to volatility in the price of jet fuel. 

            For 2006,approximately****70.4% of total maintenance, materials and repairs cost consisted of power-by-the-hour expense. Approximately $16.3 million of the increase for 2006, when compared to 2005, was due to a 10.3% increase in flight hours andincreases in rate-per-flight-hour related to our power-by-the-hour contracts.  In addition, new power-by-the-hour contractsresulted in increased cost of $3.0 million for 2006.

            Other operating expense increased8.3% between the twelve months ended December 31, 2006 and 2005.  Approximately $4.6 million of the increase related to crewrelated charges, such as per diem and hotel cost, as a result of increased flight operations.  Additional transition costswere incurred to support the 69 aircraft retained to operate under our diversification strategies such as branded flying andcorporate aviation. 

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            *NonoperatingExpenses*

**

*           * Our interestexpense was primarily related to our senior convertible notes, a note payable to Continental and a loan agreement with EDC. Interest expense related to these long-term debts decreased in 2006 by approximately $3.4 million as a result of paying off thenote payable to Continental and a $0.9 million reduction in our loan agreement with EDC due to principal paydown.  Inaddition, we retired Airlines’ Series A Preferred Stock in April 2005.  Our interest income increased by approximately$6.4 million as a result of an approximate two-point increase in our average returns from our investments and a higher average cashand short-term investment balance.

******

***            Comparison of 2005 to2004***

            *OperatingRevenue*

            Our operating income in 2005reflected a 10.0% operating margin, compared with an operating margin of 13.6% in 2004.  As part of the 2005 rate negotiation,Airlines agreed to cap its prevailing margin at 10.0% in lieu of the margin cap of 11.5% in 2004.  Beginning in 2005, Airlinesalso includes previously unreconciled costs within the margin band, such as wages, salaries and related costs, although it is notreimbursed if these costs are higher than agreed in the block hour rates and cause its prevailing margin to fall below the 8.5%margin floor.  The 2004 operating margin included the benefits of cost savings in Airlines’ previously unreconciledcosts and $11.5 million in performance incentive payments under the Continental CPA.  The 2005 operating margin included $4.2million of performance incentive payments.  Cost savings related to previously unreconciled costs were included in theprevailing margin calculation, hence they did not impact the 2005 operating margin.

            The incentive payments areprimarily based on the current controllable completion factor compared to a historical controllable completion factorbenchmark.  Because the historical rates are measured on a rolling monthly average, higher controllable completion factorsresult in higher incentive payments in the near term but reduce Airlines’ opportunity to earn incentive payments in thefuture.  Airlines’ controllable completion factor in 2005 was 99.7% and its historical benchmark completion factor was99.3% for the same period.  As part of the 2005 amendment, Airlines is only required to pay Continental a penalty forcontrollable completion factors below 99.5% instead of using its rapidly rising historical benchmark.

            As a substantial portion ofAirlines’ costs under the Continental CPA are reconciled for differences between its actual costs and the estimated costsincluded in its block hour rates at a 10.0% operating margin, if Airlines’ prevailing margin (before any reconciliationpayments) fell outside its margin band of 8.5% to 10.0% for 2005 and 8.5% to 11.5% for 2004, Airlines’ revenue would havebeen adjusted to bring it back to its floor or cap.  In 2005 and 2004, Airlines’ actual cost efficiencies brought itsprevailing margin above 10.0% and 11.5%, respectively.  Reconciliation payments to Continental totaled $23.4 million and $61.0million for 2005 and 2004, respectively.  The 2005 reconciliation payment was primarily driven by lower actual wages, salariesand related costs and maintenance, materials and repair expenses as compared to the estimated costs in the block hour rates. The 2004 reconciliation payment was primarily driven by lower actual maintenance, materials and repair and passenger servicingexpenses as compared to the estimated costs in the block hour rates. 

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            *OperatingExpenses*

            Although our operations, measuredby block hours, grew over 13.4% for the year ended December 31, 2005, wages, salaries and related costs only increased by9.5%.  This resulted from our continuous focus on managing our non-union labor costs and improving productivity related to ourunionized labor force to remain competitive with our peers.  For the year ended December 31, 2005, wages increased by $21.7million.  In addition, we incurred approximately $6.7 million higher employee benefit costs, such as medical coverage,workers’ compensation costs, profit sharing and 401(k) expenses in 2005 than in 2004.

            The increase in our aircraft fuelexpense in 2005 was mainly due to a 12.4% increase in fuel consumption.  Consumption rose primarily due to a 13.4% increase inblock hours, which was partially offset by our jets’ more efficient fuel burn.  Our actual price of fuel, includingtaxes, in 2005 and 2004 was 71.2 cents per gallon.  Under the capacity purchase agreement and related fuel purchase agreementwith Continental, we incur a fuel price and fuel tax equal to the lower of the actual cost of fuel and fuel tax or the agreed-uponcaps.

            Approximately $21.2 million ofthe increase in maintenance, materials and repairs during 2005 was due to a 13.7% increase in flight hours related to ourpower-by-the-hour contracts.  Our overall maintenance, materials and repair costs per flight hour increased by approximately4.0% to support the continuing growth and aging of our fleet.

            The increase in other rentals andlanding fees during 2005 was primarily due to a $10.5 million increase in landing fees caused by an 11.2% increase in landingweights and 3.0% increase in rates per landing weight mostly due to higher rates at Continental’s hubs.  In addition,our facility rent increased by approximately $5.5 million primarily as a result of rate increases at various stations andmaintenance facilities. 

            Ground handling and outsideservices decreased in 2005 because, as part of the 2005 annual rate resetting process and as a result of Continental’scost-saving initiatives, the costs for Continental to provide us with certain services currently classified as outside services(such as technology infrastructure and other services) and ground handling were reduced by approximately $53.0 million for the yearended December 31, 2005.  As these are fully reconciled costs, our operating income for 2005 was reduced by approximately $5.3million as a result of these cost reductions.

            The decrease in other operatingexpenses for the year ended December 31, 2005 resulted primarily from:

      

• 

a $14.5 million decrease in security and miscellaneous facility fees as a result of the 2005rate-resetting under the Continental CPA, partially offset by additional TSA assessed security screening fees of approximately $0.8million in January 2006 that were related to 2005;

         

• 

a $4.0 million charge in 2004 for settlement of a claim by Continental for indemnification under theContinental CPA;

• 

a $3.4 million charge in 2004 for the final settlement of a $6.7 million deferred tax assetreceivable related to our spin-off from Continental in 2002;

• 

a $4.7 million increase in international navigational charges; and

• 

a $3.7 million increase in crew related charges, such as per diem and hotel cost, as a result ofincreased flight operations.

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            *NonoperatingExpenses*

**

*           * Our interestexpense was primarily related to our senior convertible notes, note payable to Continental and loan agreement with EDC. Interest expense related to these long-term debts decreased in 2005 by approximately $1.1 million as a result of an $81.3 millionreduction in our note payable to Continental and a $0.9 million reduction in our loan agreement with EDC.  In addition, weretired Airlines’ Series A Preferred Stock in April 2005.  Our interest income increased by approximately $4.6 millionas a result of a two-point increase in our average returns from our investments despite a lower average cash and short-terminvestment balance of approximately $208.9 million in 2005.

**Liquidity and Capital Commitments**

            ***Sources and Uses ofCash***

            Our primary source of liquidityis cash flow provided from our operations.  For the years ended December 31, 2006 and 2005, our operations provided $116.7million and $130.6 million, respectively, in cash flow.  As of December 31, 2006 and 2005, we also had $11.2 million and $9.2million of restricted cash, respectively, which is comprised of collateral for our workers’ compensation coverage, customerdeposits for future charter flights and letters of credit.

            In 2006 and 2005, we spent $27.5million and $21.1 million, respectively, on capital expenditures.  A majority of the expenditures for 2006 and the entireamount for 2005 were spent on flight and ground equipment to support our fleet deliveries and the increase in our flight schedulesunder the Continental CPA.  Of the $27.5 million spent in 2006 $11.1 million was spent on capital expenditures for ourstrategic business ventures which are outside of the Continental CPA.

            In 2006, we made the followingcash investments:

• 

In January 2006, we invested $3 million for a 44% ownership interest in the capital stock of FlightServices & Systems, Inc., an Ohio corporation that provides airport services such as passenger assistance, ground handling, EZcarts and security. 

         

• 

On August 31, 2006, we purchased the remaining 51% of American Composites, LLC, an aviationmaintenance business in Miami, Florida, for $0.8 million in cash and the results of operations were consolidated in our financialstatements beginning in September 1, 2006.  Prior to this date, we accounted for this investment under the equity method ofaccounting as prescribed by Accounting Principles Board Opinion No. 18 – “The Equity Method of Accounting forInvestments in Common Stock.”  As the results of operations and financial conditions of this company are immaterial toHoldings, we applied the consolidation prospectively as of September 1, 2006. 

         

• 

During the second quarter of 2006, we invested a total of $0.8 million for a 50% interest inSaltillo Jet Center, S. de R.L. C.V., a start-up business located in Saltillo, Mexico.  Saltillo Jet Center was created forthe purpose of providing aircraft painting services.  We also invested $9.2 million in the construction of the hangar and theoffice facilities from which Saltillo Jet Center conducts its operations.  In December 2006, in exchange for a note receivableof $0.8 million held from the start-up business partners, Saltillo Jet Center was restructured with our ownership percentageincreasing to 80% as of December 31, 2006. 

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            ***Long-termDebt*.**  We did not enter into any new financing transactions in 2006.  We paid off the remaining balance on ournote payable to Continental.  This payment totaled $17.8 million, of which $17.5 million related toprincipal. 

            In 2006, we made principal andinterest payments in the amount of $1.9 million on our loan agreement with EDC, of which $0.9 million related to principal. As of December 31, 2006, the balance on this loan agreement was $14.4 million.  In addition, we made required interestpayments in 2006 on our 4.25% senior convertible notes due 2023 totaling $5.8 million. 

            ***CapitalLeases.***  As of December 31, 2006, we had approximately $1.0 million (including current maturities) of capital leaseobligations.  In 2006, we made $0.9 million total payments related to our capital leases, of which $0.8 million related toprincipal.

            Other than the financingactivities described above, we do not have any other sources of long-term borrowings or available lines of credit. Additionally, there is no covenant under any of our long-term debt agreements that restricts our ability to undertake additionaldebt or equity financing.  If we default on our payment obligations under our aircraft subleases with Continental, in additionto any other remedies it may have, Continental can elect to reduce its payments to us under the Continental CPA by the amount ofthe defaulted payment.  In addition, Continental or we can reduce any payments to the other party under the agreement in anamount corresponding to any defaulted payments by the other party under the foregoing obligations.

            See Item 8. “Financial Statements and Supplementary Data –Notes to Consolidated Financial Statements –Note 4,”“– Note 5” and “–Note 6” for detailed descriptions of these long-term debts andobligations.

***            Securities RepurchaseProgram.***  In July 2005, our board of directors authorized the expenditure of up to $30 million to repurchaseshares of our common stock.  Since the inception of the program, we have purchased 590,800 shares of our common stock at anaverage cost per share of $9.55.  In February 2006, the board authorized the inclusion of our 4.25% convertible notes due 2023within the previously announced $30 million program.  We did not make any purchases under this program during 2006.

            ***Collective BargainingAgreements***

            The following table providesinformation related to our principal collective bargaining agreements and their respective amendable dates as of December 31,2006:

**Employee Group**

**Approximate Number of Employees**

**Representing Union**

**Contract Amendable Date**

  

  

  

Pilots and Instructors

2,600

Air Line Pilots Association, International

December 2010

Mechanics

1,000

International Brotherhood of Teamsters

August 2009

Flight Attendants

1,300

International Association of Machinists and Aerospace Workers

August 2010

Dispatchers

80

Transport Workers Union of America

July 2009

            Our other employees are notcovered by collective bargaining agreements.

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            ***Deferred IncomeTaxes***

**

            In October 2006, Continentalentered into a final settlement agreement with the IRS that included periods during which we were included in its consolidatedfederal income tax return.  Our taxable income was not adjusted, but the amount of net operating losses allocated to us wasincreased by approximately $31.2 million.  In accordance with our tax agreement with Continental, we paid Continentalapproximately $10.9 million for the increase of our federal net operating loss carryforwards.  In addition, we adjusted ourtax accounts for the increase in our federal net operating loss which was fully utilized in our 2005 tax year.

            In conjunction with our initialpublic offering in April 2002, the tax basis of our tangible and intangible assets was adjusted to fair value.  Thisadjustment to tax basis should result in additional tax deductions being available to us through 2017.  In accordance with ourtax agreement with Continental, to the extent we generate taxable income sufficient to realize the additional tax deductions, weare required to pay Continental a percentage of the amount of tax savings actually realized, excluding the effect of any losscarrybacks.  We are required to pay Continental 100% of the first third of the anticipated tax benefit, 90% of the secondthird and 80% of the last third.  However, if the tax benefits are not realized by the end of 2018, we will be obligated topay Continental 100% of any benefit realized after that date.  Since these payments are solely dependent on our ability togenerate sufficient taxable income to realize these deferred tax assets, they are recorded as an obligation to Continental withinthe deferred tax asset accounts, and the portion we may retain in the future is offset by a valuation allowance.  At the timeof the initial public offering, the valuation allowance and the obligation to Continental offset the step-up in basis of assets inour long-term deferred tax asset account.  We made approximately $24.8 million and $25.3 million of net payments toContinental under the tax agreement related to the additional tax deductions during 2006 and 2005, respectively.

            The tax agreement requiresContinental to reimburse us for any net increase in our cash tax payments resulting from any decreased availability of netoperating loss carryovers related to the basis increase at the time our payment occurs.  The resulting receivable and/orpayable is recorded within the deferred tax asset account since its performance is dependent on our ability to generate taxableincome.

            No valuation allowance wasestablished on our net operating loss carryforwards or on our receivable from Continental for reimbursing carryforward lossesutilized resulting from the basis increase because we believe our stand-alone taxable income will be sufficient to utilizesubstantially all of these assets within the next several years.

            We believe that our initialpublic offering created a change in ownership limitation on the utilization of our federal tax attribute carryforwards, primarilynet operating losses.  Section 382 of the Internal Revenue Code limits our utilization of these attributes to offset up toapproximately $43.3 million of post-change taxable income per year.  This limitation did not have any impact on our financialcondition during the years ending 2006 and 2005.

            Our tax agreement increases ourdependence on Continental’s financial condition.  If it is determined that any of the tax benefits related to the basisincrease should not have been available at the time of utilization and, as a result, we are required to pay additional taxes,interest and penalties, then we could be adversely affected if Continental were unable to indemnify us under theagreement.

***Purchase Commitments***

            As of December 31, 2006, we haveoptions for 100 ERJ-145XR aircraft that may be exercised for other types of aircraft within the ERJ-145 Family.  During 2005,Continental declined the right to exercise any of these options.  We retain the right to exercise them and fly these aircraftfor other airlines or under our own code, subject to some restrictions; however, we will have to finance our acquisition of theseaircraft independently.  Currently, we do not have any firm commitments for aircraft purchases. 

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            Prior to December 2005, under ourpower-by-the-hour agreement with Rolls Royce, we were obligated to acquire up to three spare engines to support our existingaircraft and the remaining eight aircraft on firm order.  In December 2005, we negotiated the sale of eight engines to RollsRoyce and, in exchange, entered into seven new engine leases with a Rolls Royce subsidiary.  The engines leased have greaterinterchangeability than the engines sold. As a result, we have satisfied our engine obligations and are no longer obligated topurchase the three engines.  These leases are classified as operating leases; hence they are not reflected as assets andliabilities on our balance sheet. 

            We also have other contractualobligations of approximately $1.4 billion under our power-by-the-hour contracts with various service providers.  Thepower-by-the-hour contracts dictate the method by which we pay a vendor based on our actual level of operations in exchange forvendor coverage on specific parts and equipment on our aircraft when those parts and equipment are in need of repair orreplacement.  Each contract varies in term and payment procedure.  The estimated amount of our future commitment is basedon assumptions related to future level of operations and forecasted payment rates.  Our level of operations is determinedbased on Continental’s most recent operating plan for us, which can be altered at Continental’s sole discretion, andour estimates for the 69 aircraft that we are re-deploying.  Forecasted payment rates are based on actual rates as of January1, 2007 and increased annually according to the particular inflation indices detailed in each contract.  Contractual rateincreases at actual time of occurrence may be different than the forecasted rates.

            For the year ended December 31,2006, we spent $27.5 million on capital expenditures.  We anticipate cash outlays for 2007 fleet-related capital expendituresto be approximately $18.0 million.  Other 2007 cash outlays, exclusive of fleet plan requirements, relating to facilityimprovements or construction in conjunction with branded flying operations, back office infrastructure, tooling and groundequipment are expected to total approximately $27.0 million.  We expect to fund our future capital commitments throughinternally generated funds.  However, there can be no assurance that sufficient financing will be available for all aircraftand other capital expenditures not covered by firm financing commitments. 

***            Off-Balance SheetArrangements***

**

*           * In the ordinarycourse of business, we enter into operating leases related to our aircraft, spare engines and facilities.  In accordance withU.S. generally accepted accounting principles, these arrangements are not reflected on our balance sheet; however, they arereasonably likely to have a material effect on our future financial statements and financial outlook.

            We enter into these arrangementsto gain access to aircraft, equipment and facilities without requiring significant capital up front.  Since these assets areused in connection with our capacity purchase agreement, these assets are required to generate substantially all of ourrevenue.

            If Continental terminated theContinental CPA for cause, it would have the right to terminate our leases or subleases for aircraft covered by the agreement andtake possession of them.  In addition, Continental would have the ability to reject the leases and subleases on our aircraftif it filed for bankruptcy protection.  Moreover, with the reduction notice and Continental’s ability to terminate theContinental CPA, we could lose access to some or substantially all of our airport facilities. See Item 1A. “RiskFactors” for additional information.

            ***AircraftLeases.***  Our aircraft leases and subleases expire between 2013 and 2022.  As of December 31, 2006, our expectedtotal minimum annual rental payments for 2007 under current and future non-cancelable aircraft operating leases are approximately$345.2 million including rental payments for the 69 aircraft removed from the capacity purchase agreement with ContinentalAirlines.  Over 90% of our aircraft are leased directly by Continental from third parties and subleased by Continental tous.  If Continental were to default under these leases, our ability to retain access to the aircraft could be adverselyaffected.  See more detailed description of our risks related to our aircraft leases under Item 1A. "Risk Factors."

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            ***Other Leases.*** Other leases and subleases are primarily related to ground facilities (airport and maintenance) spare engines, and a flighttraining device.  These leases have greatly varying terms, which we expect, in most cases, to be renewed or replaced.  Asof December 31, 2006, our expected total minimum annual, non-aircraft rental payments for 2007 under current and futurenon-cancelable operating leases are approximately $15.2 million. The expected total minimum rental payments for 2007, by category,are as follows (in millions):

Airportfacilities                                      

$

7.3

Maintenance facilities

3.2

Flight equipment

4.0

Other

0.7

$

15.2

            Airport facility rent under theContinental CPA is a fully reconciled cost.  Maintenance facilities and flight equipment rentals related to the agreement arecosts within the margin band which could impact our quarterly reconciliation payment if these costs drive the prevailing margin tobe less than 8.5% or higher than 10.0%.

            ***Contractual Obligations andCommercial Commitments***

            The following table summarizesthe expected effect our material debt, capital leases, operating leases and other contractual obligations have on our future cashflows as of December 31, 2006 (in millions):

**                                                                    **

**Total**

**2007**

**2008**

**2009**

**2010**

**2011**

**Over 5 Years**
****************************
4.25% senior convertible notes due 2023 (1)

148.9

 

5.8

 

143.1

 

—

 

—

 

—

 

—

Other long-term debt (2)

17.7

2.7

4.4

4.1

3.9

2.6

—

Capital lease (3)

1.1

0.9

0.2

—

—

—

—

Aircraft operating leases (4)

4,060.9

345.2

347.9

347.9

347.9

347.9

2,324.1

Other operating leases (5)

252.2

33.8

34.6

35.4

36.2

37.1

75.1

Obligations under capacity purchase and   other agreements with Continental (6)

64.6

16.4

16.1

16.1

16.0

—

—

Other contractual obligations (7)

1,420.6

145.5

149.6

154.5

157.9

158.6

654.5

Total expected cash obligations

$

5,966.0

$

550.3

$

695.9

$

558.0

$

561.9

$

546.2

$

3,053.7

(1)  

The expected impact of our 4.25% senior convertible notes due 2023 on our future cash flows assumesthe notes will be redeemed on August 1, 2008, the earliest date the holders of the notes may require us to repurchase thenotes.  If the notes are held until August 1, 2023, the maturity date, our obligations outlined above would increase by $87.5million as a result of additional interest expense related to these notes.  See Item 8.  “Financial Statements andSupplementary Data – Note to Consolidated Financial Statements – Note 7” for a detailed description of thesenotes.

(2)  

Other long-term debt represents our obligation for the advances received under our loan agreementwith EDC.  See detailed discussion of our financing arrangement with EDC in Item 8. ”Financial Statement andSupplementary Data – Notes to Consolidated Financial Statements – Note 5.”  The expected effect of ourfinancing arrangement with EDC on our future cash flows is calculated based on the six-month LIBOR plus 1.75% per annum andincludes principal payments of $14.4 million and estimated interest payments of $3.2 million. 

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(3)  

Capital lease obligation represents the minimum lease payments, including interest expense, for someof our ground service equipment that are under a capital lease agreement.  See Item 8 “Financial Statements andSupplementary Data – Notes to the Consolidated Financial Statements – Note 4”.

(4)  

Aircraft operating lease obligations are the estimated lease payments for all of our aircraft underlong-term operating leases and subleases from Continental at December 31, 2006, including the 69 that we are required to continueleasing due to our decision to retain the aircraft, and the 205 that remain subject to the Continental CPA.  If the lateraircraft were withdrawn from the agreement, we would have the option to retain them or return them to Continental.  Theseagreements with Continental have substantially the same terms as the lease agreements between Continental and the third-partylessors, and expire between 2013 and 2022.  See Item 8. “Financial Statements and Supplementary Date – Notes tothe Consolidated Financial Statements – Note 4.”  The aircraft lease payments in the table above include theadjusted lease payments for the 69 being withdrawn from the Continental CPA beginning in December 2006.  The agreementcontains a provision for the interest rate implicit in calculating the scheduled lease payments for these aircraft to increase by200 basis points.

(5)  

Other operating lease obligations represent the estimated lease payments for our ground serviceequipment, spare engines and substantially all of our ground facilities, including facilities at public airports, from Continentalor the municipalities or agencies owning and controlling such airports that are under operating leases.  Other operating leaseobligations also include the lease payments related to a flight training device.  Continued operations are assumed throughnormal lease renewals.

(6)  

Obligations under the Continental CPA and other agreements with Continental represent fixed chargesfor ground handling costs at Continental stations and charges for administrative services provided by Continental, such astechnology, fuel management and insurance services.  The amounts disclosed above are based on our best estimates as ofDecember 31, 2006 under the terms of our contracts currently in place.

(7)  

Other contractual obligations include our power-by-the-hour agreement with Rolls Royce.  Weexpect to fund these commitments with cash generated from operations.  The estimated amount of future commitments is based onassumptions related to anticipated future levels of operations and forecasted payment rates.  The level of operations inherentin the estimated amounts detailed above is based on Continental’s most recent operating plan for Airlines, which can bealtered at Continental’s sole discretion and includes the 69 aircraft exiting the Continental CPA.   Contractualrate increases at actual time of occurrence may be different than the forecasted rate inherent in the amounts detailedabove. 

            The actual effects that thelisted obligations above may have on our future cash flow may differ materially from our estimates.

***            Other ContingentLiabilities or Commitments***

            We are a party to many contractsin which it is common for us to agree to indemnify third parties for tort liabilities that arise out of or relate to the subjectmatter of the contract.  In some cases, this indemnity extends to related liabilities arising from the negligence of theindemnified parties, but usually excludes any liabilities caused by gross negligence or willful misconduct.  We cannotestimate the potential amount of future payments under these indemnities until events arise that would trigger a liability underthe indemnities.  However, we expect that we would be covered by insurance for any such liabilities, subject todeductibles.

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            We are a defendant in variouslawsuits and proceedings arising in the ordinary course of our business.  While the outcome of these lawsuits and proceedingscannot be predicted with certainty, we do not believe that the ultimate disposition of these proceedings will have a materialadverse effect on our financial position, results of operations or cash flows.

****

            In September 2006, Airlines begandiscussions with Continental to adjust the scheduled block hour rates for 2007 under the Continental CPA.  Although theagreement contemplates a November 1 deadline for setting the rates each year, the parties extended that deadline in an attempt toreach agreement.  In January 2007, the parties submitted their disagreements to binding arbitration in accordance with theterms of the agreement, which provides that it will be conducted pursuant to the Federal Arbitration Act.  Each party hasselected******one arbitrator, and those two will select a third arbitrator to complete the panel.  The agreement setsforth procedures and a schedule that will likely result in a hearing and issuance of a final decision by late in the second orearly in the third quarter of 2007.  Airlines will continue to be paid under the 2006 block hour rates during the arbitrationprocess, and expects the decision setting the revised rates to be retroactive to January 1, 2007.  We do not intend to issueany reports on the progress of the arbitration until the panel issues its final decision.  We cannot predict the outcome ofthe arbitration.  If decided adversely to us, the arbitration could have a material adverse effect on our results ofoperations, liquidity and financial position.  See Item 1A. “Risk Factors.”

****

**Item 7A.  Quantitative and Qualitative Disclosure About MarketRisk**

            We have been and are subject tomarket risks, including commodity price risk (such as, to a limited extent, aircraft fuel prices) and interest raterisk.

**Aircraft Fuel**

            Effective January 1, 2001, weentered into the Continental CPA, which is scheduled to expire on December 31, 2010 (subject to any extensions by Continentalthrough 2030 and its right to terminate the agreement without cause upon 12 months’ notice or at any time for cause), and arelated fuel purchase agreement with Continental, which terminates when the Continental CPA terminates.  Under theseagreements, Continental provides all of Airlines’ aircraft fuel needs for the aircraft covered by the Continental CPA, andAirlines incurs an expense equal to the lower of the actual cost of the fuel or an agreed-upon cap.  Airlines’ averageactual fuel costs, including tax, and the respective agreed-upon fuel cost and fuel tax caps are 71.20 for the years ended 2006,2005 and 2004.

            If the fuel agreement withContinental were not in place, Airlines’ average fuel cost, including related taxes, would have been $2.04, $1.80 and $1.23per gallon for the years ending December 31, 2006, 2005 and 2004, respectively.  As Airlines’ current fuel price is atits combined agreed-upon cap under the fuel purchase agreement, we are not subject to any fuel price risk for flying under theContinental CPA..

            Under the Continental CPA,Airlines recovers its fuel expense from Continental with a 10% margin.

**Interest Rates**

           During2006, we notified Continental that we would retain the 69 aircraft being released from the Continental CPA.  The agreementcontains a provision for the long-term interest rate implicit in calculating the scheduled lease payments we make to Continentalfor these aircraft to increase by 200 basis points when the aircraft are removed from the agreement, however, the agreementprovides that our block hour rates for the 205 aircraft remaining in the agreement will be adjusted higher or lower to reflect anychanges in the average rental rates.

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            We also have potential interestrate exposure with respect to our loan agreement with Export Development Canada, which bears interest at the six-month LIBOR plus1.75% per annum.  The interest rate applicable to this variable rate note may rise, increasing our interest expense.  Theimpact of market risk is estimated using a hypothetical increase in interest rates by 100 basis points for our variable ratelong-term debt.  Based on this hypothetical assumption, we would have incurred an additional $0.2 million and $1.0 million ininterest expense for the 2006 and 2005, respectively. 

            As of December 31, 2006 and 2005,we estimated the fair value of our $137.2 million (carrying value) convertible fixed-rate debt to be $127.9 million and $112.8million, respectively based upon quoted market prices.  Changes in the fair market value of our fixed-rate debt could beaffected by a variety of factors including, but not limited to, general investor behavior, industry specific risks and interestrate risks.

**Item 8.  Financial Statements and Supplementary Data**

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

                                                                                                                                           

   

**Page**

Report of Management

54

Report of Independent Registered Public Accounting Firm

55

Report of Independent Registered Public Accounting Firm on Internal Control over     Financial Reporting

56

Consolidated Statements of Operations for each of the Three Years Ended     December 31, 2006

58

Consolidated Balance Sheets as of December 31, 2006 and 2005

59-60

Consolidated Statements of Cash Flows for each of the Three Years Ended     December 31, 2006

61

Consolidated Statements of Stockholders' Equity (Deficit) for each of the Three     Years Ended December 31, 2006

62

Notes to Consolidated Financial Statements

63

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**REPORT OF MANAGEMENT**

The Board of Directors and Stockholders ofExpressJet Holdings, Inc.

****

            Management is responsible for thepreparation and fair presentation of the financial statements included in this report.  The financial statements have beenprepared in conformity with U.S. generally accepted accounting principles and reflect management’s judgments and estimatesconcerning effects of events and transactions that are accounted for and disclosed.

            Management is also responsiblefor establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a -15(f) and 15d - 15(f)under the Securities Exchange Act of 1934.  The internal control over financial reporting of ExpressJet Holdings, Inc. (the“Company”) is designed to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:

  

(i)  

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of assets of the Company; 

(ii)  

provide reasonable assurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of theCompany are being made only in accordance with authorizations of management and directors of the Company; and

(iii)  

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of the Company’s assets that could have a material effect on the financial statements.

            Management recognizes that thereare inherent limitations in the effectiveness of any internal control over financial reporting, including the possibility of humanerror and the circumvention or overriding of internal control.  Accordingly, even effective internal control over financialreporting can provide only reasonable assurance with respect to financial statement preparations and may not prevent or detectmisstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controlsmay become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures maydeteriorate.

            Under the supervision and withthe participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluationof the effectiveness of our internal control over financial reporting as of December 31, 2006 based on the framework in InternalControl—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based onthat evaluation, our management concluded that our internal control over financial reporting was effective as of December 31,2006.

            Management’s assessment ofthe effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by Ernst & Young,LLP, an independent registered public accounting firm, as stated in their report which is included elsewhere herein.

/s/JAMES B.REAM                               James B. Ream President and Chief Executive Officer

             

/s/FREDERICK S.CROMER                  Frederick S. Cromer Vice President and Chief Financial Officer

/s/PHUNGNGO-BURNS                        Phung Ngo-Burns Staff Vice President and Controller

                                                                         

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

The Board of Directors and Stockholders ofExpressJet Holdings, Inc.

           We have audited the accompanying consolidated balance sheets of ExpressJet Holdings, Inc. (the “Company”) as ofDecember 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity (deficit) and cashflows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on these financial statements based on ouraudits.

            We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.An audit includes assessing the accounting principles used and significant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

            In our opinion, the consolidatedfinancial statements referred to above, present fairly, in all material respects, the consolidated financial position of theCompany as of December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles**.**

            As discussed in Note 9 to theconsolidated financial statements, in 2006 the Company changed its method of accounting for share-based compensation as required byStatement of Financial Accounting Standards No. 123(R), “Share-Based Payments.”

            We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of theCompany’s internal control over financial reporting as of December 31, 2006, based on criteria established in InternalControl – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our reportdated February 21, 2007 expressed an unqualified opinion thereon.

        

ERNST & YOUNG LLP

Houston, Texas February 21, 2007

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMON INTERNALCONTROL OVER FINANCIAL REPORTING**

The Board of Directors and Stockholders ofExpressJet Holdings, Inc.

           We have audited management’s assessment, included in the accompanying Report of Management, that ExpressJet Holdings,Inc. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (theCOSO criteria). ExpressJet Holdings, Inc.’s management is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internal control over financial reporting.  Ourresponsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’sinternal control over financial reporting based on our audit.

            We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonablebasis for our opinion.

            A company’s internalcontrol over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain tothe maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the companyare being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assetsthat could have a material effect on the financial statements.

            Because of its inherentlimitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes inconditions, or that the degree of compliance with the policies or procedures may deteriorate.

            The Company installed a newintegrated human resources, payroll, and financial system on January 1, 2007, which was subsequent to the date ofmanagement’s assessment of the effectiveness of internal control over financial reporting.

            In our opinion,management’s assessment that ExpressJet Holdings, Inc. maintained effective internal control over financial reporting as ofDecember 31, 2006, is fairly stated, in all material respects, based on the COSO criteria.  Also, in our opinion, ExpressJetHoldings, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006,based on****the COSO criteria**.**

            We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets ofExpressJet Holdings, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations,stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006 of ExpressJetHoldings, Inc. and our report dated February 21, 2007 expressed an unqualified opinion thereon.

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ERNST & YOUNG LLP

Houston, Texas February 21, 2007

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**EXPRESSJET HOLDINGS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)**

**                                                                                            **

**Year Ended December 31,**
****
**2006**

**2005**

**2004**
************
Operating Revenue

$

1,679,637

$

1,562,818

$

1,507,524

 

Operating Expenses:

     Wages, salaries and related costs

386,678

349,390

319,159

     Aircraft rentals

332,441

309,018

281,455

     Aircraft fuel and related taxes

227,164

210,412

187,088

     Maintenance, materials and repairs

207,251

181,355

154,027

     Ground handling

99,876

95,423

105,742

     Other rentals and landing fees

116,216

104,043

87,602

     Outside services

33,798

28,663

29,299

     Depreciation and amortization

25,770

26,992

23,537

     Other operating expenses

109,372

100,979

114,188

 

 

1,538,566

1,406,275

1,302,097

 

Operating Income

141,071

156,543

205,427

 

Nonoperating Income (Expense):

     Interest expense

(7,335

)

(10,745

)

(11,841

)

     Interest income

14,665

8,295

3,673

     Capitalized interest

294

506

581

     Equity investment loss

(2,036

)

(606

)

—

     Other, net

(203

)

241

164

 

5,385

(2,309

)

(7,423

)

Income before Income Taxes

146,456

154,234

198,004

Income Tax Expense

53,891

56,241

75,233

 

Net Income

$

92,565

$

97,993

$

122,771

 

Basic Earnings per Common Share

$

1.72

$

1.81

$

2.26

 

Diluted Earnings per Common Share

$

1.56

$

1.65

$

2.04

 

Shares Used in Computing Basic Earnings per Common   Share:

    Basic

53,864

54,117

54,220

    Diluted

61,529

61,722

61,779

The accompanying Notes to Consolidated Financial Statements are an integral part ofthese statements.

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****

**EXPRESSJET HOLDINGS, INC.CONSOLIDATED BALANCE SHEETS(In thousands)**

**ASSETS**

**December 31,**

**                                                                                                       **

**2006**

**2005**
********
Current Assets:

     Cash and cash equivalents

$

291,633

$

227,285

     Restricted cash

11,227

9,218

     Accounts receivable, net

7,603

3,916

     Amounts due from Continental Airlines, Inc., net

—

4,832

     Spare parts and supplies, net

23,717

26,555

     Prepayments and other

14,614

6,163

        Total Current Assets

348,794

277,969

Property and Equipment:

     Owned property and equipment:

        Flight equipment

213,682

207,010

        Other

143,815

124,156

 

357,497

331,166

        Less:  Accumulated depreciation

(113,195

)

(92,095

)

244,302

239,071

     Capital Leases:

 

        Ground Service Equipment

4,338

4,310

        Less:  Accumulated amortization

(3,557

)

(2,930

)

781

1,380

        Total Property and Equipment

245,083

240,451

Investments in Other Entities

18,017

17,255

Reorganization Value in Excess of Amounts Allocable to   Identifiable Assets, net

12,986

12,789

Airport Operating Rights, net

3,691

3,942

Debt Issuance Cost, net

3,497

3,696

Other Assets, net

4,961

4,168

 

        Total Assets

$

637,029

$

560,270

 

The accompanying Notes to Consolidated Financial Statements are an integral part ofthese statements.

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**EXPRESSJET HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands, except for share data)**

**LIABILITIES AND**

**December 31,**

**STOCKHOLDERS' EQUITY**

**2006**

**2005**

**                                                                                                                        **
********
Current Liabilities:

 

     Current maturities of long-term debt

$

1,668

$

865

     Current maturities of note payable to Continental Airlines,Inc.

—

17,545

     Current maturities of capital lease obligations

821

770

     Accounts payable

3,668

3,467

     Accrued payroll and related costs

48,643

50,157

     Amounts due to Continental Airlines, Inc., net

3,522

—

     Deferred income taxes

14,785

11,178

     Accrued other liabilities

61,985

67,639

        Total Current Liabilities

135,092

151,621

Long-term Debt

12,818

14,435

4.25% Senior Convertible Notes due 2023

137,200

137,200

Capital Lease Obligations

214

1,035

Deferred Income Taxes

38,030

37,461

Other Long-term Liabilities

9,361

10,008

Stockholders’ Equity:

     Preferred stock - $.01 par, 10,000,000 shares authorized, no         shares and one share issued and outstanding, respectively

—

—

     Common stock - $.01 par, 200,000,000 shares authorized, and         54,653,942 and 54,653,942 shares issued, respectively

547

547

     Additional paid-in capital

165,658

165,074

     Accumulated earnings

142,349

50,082

     Unearned compensation on restricted stock

—

(1,518

)

     Accumulated other comprehensive income

364

—

     Common stock held in treasury, at cost — 487,261 and594,747          shares, respectively

(4,604

)

(5,675

)

        Total Stockholders’ Equity

304,314

208,510

        Total Liabilities and Stockholders’Equity

$

637,029

$

560,270

 

The accompanying Notes to Consolidated Financial Statements are an integral part ofthese statements.

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**EXPRESSJET HOLDINGS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

**                                                                                                                    **

**Year Ended December 31,**
****
**2006**

**2005**

**2004**
************
Cash Flows from Operating Activities:

  Income before dividends

  

$

92,565

  

$

97,993

  

$

122,771

  Adjustments to reconcile net income to net cash provided by     operating activities

      Deferred income taxes

3,961

2,018

14,411

      Depreciation and amortization

25,771

26,992

23,537

      Equity loss from investments in other entities

2,036

606

—

      Other, Net

2,855

3,240

8,067

  Changes in operating assets and liabilities:

      Increase in restricted cash

(2,009

)

(2,906

)

(3,112

)

      (Increase) decrease in account receivable, net

(3,003

)

1,732

(1,001

)

      (Increase) decrease in amounts due Continental Airlines, Inc.,net

8,353

(16,071

)

2,322

      (Increase) decrease in spare parts and supplies, net

894

(944

)

(4,672

)

      (Increase) decrease in prepayments and other assets

(6,816

)

(696

)

6,482

      Increase (decrease) in accounts payable

(224

)

321

(4,044

)

      Increase (decrease) in other liabilities

(7,680

)

18,305

(11,156

)

      Net cash provided by operating activities

116,703

130,590

153,605

Cash Flows from Investing Activities:

  Capital expenditures

(27,542

)

(21,147

)

(37,536

)

  Purchase of flight equipment from Continental Airlines, Inc.

—

—

(1,368

)

  Proceeds from the sale of property and equipment to     Continental Airlines, Inc.

397

901

—

  Proceeds from disposition of equipment

—

1,826

383

  Sale (purchase) of short-term investments

—

18,650

(5,000

)

  Investments in and Advances to consolidated and other entities

(6,414

)

(20,984

)

—

  Net cash used in investing activities

(33,559

)

(20,754

)

(43,521

)

Cash Flows from Financing Activities:

  Repurchase of common stock

—

(5,643

)

—

  Payments on note payable to Continental Airlines, Inc.

(17,545

)

(81,259

)

(94,368

)

  Payments on long-term debt and capital lease obligations

(1,642

)

(6,708

)

(2,611

)

  Redemption of note related to Series A Preferred Stock

—

5,000

—

  Proceeds from issuance of common stock

391

602

842

  Proceeds from sale-leaseback transactions

—

15,268

—

    Net cash used in financing activities

(18,796

)

(72,740

)

(96,137

)

  Net Increase in Cash and Cash Equivalents

64,348

37,096

13,947

Cash and Cash Equivalents - Beginning of Year

227,285

190,189

176,242

  

Cash and Cash Equivalents - End of Year

$

291,633

$

227,285

$

190,189

Supplemental Cash Flow Information:

  Interest paid

$

7,186

$

9,900

$

11,165

  Income taxes paid, net (including amounts from our tax      agreement with Continental Airlines, Inc.)

$

65,783

$

51,751

$

65,353

The accompanying Notes to Consolidated Financial Statements are an integral part ofthese statements.

.

**Table ofContents**

**EXPRESSJET HOLDINGS, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)(In thousands)**

**Common Stock**

**Treasury Stock**

**Share**

**Amount**

** **

**Share**

** **

**Amount**

** **

**Additional Paid-in Capital**

** **

**Unearned Compensation on Restricted Stock**

** **

**Accumulated Other Comprehensive Income/(Loss)**

**Accumulated Earnings (Deficit)**

** **

**Total**
************************************
Balance at December 31, 2003

54,165

542

0

—

159,841

—

—

(170,670

)

(10,287

)

Net Income

—

—

—

—

—

—

—

122,771

122,771

Issuance of common stock pursuant to stock plans

210

2

(3

)

35

2,571

(1,763

)

—

(1

)

844

Cancellation of previously   issued equity awards

—

—

5

(57

)

—

57

—

—

—

Amortization of deferred   compensation

—

—

—

—

—

710

—

—

710

Deferred compensation income   tax effect

—

—

—

—

6

—

—

—

6

Balance at December 31, 2004

54,375

544

2

(22

)

162,418

(996

)

—

(47,900

)

114,044

Net Income

—

97,993

97,993

Issuance of common stock   pursuant to stock plans

279

3

(8

)

99

2,637

(2,126

)

—

(11

)

602

Cancellation of previously   issued equity awards

—

—

10

(109

)

—

36

—

—

(73

)

Amortization of deferred   compensation

—

—

—

—

—

1,568

—

—

1,568

Deferred compensation income   tax effect

—

—

—

—

19

—

—

—

19

Stock repurchase

—

—

591

(5,643

)

—

—

—

—

(5,643

)

Balance at December 31, 2005

54,654

547

595

(5,675

)

165,074

(1,518

)

—

50,082

208,510

Net Income

92,565

92,565

Other Comprehensive Income,   net of tax

364

—

364

Comprehensive Income

92,929

Issuance of common stock   pursuant to stock plans

—

—

(126

)

1,184

(631

)

—

—

(279

)

274

Cancellation of previously   issued equity awards

—

—

18

(113

)

12

—

—

—

(101

)

Amortization of deferred   compensation

—

—

—

—

(1,518

)

1,518

—

—

—

Stock based compensation

—

—

—

—

2,707

—

—

—

2,707

Deferred compensation income   tax effect

—

—

—

—

14

—

—

—

14

Other

—

—

—

—

—

—

—

(19

)

(19

)

Balance at December 31, 2006

54,654

$

547

487

$

(4,604

)

$

165,658

$

—

$

364

142,349

$

304,314

 

The accompanying Notes to Consolidated Financial Statements are an integral part ofthese statements.

Table of Contents

****

**EXPRESSJET HOLDINGS, INC**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

            ExpressJet Holdings, Inc.(“Holdings”) has strategic investments in the air transportation industry.  Our principal asset is all of theissued and outstanding shares of stock of XJT Holdings, Inc., the sole stockholder of ExpressJet Airlines, Inc.(“Airlines”), which currently operates as Continental Express (Holdings and Airlines are together referred to as “ExpressJet,” “we,” “us” and “our”).  Airlines is one of the largest regionalairlines in the world, based on available seat miles, number of regional jets in its fleet and number of passengers flown.  Wealso invest in other entities that permit us to leverage the management experience, efficiencies and economies of scale present inour subsidiaries.

           Airlines currently operates a fleet of 274 aircraft.  During substantially all of 2006, the entire fleet operated onbehalf of Continental as Continental Express pursuant to our capacity purchase agreement (the “Continental CPA”) and wereceived substantially all of our revenue under that agreement.  In December 2006, Continental began releasing 69 aircraft(25% of our fleet) from that agreement.  We redeployed two of these aircraft to charter service in 2006; the other 67 arebeing removed from Continental service during the first six months of 2007 and will be deployed in branded flying, charter service,or a CPA arrangement with a major network carrier.  Branded flying, under the name “ExpressJet” will provideregularly scheduled air service to West, Midwest and Southeast destinations in the United States commencing service on April 2,2007.  We will continue to operate the remaining 205 aircraft under the Continental CPA.  Although we believe that thesenew operations will enhance stockholder value in the long term, significant start-up costs will be incurred during our transitionperiod, which is likely to significantly reduce our overall profitability for 2007.  In addition, we may experience volatilityin our quarterly results as these operations begin.

**Note 1 – Summary of Significant Accounting Policies**

**            *  (a) Principles ofConsolidation* –**

            The accompanying consolidatedfinancial statements have been prepared in accordance with U.S. generally accepted accounting principles and include the accountsof Holdings and its subsidiaries.  All material intercompany transactions have been eliminated in consolidation.

            On August 31, 2006, ExpressJetpurchased the remaining 51% interest in American Composites, LLC, an aviation maintenance business in Miami, Florida, for $0.8million in cash and the results of operations were consolidated in our financial statements beginning on September 1, 2006. Prior to this date, we accounted for this investment under the equity method of accounting as prescribed by Accounting PrinciplesBoard Opinion No. 18 – “The Equity Method of Accounting for Investments in Common Stock.” 

            During 2006, we invested $1.5million for an 80% interest in Saltillo Jet Center, S. de R.L. de C.V. (“Saltillo Jet Center”) an aircraft paintfacility located in Saltillo, Mexico.  We invested $9.2 million for the construction of the hangar and office facilities fromwhich the company conducts its operations.    As a result, we consolidated Saltillo Jet Center beginning on August1, 2006.

            In addition, we purchased InTechAerospace Services, LP (“InTech”), an aircraft interior refurbishment company for $3.0 million in November2005.

**            *(b) Use of Estimates*–**

            The preparation of financialstatements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions thataffect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from thoseestimates. 

**            *(c) Cash and CashEquivalents* –**

            Cash and cash equivalents consistof cash and short-term, highly liquid investments that are readily convertible into cash and have maturities of three months orless when purchased.  Restricted cash is our collateral for estimated future workers’ compensation claims, letters ofcredit, and charter deposits.

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***            (d) Accounts Receivables,net –***

**

            Accounts receivable are stated atthe historical carrying amount net of write-offs and allowance for uncollectible accounts.  Our allowance for uncollectibleaccounts at the end of 2006 and 2005 was $0.1 million.

**            *(e) Spare Parts andSupplies, net –***

**

*           * Inventories,expendable parts and supplies relating to flight equipment are carried at average acquisition cost and are expensed whenused.  An allowance for obsolescence is provided over the remaining estimated useful life of the related aircraft, plusallowances for spare parts currently identified as excess to reduce the carrying costs to the lower of amortized cost or netrealizable value.  These allowances are based on our estimates, which are subject to change.  Our allowance forobsolescence at December 31, 2006 and 2005 was $9.8 million and $9.1 million, respectively.

**            *(f) Property and Equipment–***

**

*           * Property andequipment are recorded at cost and are depreciated to estimated residual values over their estimated useful lives using thestraight-line method.  Property and equipment acquired under capital leases are recorded at the lower of the present value ofthe future minimum lease payments or the fair value of the asset at the inception of the lease.  The estimated useful livesand residual values for our property and equipment are as follows:

**Estimated Useful Life**

**Estimated Residual Value**

**                                                                           **

    

    

Flight Equipment

5 to 25 years

0% to 15%

Ground property and equipment

2 to 30 years

0%

Capital lease - flight and ground

3 to 8 years

0%

            Amortization related to assetsunder capital leases and operating leasehold improvements is included in our depreciation and amortization expense on the incomestatement.  We amortize assets under capital leases and operating leasehold improvements over the shorter of the asset life orlease term.

            In accordance with Statement ofFinancial Accounting Standards No. 144 – “Accounting for the Impairment or Disposal of Long-Lived Assets,” werecord impairment losses on long–lived assets used in operations when events and circumstances indicate that the assets mightbe impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of thoseassets.  The net carrying value of assets not recoverable is reduced to fair value.

            As shown in the following table,our aircraft fleet consisted of 274 regional jets at December 31, 2006.   We currently lease or sublease all of our existingregional jet aircraft from Continental.  See “—Note 4.”  Our aircraft options as of December 31, 2006are also shown below.  See Item 7.  “Management’s Discussion and Analysis of Financial Condition and Resultsof Operation – Liquidity and Capital Commitments – Purchase Commitments.”

**Type**

**Total Leased Aircraft**

**Options**

**Seats in Standard Configuration**

 

  

  

  

ERJ-145XR                             

104

100

50

ERJ-145

140

—

50

ERJ-135

30

—

37

Total

274

100

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Pursuant to our agreement with Embraer, the 100 ERJ-145XR option aircraft can be converted to someother types of aircraft within the ERJ-145 Family at our discretion.

**            *(g) Intangible Assets–***

**

*           * ReorganizationValue in Excess of Amounts Allocable to Identifiable Assets represents primarily the amount that arose from Continental’semergence from bankruptcy reorganization in 1993.   Effective January 1, 2002, we adopted and began to account for thisasset in accordance with Statement of Financial Accounting Standard No. 142–“Goodwill and Other IntangibleAssets” (“SFAS 142”).  SFAS 142 requires testing of goodwill and intangible assets with indefinite lives forimpairment rather than amortizing them.

            We evaluate the carrying value ofthis asset each reporting period to determine whether events and circumstances continue to support an indefinite useful life. We perform an impairment review on an annual basis, or more frequently if events or changes in circumstances indicate that theasset may be impaired.  Our review includes the acquisition, market-multiple and income approaches to valuation.  If thisreview indicates that our Reorganization Value in Excess of Amounts Allocable to Identifiable Assets will not be recoverable, thecarrying value is reduced to the fair value.  We performed this review during 2006, 2005 and 2004 and determined that we didnot have any impairment of our Reorganization Value in Excess of Amounts Allocable to Identifiable Assets.  Our annualimpairment test is performed as of June 30 of each year.

            In finalizing the business modelfor the aircraft being released from the Continental CPA, we determined a triggering event had occurred during the fourth quarterof 2006.  In accordance with our policy, we performed an SFAS 142 impairment analysis as soon as reasonably possible after thetriggering event, using the latest data available.  No impairment was identified.

            Airport operating rights, therights to use certain take-off and landing slots and gates, are amortized on a straight-line basis over the life of the relatedairport facility lease, which approximates 20 years, with no residual value.  Debt issuance cost and capitalized costs relatedto our senior convertible notes is amortized on a straight-line basis over 20 years, the term of the notes, and with no residualvalue.

**            *(h) Investments in OtherEntities –***

**

           Investmentsin unconsolidated companies are accounted for by the equity method of accounting when we have significant influence over theoperation of the companies as prescribed by Accounting Principles Board Opinion No. 18 – “The Equity Method ofAccounting for Investments in Common Stock” (“ABP 18”).  The following table details our currentnon-controlling interests that are accounted for under the equity method of accounting:

**Company**

**Carrying Amount of Investment at December 31, 2006 (in millions)**

 

 

JetX Aviation Limited

$

—

Wing Holdings, LLC

14.8

Flight Services and Systems, Inc.

3.2

           In March2005, we purchased an interest, constituting one share less than 50%, in JetX Aviation Limited, also known as ExpressJet Europe,for approximately $0.9 million.  The carrying amount of our investment exceeded the amount of the company’s underlyingequity by approximately $0.5 million at the date of the investment.  This difference was treated as goodwill and thus was notamortized.  On June 14, 2006, we loaned the company approximately $0.4 million to extend the level of support, which wascontemplated by the governing agreements and original business plan, through its development stage.  We recorded thisreceivable accordingly in Other Assets, net.  During the third quarter of 2006, after exhaustive discussions with numerousEuropean air carriers and the company’s failure to successfully negotiate a transaction, we determined that a decline in ourinvestment was other than temporary, and recorded an impairment loss of $0.4 million for the investment and related goodwill. Additionally, the outstanding loan balance was fully reserved during the third quarter 2006 resulting in a loss of $0.4 millionrecorded in Other Operating Expenses.

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            We purchased a 49% interest inWing Holdings, LLC for $16.0 million in June 2005.  The carrying amount of our investment exceeded the amount of thecompany’s underlying equity by approximately $8.5 million at the time of our investment.  We evaluated the net bookvalue of the company’s fixed assets as of June 30, 2005 and identified approximately a $1.9 million difference between netbook value and fair value.  The majority of the difference is being amortized over the remaining average life of the assetsidentified.  As of December 31, 2006, the balance of the fair value difference, net of amortization, was approximately $0.8million.  The remaining $6.6 million of our difference in the underlying investment is considered goodwill and thus is notamortized.

            In January 2006, we purchased a44% interest in Flight Services and Systems, Inc. for $3 million.  At the same time, we loaned the company $1 million which isclassified in Other Assets, net, on the consolidated balance sheets.  The note is due and payable in full on September 30,2007 with interest due and payable quarterly on the 15th day following the close of each calendar quarter.  The loan interestrate is equal to the lesser of 7% per annum or the three-month LIBOR plus 150 basis points.  We have received interestpayments pursuant to the terms of the agreement including the fourth quarter 2006 interest payment that was due January 15,2007.  

            Our proportionate shares of theresults of operations from these entities are included in the line “Equity investment income (loss), net” on ourconsolidated statements of operations.  Although no impairment losses on the investments, other than JetX Aviation, have beenrecognized, an impairment loss will be recorded whenever a decline in value of an equity investment below its carrying amount isdetermined to be other than temporary.  In evaluating “other than temporary,” we consider the length of time andextent to which the fair value of the investment has been less than the carrying amount of the equity investment, the near andlonger-term operating and financial prospects of the entity and our longer-term intent of retaining the investment in theentity.

**            *(i) Deferred Credits–***

            Our spare part and flighttraining credits are primarily derived from our purchase agreement with Embraer.  All spare part credits are used to offsetthe purchase price of initial spare parts provisioning for our newly delivered aircraft.  Similarly, the flight trainingcredits are used to pay for the initial simulator rent costs for our pilots.  These credits are recorded in long-termliabilities, with an offsetting entry to prepayments and other current assets or current accrued liabilities if we used morecredits than the amount we are entitled to at year-end.  The deferred credits are amortized as a reduction to our aircraftrent expense over the life of the associated aircraft lease.  Amortization totaled $0.9 million for each 2006 and 2005. The prepayments and other current assets or current accrued liabilities are reduced as the credits are used or as the remainingfirm order aircraft are delivered.

**            *(j) Operating Revenue–***

**

*           * We recognized ouroperating revenue under the Continental CPA based on negotiated rates for each scheduled block hour Airlines flies forContinental.  The rates were designed to provide Airlines with a target operating margin of 10% before taking into accountvariations in some costs and expenses that are generally controllable by Airlines.  We also record other revenues earned underthe Continental CPA, such as percentage of completed flights, certain on-time departures and baggage handling.  See“– Note 2” for details of the block hour rates and the performance incentive payments.  Our operatingrevenue is reconciled and settled with Continental on a monthly basis, except for the quarterly reconciliation of Airlines’costs within the margin band as defined in the Continental CPA.  The rates we use to calculate our operating revenue are basedon our interpretation of the agreement.  If our interpretation materially differs from Continental’s, our revenue couldbe materially understated or overstated. 

            All fully-reconciled costsincurred in connection with the Continental CPA are recorded as expense and revenue on a gross basis except for certain costs suchas fuel costs above our fuel and related tax cap and facility rent at Continental’s hubs.  These costs are absorbed byContinental under the terms of the Continental CPA and as such we are not the primary obligor for these costs and accordingly,these costs are not recorded as either revenue or expense by us.

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            ***(k) Wages, Salaries andRelated Expenses –***

**

*           * As our collectivebargaining agreements become amendable, we accrue for anticipated retroactive pay that we estimate will be due under the newcontract.  We have two stock-based compensation plans: the ExpressJet Holdings, Inc. 2002 Stock Incentive Plan and theExpressJet Holdings, Inc. 2003 Employee Stock Purchase Plan. The Company accounts for stock-based compensation utilizing the fairvalue recognition provisions of SFAS No. 123R, “Share-Based Payment”. See “- Note 9” forfurther details.

****

***            (l) Maintenance and RepairCosts –***

*           * Maintenance andrepair costs for owned and leased flight equipment, including the overhaul of aircraft components, are charged to operating expenseas incurred, except for those maintenance costs covered by power-by-the-hour agreements, which are expensed based on contractualterms.  In 2006 and 2005, power-by-the-hour arrangements represented approximately 70% of our maintenance, materials andrepairs costs.

**            *(m) Income Taxes–***

**

*           * Deferred incometaxes, which are provided under the liability method, are determined based on differences between the financial reporting andincome tax basis of assets and liabilities and are measured using enacted tax rates and laws.  A valuation allowance isprovided on deferred tax assets if, based on available evidence, it is more likely than not that future tax benefits will not berealized.

**            *(n) Earnings per Share–***

            We account for earnings per sharein accordance with Statement of Financial Accounting Standard No. 128 — “Earnings perShare.” Basic earnings per common share (“Basic EPS”) excludes dilution and is computed by dividing net incomeavailable to common stockholders by the weighted average number of common shares outstanding during the periods presented. Diluted EPS reflects the potential dilution that could occur if securities or other obligations to issue common stock wereexercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of thecompany.  The following table sets forth the reconciliation of the numerator and denominator of Basic EPS to the numerator anddenominator of Diluted EPS for the years ended December 31, 2006, 2005, and 2004 (in thousands, except per shareamounts):

**                                                                                               **

**Year ended December 31,**

**2006**

**2005**

**2004**

**Numerator:**

Net income

$

92,565

  

$

97,993

  

$

122,771

  

Income impact of assumed conversion of convertible debt

3,662

3,656

3,506

$

96,227

$

101,649

126,277

 

 

**Denominator:**

Weighted average common shares outstanding

53,864

54,117

54,220

Effect of stock options

2

11

9

Effect of restricted stock

125

56

12

Assumed conversion of convertible debt

7,538

7,538

7,538

61,529

61,722

61,779

Basic earnings per share

$

1.72

$

1.81

$

2.26

Diluted earnings per share

$

1.56

$

1.65

$

2.04

Table of Contents

            We excluded 239,078 and 287,563shares of restricted stock from the weighted average shares used in computing Basic EPS for the year ended December 31, 2006 and2005, respectively, as these shares were not vested as of these dates.

            We adopted the Emerging IssuesTask Force Issue No 04-08 – “The Effect of Contingently Convertible Debt on Diluted Earnings per Share”(“EITF 04-08”) on December 15, 2004.  As a result, we included the potential common stock equivalents related toour senior convertible notes in our computation of Diluted EPS and restated all prior periods in which the convertible notes wereoutstanding, as shown in the table above.

            The weighted average commonshares outstanding for the Diluted EPS calculation also includes the incremental effect of shares that would be issued upon theassumed exercise of stock options and vesting of restricted stock.  We excluded the following common stock equivalents fromour Diluted EPS calculations, because their inclusion would have been anti-dilutive:

         

• 

options to purchase 2.3 million, 1.6 million and 1.1 million shares of our common stock for theyears ended December 31, 2006, 2005 and 2004, respectively these options' exercise prices were greater than the average marketprice of the common shares for the respective periods; and

• 

0.2 million shares of restricted stock for the year ended December 31, 2005 and 2004.

**            *(o) Comprehensive Income–***

******

***           *** We providemedical bridge coverage for employees between the ages of 60 to 65, with at least 10 years of service who have retired from thecompany.  On December 31, 2006 we adopted the recognition and disclosure provisions of FASB Statement No. 158,*Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No 87,88, 106 and 132(R)* (“Statement 158”).  Statement 158 required the recognition of fund status (i.e., thedifference between the fair value of plan assets and projected benefit obligations) of its pension plan in the December 31, 2006statement of financial position, with a corresponding adjustment to accumulated other comprehensive income, net of tax.  Theincremental effects of adopting the provisions of Statement 158 on the statement of financial position at December 31, 2006 is anincrease to accumulated other comprehensive income and a decrease to accrued payroll and related cost of $0.4 million, net oftax. 

            ***(p) Financial Instrumentsand Risk Management –***

            *Financial Instruments––* Our financial instruments consist of cash and cash equivalents, short-term investments, accounts receivable,accounts payable, our long-term secured debt to EDC, note payable to Continental (which has been repaid in full) and 4.25% seniorconvertible notes due 2023.  The carrying amount of cash and cash equivalents, short-term investments, accounts receivable andaccounts payable approximate fair value due to the highly liquid nature of these short-term instruments.  As of December 31,2006 and 2005, the fair value of our long-term secured debt to EDC was approximately $14.7 million and $15.0 million,respectively.  The fair value of our 4.25% senior convertible notes due 2023 was approximately $127.9 million and $112.8million based on the quoted market price as of December 31, 2006 and 2005, respectively.  As of December 31, 2004, we also hadone share of non-voting Series A Preferred Stock, par value $.01 per share, outstanding.  The carrying value of our Series APreferred Stock at December 31, 2004 approximated fair value.  We redeemed this instrument in April 2005.  See“—Note 5” below.

Table of Contents

            *Credit Risk Due to CertainConcentrations ––* We provide Continental substantially all of its regional jet capacity at its hub airports as wellas additional non–hub service.  We are economically dependent upon Continental as substantially all of our revenue isreceived from Continental.  See Item 1A. “Risk Factors” for detailed discussions.  If Continental defaults onthe payment obligations it has to us under the Continental CPA or other agreements, then in addition to any other remedies we mayhave, we can offset the amount of the defaulted payments against the amounts we owe to Continental under any agreements in anamount corresponding to its defaulted payments. 

            ***(q) Recently IssuedAccounting Standards* –**

            In June 2006,the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109" ("FIN 48"), which clarifies the accounting for uncertainty in income taxes recognized infinancial statements. FIN 48 requires the impact of a tax position to be recognized in the financial statements if that position ismore likely than not of being sustained by the taxing authority.  FIN 48 is effective for fiscal years beginning afterDecember 15, 2006.  We are currently evaluating the requirements of FIN 48; however, we do not believe that it will have amaterial effect on our consolidated financial position or results of operations.

**            *(r) Reclassifications–***

            Certain reclassifications havebeen made in prior years’ financial statements to conform to the current year presentation.  They include areclassification amount due from Continental to Other Assets for seven engines sold to Rolls Royce; a reclassification from AccruedOther Liabilities to Accounts Payable for our “received not invoiced” accrual; and a reclassification from Other LongTerm Liabilities to Accrued Other Liabilities for the current portion of deferred credit amortization expense.

****

**Note 2 – Capacity Purchase Agreement with Continental**

             ***General.***  We currently derive substantially all of our revenue from the Continental CPA.  Under thisagreement, Airlines operates flights on behalf of Continental as Continental Express.  Continental controls and is responsiblefor scheduling, pricing and managing seat inventories and is entitled to all revenue associated with the operation of theaircraft.  We also have various other agreements with Continental that govern our relationship.

            Under the Continental CPA, somemarketing-related costs normally associated with operating an airline are borne by Continental.  These costsinclude:

        

• 

reservations andsales;                                                                                                          

• 

commissions;

• 

advertising;

• 

revenue accounting;

• 

fare and tariff filings; and

• 

food and beverage service.

            On December 28, 2005, Continentalgave us notice of its intention to withdraw 69 aircraft from the agreement beginning in December 2006 and ending in June2007.  We subsequently decided to retain all 69 aircraft.  As of February 21, 2007, we have transitioned 21 aircraft fromContinental.

            ***Compensation andOperational Responsibilities.*****  Under the agreement, Airlines is entitled to payment for each block hour thatContinental schedules it to fly.  Payment is based on a formula designed to provide Airlines with a target operating margin of10% before taking into account variations in certain costs and expenses that are generally within our control.  In accordancewith the agreement, the original cost components used in this formula remained in place until December 31, 2004, after which newrates are to be established annually with the same methodology.  We have exposure for most labor costs and some maintenanceand general administrative expenses, if the actual costs are higher than those reflected in our block hour rates.

Table of Contents

            Beginning in the fall of 2004, wenegotiated with Continental to adjust the scheduled block hour rates annually as required under the capacity purchaseagreement.  The agreement calls for rates to be set by November 1 of each year.  See the detailed discussion of the 2007rate setting process below.

            ***2005 Rate Negotiation andAmendment*.**  As part of the 2005 rate negotiation, we agreed to cap Airlines’ prevailing margin at 10.0%. Airlines also included previously unreconciled costs within the margin band, although it is not reimbursed if these costs arehigher and cause its prevailing margin to fall below the 8.5% margin floor.  In addition, Airlines is still entitled toreceive incentive payments from Continental if its rate of controllable cancellations is lower than its historical benchmark, butis not required to pay Continental a penalty for controllable cancellations unless the rate rises above 0.5%.  Airlinescontinued to receive a small per-passenger fee and incentive payments for certain on-time departure and baggage handlingperformance.

            During 2005, Airlines’quarterly reconciliation payments to Continental totaled $23.4 million, based on the terms of this agreement.  The table belowdescribes how variations between Airlines’ actual costs and estimated costs, as determined in the block hour rates, have beentreated under the capacity purchase agreement since January 1, 2005:

Fully reconciled costs: reconciliation payment, including 10% margin, to the full extent actualcosts differ from estimated costs.

  • Fuel and into-plane expenses(1)  • Aircraft rent  • Terminal facility rent  • On-time bonuses and 401(k) company match under     current plans  • Taxes (other than income taxes)  • Passenger liability insurance  • Hull insurance  • War risk insurance  • Landing fees

  • Ground handling services  • Administrative services provided by Continental  • Third-party security and screening expenses  • Substantially all regional jet engine expenses under     current long-term third-party contracts  • Depreciation and amortization(2)  • Glycol, de-icing, snow removal  • International navigational fees

Costs within the margin band: if actual expenses in this category are sufficiently different fromestimates used in the block hour rates so that the prevailing margin is less than 8.5% or greater than 10.0%, then a reconciliationpayment will be made by either Continental or Airlines to the other so that this prevailing margin will be 8.5% or 10.0%, asapplicable.  If the prevailing margin were less than 8.5% due to the impact of certain costs, as described below, or if theprevailing margin were above 10.0% due to other items(3), no reconciliation payments would be made from eitherContinental or Airlines.

  • Maintenance, materials and repairs not included     above  • Passenger services

 • Other rental expenses • Other operating expenses

(1)  

Under the fuel purchase agreement with Continental, fuel and fuel tax expense are reconciled to thelower of the actual costs or the agreed-upon caps of 66.0 cents per gallon and 5.2 cents per gallon, respectively, based onAirlines’ fuel purchase agreement with Continental.   If the fuel purchase agreement with Continental were not in place,the fuel cost, including related taxes, would have been $1.80 per gallon for the year ended December 31, 2005.

(2)  

Depreciation is reconciled for assets and capital projects accounted for in the capacity purchaseagreement or those approved by Continental outside of the capacity purchase agreement.

(3)  

The prevailing margin used to calculate the reconciliation payment does not take into accountperformance incentive payments, including payments from controllable cancellation performance, litigation costs above a historicalbenchmark and other costs that are not included in the block hour rates (or covered by adjustments to them) or are not reasonableand customary in the industry.

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            In 2005, the fully reconciledcosts and costs within the margin band under the capacity purchase agreement represented approximately 64% and 36% of totaloperating costs, respectively.

            Certain costs that wereunreconciled under the capacity purchase agreement prior to 2005 now require Airlines to make a reconciliation payment toContinental if the differences cause the prevailing margin to be greater than 10.0%.  However, if the differences cause theprevailing margin to be less than 8.5%, they remain unreconciled.  These costs are:

      

• 

wages and salaries;and                                                                                                   

• 

benefits not included in the table above.

           ***2006Rate Setting.***  Pursuant to the terms of our current capacity purchase agreement withContinental, the 2006 scheduled block hour rates were finalized in April 2006 to be consistent with the 2005rates. 

***            2007 RateSetting. ***  We began 2007 rate discussions with Continental last September. Although thecapacity purchase agreement contemplates a November 1 deadline for setting the rates, the parties agreed to extend thedeadline.  However, in January, ExpressJet and Continental submitted their disagreements regarding 2007 rates to bindingarbitration in accordance with the terms of the capacity purchase agreement.

            In the arbitration, each partyhas selected one arbitrator, and those two arbitrators will select the third arbitrator to complete the panel.  TheContinental CPA sets forth procedures and a schedule that will likely result in a hearing and the issuance of a final decision bylate in the second or early in the third quarter of 2007.  ExpressJet will continue to be paid under the 2006 block hour ratesduring the arbitration process and expects the decision setting the revised rates to be retroactive to January 1, 2007.

            ***Capacity and FleetMatters.***  Subject to the aircraft withdrawal that began in December 2006, the capacity purchase agreement covered allof Airlines’ 274 aircraft for most of 2006.  By June 30, 2007, 205 aircraft will remain covered under our agreement withContinental. 

            The capacity purchase agreementalso allowed us to be Continental’s exclusive regional jet service provider at Newark’s Liberty International,Houston’s Bush Intercontinental and Cleveland’s Hopkins International airports through December 31, 2006.  TheContinental CPA also provides that Continental has the right to withdraw a limited number of our regional jets covered by theagreement under certain circumstances upon 12 months notice.  On December 28, 2005, Continental gave us a withdrawal noticewith respect to 69 aircraft, the maximum number that it could withdraw at that time.  Under the terms of the agreement,Continental cannot withdraw additional aircraft until December 28, 2009 unless the agreement is terminated early, which Continentalcan do at any time upon twelve months’ notice.

            The Continental CPA has aprovision for the interest rate implicit in calculating the scheduled lease payments we make to Continental to increase by 200basis points, which was triggered when we chose to retain the aircraft released from the agreement.  See Item 1.“Business–Capacity Purchase and Other Agreements with Continental Airlines – AircraftFinancing.” 

            We have options for 100 ERJ-145XRaircraft that may be exercised for other types of aircraft within the ERJ-145 Family.  During 2005, Continental declined theright to exercise any of these options.  We retain the right to exercise them and fly these aircraft for other airlines orunder our own code, subject to some restrictions; however, we will have to finance our acquisition of these aircraftindependently. 

            So long as scheduled flightsunder the capacity purchase agreement with Continental represent either at least 50% of all our scheduled flights or at least 200of our aircraft are covered by the capacity purchase agreement, we are required to allocate our crews, maintenance personnel,facilities and other resources on a priority basis to scheduled flights under the capacity purchase agreement above all of ourother flights and aircraft.

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            ***Term ofAgreement*.**  The capacity purchase agreement is scheduled to expire on December 31, 2010.  Continental hasthe option to extend the term of the agreement with 24 months’ notice for up to four additional five-year terms throughDecember 31, 2030.

            Continental may terminate theagreement at any time upon 12 months’ notice, or at any time without notice for cause, which is defined as:

        

• 

our bankruptcy;

• 

suspension or revocation of our authority to operate as a scheduled airline;

• 

cessation of our operations as a scheduled airline, other than as a result of a union-authorizedlabor strike or any temporary cessation not to exceed 14 days;

• 

a union-authorized labor strike that continues for 90 days; or

• 

our intentional or willful material breach that substantially deprives Continental of the benefitsof the agreement, which is not cured within 90 days of notice of the breach.

            Continental may also terminatethe agreement at any time upon our material breach that does not constitute cause and continues for 90 days after we receivenotice of the breach.   If we materially breach the agreement (including for cause) and, for breaches other than cause, failto cure the breach within 60 days after we receive notice of the breach, we will have to pay Continental an amount equal tothe expected margin contained in the block hour rates for scheduled flights from the 60th day (or immediately, without receipt ofany notice, if the breach is for cause) until the breach is cured.  In addition, Continental may terminate the agreementimmediately without notice or giving us an opportunity to cure if it makes a reasonable and good faith determination, usingrecognized standards of safety, that there is a material safety concern with our operation of any flight under the capacitypurchase agreement.

            If Continental materiallybreaches the agreement and fails to cure the breach within 60 days after we notify it of the breach, we will be entitled toobtain our payments directly from Airline Clearing House, Inc. from the 60th day for the duration of the default.  Inaddition, Continental and we are each entitled to seek damages and equitable remedies in arbitration.

            As discussed above, Continentalhas reduced the level of its commitment for our aircraft under the capacity purchase agreement, which could materially reduce ourrevenue and earnings.  Furthermore, Continental leases from third parties a substantial portion of the aircraft and airportfacilities that it subleases to us.  If Continental declared bankruptcy or otherwise defaulted under these leases, we wouldhave no rights to these aircraft or facilities.  Our access to our aircraft and airport facilities would depend onnegotiations between the lessors and us. 

***            Most FavoredNations.***  So long as Continental is our largest customer, if we enter into a capacity purchase or economicallysimilar agreement with another major airline (defined as any airline with annual revenues greater than $500 million, prior toadjustment for inflation since 2000) to provide regional airline service for more than 10 aircraft on terms and conditions thatare, in the aggregate, less favorable to us than those in the Continental CPA, the agreement has a provision that may allowContinental to amend its agreement with us to conform to the terms and conditions of our new agreement.

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**Note 3 –– Details of Certain Accounts**

Accrued other liabilities consist of the following (in thousands):

**As of December 31,**

**2006**

**2005**
********
Airportservices                                                     

$

18,565

  

$

16,596

Maintenance, materials and repairs

17,701

17,627

Taxes (1)

8,917

16,592

Flight operation related expenses

6,965

7,343

Interest

2,586

2,574

Other

7,251

6,907

$

61,985

$

67,639

(1) Includes income taxes payable as well as other taxes payable.

           

Other long-term liabilities consist of the following (in thousands):

**As of December 31,**

**2006**

**2005**
********
Spare partscredit                                                  

$

3,116

  

$

3,802

Flight training credits

5,354

5,597

Other

891

609

$

9,361

$

10,008

**Note 4 –– Leases**

            We lease or sublease all 274 ofour aircraft under operating leases with lease terms ranging from 16 to 16.5 years from Continental. Our sublease agreements withContinental for the remaining 205 aircraft have substantially the same terms as the lease agreements between Continental and thethird-party lessors, and expire between 2013 and 2022.  The agreement has a provision for the interest rate implicit incalculating the scheduled lease payments we make to Continental to increase by 200 basis points, which was triggered when we choseto retain the 69 aircraft released from the Continental CPA.  This increase is included in the tables below.  Rentalpayments for each aircraft are fixed upon lease execution with no escalation clauses.  We also lease or sublease, undervarious operating leases, ground equipment and substantially all of our ground facilities, including facilities at public airportsfrom Continental or the municipalities or agencies owning and controlling such airports.  Though the duration and terms ofthese leases vary greatly, we expect, in most cases, leases to be renewed or replaced by new leases as required in the normalcourse of business.  Our leases do not include residual value guarantees.

            At December 31, 2006, thescheduled future minimum lease payments under capital leases due to third-party lessors and the scheduled future minimum leasepayments under operating leases that have initial or remaining non-cancelable lease terms in excess of one year are as follows (inmillions):

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**Operating Leases**
****
**Capital Leases**

**CAL CPA (205 Aircraft)**

**69 Aircraft**

**Non- Aircraft**

**Totals**

**                                                                  **
********************
Year ending December 31, 2007

$

0.9

 

$

264.7

 

$

80.5

 

$

15.2

$

360.4

2008

0.2

243.2

104.8

14.2

362.2

2009

—

243.2

104.8

13.7

361.7

2010

—

243.2

104.8

12.8

360.8

2011

—

243.2

104.8

11.1

359.1

Later years

—

1,388.1

935.6

61.1

2,384.8

Total minimum lease payments

1.1

$

2,625.6

 

$

1,435.3

 

$

128.1

 

$

4,189.0

Less:  amount representing interest

0.0

 

Present value of capital leases

1.1

Less:  current maturities of capital leases

0.9

Long-term capital leases

$

0.2

            Amortization of capital leases isincluded with depreciation expense as disclosed in the financial statements.

            Our total rental expense for allnon-aircraft operating leases was approximately $45.6 million, $39.3 million and $33.4 million for the years ended December 31,2006, 2005 and 2004, respectively.

            Total aircraft and non-aircraftrent expense was approximately $378.0 million, $348.3 million and $314.8 million for the years ended December 31, 2006, 2005 and2004, which included $349.5 million, $323.3 million and $292.6 million of payments under leases with Continental CPA.  Inaddition, of the total rental expense, $315.1 million, $290.4 million and $262.7 million are related to subleases with Continentalfor 2006, 2005 and 2004, respectively. 

            If we defaulted on our paymentobligations under our aircraft and facility leases or subleases with Continental, Continental would be entitled to reduce futurepayments to us under the Continental CPA by the amount of the defaulted payment. 

**Note 5 –– Note Payable to Continental**

            Under the promissory note datedMarch 31, 2001, net amounts due Continental were converted into a long-term note payable of $552.3 million, which bore interest ata fixed rate of 4.9% through June 30, 2001.  Effective July 1, 2001, the rate for subsequent quarters was set at thethree-month LIBOR plus 1.25% per annum.  The note was our unsecured general obligation and was subordinated in right ofpayment to all of our future senior indebtedness and was junior to any of our secured obligations and the secured obligations ofour wholly owned subsidiaries to the extent of the collateral pledged.

            On March 31, 2006, we paid theremaining principal balance and accrued interest at 5.78% on our note to Continental.  Total payments made during 2006 and2005 (including the discretionary prepayments) were $17.8 million and $84.7 million, respectively.

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            The weighted average interestrate for the year ended December 31, 2006, 2005 and 2004 was 5.8%, 4.4% and 2.6% per annum, respectively.  The statements ofoperations include total interest charges from Continental of $0.3 million, $3.5 million and $4.4 million for the years endedDecember 31, 2006, 2005 and 2004, respectively.

****

**Note 6 –– Long-term Debt**

            As of December 31, 2006,long–term debt, including current maturities, totaled $14.5 million, which consisted of secured debt owed to EDC.

            EDC loaned us $10.7 million inMay 2003 and $6.6 million in September 2003.  The loan is secured by certain of our flight simulators, flight data softwareand other equipment related to the simulators.  We used all of the proceeds from the loans to reduce the principal under ournote payable to Continental.  The amount due to EDC accrues interest at the six-month LIBOR plus 1.75% per annum.  Theterm of each advance to us is 96 months.  The loan agreement has customary representations, warranties and covenants. Additionally, Continental is the guarantor of this loan, and a default under the guarantee would cause an acceleration of theloan.

            During 2003, we completed theprivate placement of $137.2 million senior convertible notes due 2023.  Cash interest is payable on the notes at a rate of4.25% per year on the principal amount at maturity, payable semiannually in arrears on February 1 and August 1 of each year,beginning February 1, 2004.  The aggregate amount of the principal will be due on August 1, 2023.  The notes and thenotes guarantee are senior unsecured obligations and rank equally with our existing and future senior unsecured indebtedness. The notes and the notes guarantee are junior to any of our secured obligations and the secured obligations of our wholly ownedsubsidiaries to the extent of the collateral pledged.

            The notes are convertible intoshares of our common stock at a conversion rate of 54.9451 shares per $1,000 in principal amount at maturity of the notes. This conversion rate is subject to adjustment in certain circumstances.  Holders of the notes may convert all or a portion oftheir notes into shares of our common stock under the following circumstances: (i) at any time during or after any fiscal quartercommencing after September 30, 2003 if the closing sale price of our common stock for at least 20 trading days in a period of 30consecutive trading days ending on the last trading day of the fiscal quarter prior to such quarter is greater than 120% of theconversion price per share of common stock on such last day; (ii) subject to certain exceptions, during the five business dayperiod after any five consecutive trading day period in which the trading price per $1,000 principal amount of the notes for eachof the five trading days was less than 98% of the product of the closing sales price of our common stock and the number of sharesissuable upon conversion of $1,000 principal amount of the notes; (iii) if the notes have been called for redemption; or (iv) uponthe occurrence of specified corporate transactions.  We have reserved sufficient shares of our common stock to be issued uponconversion of these notes.

            We can redeem the notes, in wholeor in part, beginning on August 4, 2008, at a redemption price equal to 100% of the principal amount, plus accrued and unpaid cashinterest, if any.  The holders of the notes may require us to repurchase the notes on August 1, 2008, August 1, 2013 andAugust 1, 2018 (“Redemption Dates”) at a purchase price equal to 100% of their principal amount, plus accrued andunpaid interest, if any.  We can choose to pay the repurchase price for any such notes in cash, in shares of common stock orany combination thereof should we be required to redeem the notes at any of the Redemption Dates.  We have a shelfregistration statement on file with the Securities and Exchange Commission covering the resale of the notes and the underlyingcommon stock for the security holders name therein.

            Proceeds from the offering, netof initial purchasers’ fees, were used to repurchase 9,835,125 shares of our common stock from Continental at $13.60125 pershare pursuant to a stock repurchase agreement with Continental.  As a result of this repurchase, Continental’sbeneficial ownership of our common stock dropped below 50%. 

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            Repayment of the convertiblenotes is jointly and severally guaranteed on an unconditional basis by Airlines.  Except as otherwise specified in theindenture pursuant to which the notes were issued, there are no restrictions on Airlines’ ability to transfer funds toHoldings in the form of cash dividends, loans or advances.  General provisions of applicable state law, however, may limit theability of any subsidiary to pay dividends or make distributions to us in certain circumstances.

            The amount of all scheduled debtmaturities, due over the next five years and thereafter is as follows (in millions):

**Year ending December31,                      **

**                 **

    2007

$

1.7

    2008

$

140.7

    2009

$

3.5

    2010

$

3.5

    2011

$

2.4

    Thereafter

$

0

            The table above assumes thesenior convertible notes will be due on August 1, 2008, the earliest date that the holders of the notes may require us torepurchase the notes.

            Other than the debt obligationsdescribed above, we do not have any other source of long-term borrowings or available lines of credit.  There is no covenantunder any of our current long-term debt agreements that restricts our ability to undertake additional debt or equityfinancing.

            The following condensedconsolidating balance sheets, results of operations and cash flows present separately the financial position of the parent issuer,Holdings, the subsidiary guarantor, Airlines, and all other non-guarantor subsidiaries of Holdings on a combined basis.

 

 

**Condensed Consolidating Balance Sheet**

 

**December 31, 2006**

**(In thousands)**

 

 

 

 

 

 

 

 

 

 

 

**Other Non- Guarantor**

 

 

 

 

 

 

**Consolidated**

 

**Holdings**

**Airlines**

**Subsidiaries**

**Eliminations**

**Totals**

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

$

37

 

 

$

341,990

 

 

$

6,902

 

 

$

(135

) 

 

$

348,794

 

Property and equipment, net

 

 

—

 

 

 

229,377

 

 

 

15,706

 

 

 

—

 

 

245,083

 

Investments in other entities

 

 

3,194

 

 

 

—

 

 

 

14,823

 

 

 

—

 

 

18,017

 

Other assets

 

 

17,567

 

 

 

7,285

 

 

 

283

 

 

 

—

 

 

25,135

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

20,798

 

 

$

578,652

 

 

$

37,714

 

 

$

(135

)

 

$

637,029

 

Current liabilities

 

$

9,418

 

 

$

125,913

 

 

$

276

 

 

$

(515

)

 

$

135,092

 

Intercompany payables (receivables)

 

 

(336,128

)

 

 

330,624

 

 

(236

)

 

 

5,740

 

 

—

 

Long-term debt

 

 

137,200

 

 

 

12,981

 

 

 

51

 

 

 

—

 

 

 

150,232

 

Other liabilities

 

 

—

 

 

 

52,412

 

 

 

339

 

 

 

(5,360

)

 

 

47,391

 

Stockholders’ equity

 

 

210,308

 

 

 

56,722

 

 

 

37,284

 

 

 

—

 

 

304,314

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’     equity

 

$

20,798

 

 

$

578,652

 

 

$

37,714

 

 

$

(135

)

 

$

637,029

 

Table of Contents

 

**Condensed Consolidating Balance Sheet**

 

**December 31, 2005**

**(In thousands)**

 

 

 

 

 

 

 

 

 

 

 

**Other Non- Guarantor**

 

 

 

 

 

 

**Consolidated**

 

**Holdings**

**Airlines**

**Subsidiaries**

**Eliminations**

**Totals**

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

$

9,436

 

 

$

265,942

 

 

$

2,849

 

 

$

(258

) 

 

$

277,969

 

Property and equipment, net

 

 

—

 

 

 

230,060

 

 

 

10,391

 

 

 

—

 

 

240,451

 

Investments in other entities

 

 

—

 

 

 

—

 

 

 

17,255

 

 

 

—

 

 

 

17,255

 

Other assets

 

 

21,855

 

 

 

7,996

 

 

 

(72

) 

 

 

(5,184

) 

 

 

24,595

 

Total assets

 

$

31,291

 

 

$

503,998

 

 

$

30,423

 

 

$

(5,442

)

 

$

560,270

 

Current liabilities

 

5,869

 

 

144,894

 

 

1,116

 

 

(258

) 

151,621

 

Intercompany payables receivables)

 

(313,360

) 

 

324,830

 

 

 

(11,470

)

 

 

—

 

—

 

Long-term debt

 

137,200

 

 

15,470

 

 

 

—

 

 

 

—

 

152,670

 

Other liabilities

 

10

 

 

52,816

 

 

 

20

 

 

 

(5,377

) 

47,469

 

Stockholders’ equity

 

201,572

 

 

(34,012

) 

 

 

40,757

 

 

 

193

208,510

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’     equity

 

31,291

 

 

503,998

 

 

30,423

 

 

(5,442

)

560,270

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Condensed Consolidating Results of Operations**

 

 

**Year Ended December 31, 2006**

 

**(In thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Other Non- Guarantor**

 

 

 

 

 

 

**Consolidated**

 

**Holdings**

**Airlines**

**Subsidiaries**

**Eliminations**

**Totals**

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenue

 

$

—

 

 

$

1,674,327

 

 

$

9,542

 

 

$

(4,232

) 

 

$

1,679,637

 

Operating expenses

 

 

1,984

 

 

 

1,529,842

 

 

 

10,972

 

 

 

(4,232

) 

 

 

1,538,566

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

 

(1,984

) 

 

 

144,485

 

 

 

(1,430

) 

 

 

—

 

 

 

141,071

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(5,913

) 

 

 

(19,225

) 

 

 

(5

)

 

 

17,808

 

 

 

(7,335

)

 

Interest income

 

 

18,029

 

 

14,444

 

 

 

—

 

 

(17,808

) 

 

 

14,665

 

Capitalized Interest

—

294

—

—

294

 

Equity investment income (loss)

194

—

(2,230

)

—

(2,036

)

 

Other, net

 

 

—

 

 

153

 

 

 

(356

)

 

 

—

 

 

 

(203

)

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

10,326

 

 

140,151

 

 

(4,021

) 

 

—

 

 

146,456

 

Income tax benefit (expense)

 

 

(3,675

)

 

 

(50,764

)

 

 

548

 

 

 

—

 

 

 

(53,891

)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

6,651

 

 

$

89,387

 

$

(3,473

) 

 

$

—

 

$

92,565

 

Table of Contents

 

 

**Condensed Consolidating Results of Operations**

 

 

 

 

**Year Ended December 31, 2005**

 

 

**(In thousands)**

 

 

 

 

 

 

 

 

 

 

**Other Non- Guarantor**

 

 

 

 

 

 

**Consolidated**

 

**Holdings**

**Airlines**

**Subsidiaries**

**Eliminations**

**Totals**

 

 

 

 

 

 

 

 

 

 

 

Operating revenue

 

$

—

 

 

$

1,562,746

 

 

$

455

 

 

$

(383

)

1,562,818

Operating expenses

 

 

2,255

 

 

 

1,403,700

 

 

 

703

 

 

 

(383

)

1,406,275

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

 

(2,255

) 

 

 

159,046

 

 

 

(248

) 

 

 

—

156,543

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(6,033

) 

 

 

(22,533

) 

 

 

13

 

 

17,808

(10,745

)

Interest income

18,495

7,608

—

(17,808

)

8,295

Capitalized Interest

—

493

13

—

506

Equity investment income (loss)

—

—

(606

)

—

(606

)

Other, net

 

 

—

 

 

241

 

 

—

 

 

—

241

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

10,207

 

 

144,855

 

 

(828

) 

 

—

154,234

Income tax expense

 

 

(3,572

)

 

 

(52,853

)

 

 

184

 

 

 

—

(56,241

)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

6,635

 

 

$

92,002

 

$

(644

) 

 

$

—

97,993

 

 

**Condensed Consolidating Results of Operations**

 

 

 

 

**Year Ended December 31, 2004**

 

 

**(In thousands)**

 

 

 

 

 

 

 

 

 

 

**Other Non- Guarantor**

 

 

 

 

 

 

**Consolidated**

 

**Holdings**

**Airlines**

**Subsidiaries**

**Eliminations**

**Totals**

 

 

 

 

 

 

 

 

 

 

 

Operating revenue

 

$

—

 

 

$

1,507,524

 

 

$

—

 

 

$

—

1,507,524

Operating expenses

 

 

—

 

 

 

1,302,097

 

 

 

—

 

 

 

—

1,302,097

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

 

—

 

 

 

205,427

 

 

 

—

 

 

 

—

205,427

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(6,040

) 

 

 

(21,746

) 

 

 

—

 

 

15,945

(11,841

)

Interest income

16,306

3,312

—

(15,945

)

3,673

Capitalized Interest

—

581

—

—

581

Equity investment income (loss)

—

—

—

—

—

Other, net

 

 

—

 

 

164

 

 

—

 

 

—

164

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

10,266

 

 

187,738

 

 

—

 

 

—

198,004

Income tax expense

 

 

—

 

 

(75,233

)

 

 

—

 

 

 

—

(75,233

)

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,266

 

 

$

112,505

 

$

—

 

 

$

—

$

122,771

Table of Contents

 

 

 

**Condensed Consolidating Cash Flows Year Ended December 31, 2006 (In thousands)**

 

 

 

**Holdings**

**Airlines**

**Other Non- Guarantor Subsidiaries**

**Eliminations**

**Consolidated Totals**

 

 

 

 

  Operating activities

 

$

—

$

115,249

$

(232

)

$

1,686

$

116,703

  Investing activities

 

(4,500

)

(22,346

)

(4,679

)

(2,034

)

(33,559

)

  Financing activities

 

(4,992

)

(19,424

)

5,272

348

(18,796

)

 

 

Net increase/(decrease) in cash

 

(9,492

)

73,479

361

—

64,348

Cash at the beginning of the period

 

9,492

217,669

124

—

227,285

 

Cash at the end of the period

 

$

—

$

291,148

$

485

$

—

$

291,633

 

 

 

**Condensed Consolidating Cash Flows Year Ended December 31, 2005 (In thousands)**

 

 

 

**Holdings**

**Airlines**

**Other Non- Guarantor Subsidiaries**

**Eliminations**

**Consolidated Totals**

 

 

 

 

  Operating activities

 

$

—

$

112,395

$

(2,442

)

$

20,637

$

130,590

  Investing activities

 

—

9,276

(27,030

)

(3,000

)

(20,754

)

  Financing activities

 

(11,999

)

(72,699

)

29,595

(17,637

)

(72,740

)

 

 

Net increase/(decrease) in cash

 

(11,999

)

48,972

123

—

37,096

Cash at the beginning of the period

 

21,491

168,698

—

—

190,189

 

Cash at the end of the period

 

$

9,492

$

217,670

$

123

$

—

$

227,285

 

 

 

**Condensed Consolidating Cash Flows Year Ended December 31, 2004 (In thousands)**

 

 

 

**Holdings**

**Airlines**

**Other Non- Guarantor Subsidiaries**

**Eliminations**

**Consolidated Totals**

 

 

 

 

  Operating activities

 

$

2,551

$

153,605

$

—

$

(2,551

)

$

153,605

  Investing activities

 

—

(43,521

)

—

—

(43,521

)

  Financing activities

 

842

(99,530

)

—

2,551

(96,137

)

 

 

Net increase/(decrease) in cash

 

3,393

10,554

—

—

13,947

Cash at the beginning of the period

 

18,098

158,144

—

—

176,242

 

Cash at the end of the period

 

$

21,491

$

168,698

$

—

$

—

$

190,189
****
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**Note 7 –– Income Taxes**

            Income tax expense (benefit) forthe year ended December 2006, 2005 and 2004 consisted of the following (in millions):

**2006**

**2005**

**2004**

**                                                        **

**  **
************
Federal

   

   

    Current

$

50.1

$

51.7

$

60.6

    Deferred

2.2

1.5

10.4

State:

    Current

(0.2)

2.5

0.2

    Deferred

1.8

0.5

4.0

Total Income Tax Expense

$

53.9

$

56.2

$

75.2

            The reconciliations of income taxcomputed at the United States federal statutory tax rates to income tax expense for the years ended December 31, 2006, 2005 and2004 are as follows:

**Amount**

**Percentage**
********
**2006**

**2005**

**2004**

**2006**

**2005**

**2004**

**                                                            **
************************
(in millions)

Income tax expense at United States   statutory rates

 

$

51.3

$

53.9

 

$

69.3

 

35.0

%

35.0

%

35.0

%

State income tax expense (net of   federal benefit)

1.2

2.3

4.2

0.8

1.5

2.1

Meals and entertainment disallowance

1.6

1.7

1.4

1.1

1.1

0.7

Other

(0.2

)

(1.7

)

0.3

(0.1

)

(1.1

)

0.2

Income tax expense, net

$

53.9

$

56.2

$

75.2

36.8

%

36.5

%

38.0

%

            Deferred income taxes reflect thenet tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposesand the related amounts used for income tax purposes.  Significant components of our deferred tax liabilities and assets as ofDecember 31, 2006 and 2005 are as follows (in millions):

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**2006**

**2005**

**                                                                                         **
********
Deferred Tax Liabilities:

 

 

 

  Fixed assets

$

46.1

$

48.3

  Other

1.8

1.7

Gross deferred tax liabilities

47.9

50.0

Deferred Tax Assets:

  State loss carryforwards, net

$

5.3

$

5.4

  Intangible assets

292.0

317.8

  Other

9.6

13.0

Gross deferred tax assets

306.9

336.2

Valuation allowance / net tax agreement obligation   to Continental

311.8

334.8

Net deferred tax liabilities

$

(52.8

)

$

(48.6

)

            In October 2006, Continentalentered into a final settlement agreement with the IRS that included periods during which we were included in its consolidatedfederal income tax return.  Our taxable income was not adjusted, but the amount of net operating losses allocated to us wasincreased by approximately $31.2 million.  In accordance with our tax agreement with Continental, we paid Continentalapproximately $10.9 million for the increase of our federal net operating loss carryforwards.  In addition, we adjusted ourtax accounts for the increase in our federal net operating loss which was fully utilized in our 2005 tax year.

            In conjunction with our initialpublic offering in April 2002, the tax basis of our tangible and intangible assets was adjusted to fair value.  Thisadjustment to tax basis should result in additional tax deductions being available to us through 2017.  In accordance with ourtax agreement with Continental, to the extent we generate taxable income sufficient to realize the additional tax deductions, weare required to pay Continental a percentage of the amount of tax savings actually realized, excluding the effect of any losscarrybacks.  We are required to pay Continental 100% of the first third of the anticipated tax benefit, 90% of the secondthird and 80% of the last third.  However, if the tax benefits are not realized by the end of 2018, we will be obligated topay Continental 100% of any benefit realized after that date.  Since these payments are solely dependent on our ability togenerate sufficient taxable income to realize these deferred tax assets, they are recorded as an obligation to Continental withinthe deferred tax asset accounts, and the portion we may retain in the future is offset by a valuation allowance.  At the timeof the initial public offering, the valuation allowance and the obligation to Continental offset the step-up in basis of assets inour long-term deferred tax asset account.  We made approximately $24.8 million and $25.3 million of net payments toContinental under the tax agreement related to the additional tax deductions during 2006 and 2005, respectively.

            The tax agreement requiresContinental to reimburse us for any net increase in our cash tax payments resulting from any decreased availability of netoperating loss carryovers related to the basis increase at the time our payment occurs.  The resulting receivable and/orpayable is recorded within the deferred tax asset account since its performance is dependent on our ability to generate taxableincome.

            No valuation allowance wasestablished on our net operating loss carryforwards or on our receivable from Continental for reimbursing carryforward lossesutilized resulting from the basis increase because we believe our stand-alone taxable income will be sufficient to utilizesubstantially all of these assets within the next several years.

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            We believe that our initialpublic offering created a change in ownership limitation on the utilization of our federal tax attribute carryforwards, primarilynet operating losses.  Section 382 of the Internal Revenue Code limits our utilization of these attributes to offset up toapproximately $43.3 million of post-change taxable income per year.   This limitation did not have any impact on our financialcondition during the years ending 2006 and 2005.

            Our tax agreement increases ourdependence on Continental’s financial condition.  If it is determined that any of the tax benefits related to the basisincrease should not have been available at the time of utilization and, as a result, we are required to pay additional taxes,interest and penalties, then we could be adversely affected if Continental were unable to indemnify us under theagreement.

**Note 8 ––****Preferred, Common and TreasuryStock**

            ***PreferredStock.***  We have 10 million shares of authorized preferred stock, par value $.01 per share.  One share ofpreferred stock was issued and outstanding at December 31, 2004.

            After Continental’sownership of common shares fell below 10% on April 7, 2005, we redeemed the sole share of our Special Voting Preferred Stock heldby Continental. The redemption terminated Continental’s right to elect a director to our board of directors. In January 2007,Continental sold all but 625 shares of our common stock.

            Our board is divided into threeclasses, and our directors are elected by stockholders for three-year terms.  Two of the classes are comprised of threedirectors and the third is comprised of two.

            ***Common Stock.*** We currently have one class of common stock, par value $.01 per share, with 54.7 million shares issued.  Each share of commonstock is entitled to one vote.  Common stockholders would participate ratably in any dividends or distributions on the commonstock. 

            ***TreasuryStock.***  In July 2005, our board of directors authorized the expenditure of up to $30 million to repurchase shares ofour common stock.  Purchases have been made from time to time in the open market; the timing of any share repurchases underthe program depends on a variety of factors, including market conditions, and may be suspended or discontinued at any time. Common stock acquired through the program will be available for general corporate purposes.  In 2005, we purchased 590,800shares of our common stock at an average cost per share of $9.55.  We did not make any purchases under this program during2006.

            In addition, under the IncentivePlan, our board of directors can approve the issuance of restricted stock to various employees and non-employee directors. Forfeitures of awarded shares resulted in common stock held in treasury from which subsequent restricted stock awards can be issuedand stock option exercises can be satisfied. 

**Note 9 –– Stock Based Compensation Plans**

           We have twostock-based compensation plans: the ExpressJet Holdings, Inc. 2002 Stock Incentive Plan (the “Incentive Plan”) and theExpressJet Holdings, Inc. 2003 Employee Stock Purchase Plan (the “ESPP”).  The Incentive Plan provides that we maygrant awards in the form of stock options or restricted stock to our non-employee directors, our employees or employees of oursubsidiaries.  The aggregate number of shares of our common stock that may be issued under the Incentive Plan may not exceed3.2 million shares, subject to adjustments as provided in the Incentive Plan.  We have reserved 3.2 million shares of ourcommon stock for issuance under this plan.  Options granted under the Incentive Plan have been awarded with exercise pricesequaling the fair market value of the stock on the date of grant, vest over a four-year period for employees or a six-month periodfor non-employee directors and expire seven years after the date of grant in the case of employees and ten years after the date ofgrant in the case of directors.

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            Prior to 2006, we accounted forour stock-based compensation arrangements using the intrinsic value method in accordance with Accounting Principles Board OpinionNo. 25 — “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. Under APB 25, if the exercise price of our stock options equaled the fair market value of the underlying stock on the date ofgrant, no compensation expense was recognized.  Since our stock options have all been granted with exercise prices that equalfair market value on the grant date, no compensation expense was recognized under APB 25.  We also recognized compensationexpense for our restricted stock in accordance with APB 25.  The total compensation expense incurred for each restricted stockgrant equaled the product of the number of shares issued and the closing price of our common stock on the issuance date; theexpense was recognized over the vesting period of each grant in accordance with the method specified in Financial AccountingStandards Board Interpretation No 28 — “Accounting for Stock Appreciation Rights and Other Variable Stock Option orAward Plans” (“FIN 28”).  Under APB 25, we did not recognize compensation expense related to theESPP.

            Effective January 1, 2006, weadopted the fair value recognition provisions of Financial Accounting Standards Board Statement No. 123(R), *Share-BasedPayments* (“Statement 123(R)”) using the modified-prospective transition method.  Under that transition method,compensation cost recognized during the twelve months ended December 31, 2006 includes: (a) compensation cost for all share-basedpayments granted prior to, but not vested at January 1, 2006, based on the grant date fair value estimated in accordance with theoriginal provisions of Statement 123, and (b) compensation cost for share-based payments granted subsequent to January 1, 2006,based on the grant date fair value estimated in accordance with the provisions of Statement 123(R).  Results for prior periodshave not been restated, which is consistent with the transition method selected.

           The fairvalue of Holdings’ options granted during 2006 was estimated at the date of grant using the Black-Scholes option-pricingmodel, which requires us to make several assumptions.  The table below summarizes the weighted-average of these assumptionsfor the year ended December 31, 2006:

Risk-free interest rate    

  

4.9

%

Dividend yield   

—

 

Expected market price volatility of our common stock      

50.5

%

Expected life of options (years)  

7.0

            The risk-free interest rate isbased on the U.S. Treasury yield curve in effect for the expected term of the option at the time of grant.  The dividend yieldon our common stock is assumed to be zero since we do not pay dividends and have no current plans to pay future dividends. The market price volatility of our common stock was based on historical volatility since April 23, 2002, the date of our initialpublic offering.  Our methodology is consistent with prior period volatility assumptions. The expected life of the options isbased upon our anticipated expectations of exercise behavior since no options have been exercised since our initial public offeringto provide relevant historical data.  

            Based upon the assumptions above,the weighted-average fair value of the options granted during 2006 was determined to be $3.23.  

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**Options                                                         **

**Shares (in thousands)**

**Weighted Average Exercise Price**

**Weighted Average Remaining Contractual Term (in years)**

**Aggregate Intrinsic Value (in thousands)**
****
  
********
  
****
  
****
Outstanding at January 1, 2006

 

1,872

 

$

13.39

 

—

 

—

Granted

870

5.55

—

—

Exercised

—

—

—

—

Forfeited or Expired

(40

)

12.65

—

—

Outstanding at December 31, 2006

2,702

$

10.90

7.39

2,206

Exercisable at December 31, 2006

1,643

$

13.90

6.24

31

            A summary of the status of ournon-vested shares of restricted stock as of December 31, 2006, and changes during the twelve months ended December 31, 2006, ispresented below:

**Non-vestedShares                                                **

**Shares (in thousands)**

**Weighted Average Grant Date Fair Value**

**Aggregate Intrinsic Value (in thousands)**
****
  
****
 
****
 

 
****
Non-vested at January 1, 2006   

287

$

10.67

2,324

Granted 

53

6.09

—

Vested 

(97

)

10.19

633

Forfeited           

(4

)

10.56

—
****
Non-vested at December 31,2006          

239

$

9.86

1,937

           As ofDecember 31, 2006, there was $3.1 million of total unrecognized compensation cost related to non-vested share-based compensationarrangements granted under the Plan.  That cost is expected to be recognized over a weighted average period of 2.0years.

            On May 7, 2003, our stockholdersapproved the ESPP, which authorized the sale of up to one million shares of our common stock.  We have reserved one millionshares of our common stock for issuance under the ESPP.  Under the plan, all of our employees are eligible to purchase sharesof our common stock at 85% of the lower of the fair market value on the first or last day of the semi-annual purchase period. Our first purchase period began on July 1, 2003.  Employees may sell shares obtained under the ESPP six months after the endof the plan period in which the shares were purchased.  During 2006 and 2005, 75,081 and 69,347 shares, respectively, of ourcommon stock were issued to our employees at prices ranging from $5.87 to $6.88 in 2006 and prices ranging from $7.23 to $10.37 in2005.  In January 2007, we issued 39,473 shares of our common stock to our employees at $6.02 per share.

            The fair value of the purchaserights under the ESPP was also estimated using the Black-Scholes model with the following assumptions for 2006, 2005 and 2004,respectively: risk-free interest rate of 4.7%, 3.8% and 2.0%, dividend yield of 0%, expected volatility of Holdings’ stock of53.2%, 60.8% and 57.3% and an expected life of six months.  The weighted-average fair value of each purchase right granted in2006, 2005 and 2004 was $2.31, $2.51 and $3.53, respectively.

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            As a result of adopting Statement123(R) on January 1, 2006, our income before income taxes and net income for the year ended December 31, 2006, was approximately$2.7 million and $1.7 million lower, respectively, than if we had continued to account for share-based compensation under APB25.  Basic and diluted earnings per share for the year ended December 31, 2006 decreased by approximately $0.03 lower,respectively, than if we had continued to account for share-based compensation under Opinion 25.

            Prior to the adoption ofStatement 123(R), we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flowsin the Statement of Cash Flows.  Statement 123(R) requires the cash flows resulting from tax benefits from tax deductions inexcess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. During the twelve months ended December 31, 2006, no stock options were exercised thus having no effect on the cash flowstatement.

The following table illustrates the effect on net income and earnings per share assuming thecompensation cost for our stock option, restricted stock and employee stock purchase plans were determined using the fair valuemethod, prorated over the vesting periods in accordance with FIN 28, at the grant dates as required under SFAS 123R for the yearsended December 31, 2005 and 2004:

**(in thousands, except for per share data)**

**2005**

**2004**

**                                                                                                   **
****
**  **
****
Net Income as Reported

$

97,993

$

122,771

Add:  Total stock-based compensation expense included     in reported net income, net of taxes

973

445

Deduct:  Total stock based employee compensation     expense determined under fair value

 

(4,635

)

(2,555

)

Pro forma

$

94,331

$

120,661

Basic Earnings per Share:

  As reported

$

1.81

$

2.26

  Pro forma

$

1.74

$

2.23

Diluted Earnings per Share:

  As reported

$

1.65

$

2.04

  Pro forma

$

1.59

$

2.01

           On November4, 2005, our board of directors approved accelerating the vesting of 669,750 unvested options currently held by employees,including executive officers, with exercise prices greater than $11.00 per share and extended the term of 868,500 employee optionsthat had a five-year term to seven years.  These options were and remain out of the money, and the acceleration and extensionwere effective immediately.  No options held by non-employee directors were subject to acceleration or extension.  Theacceleration of vesting reduces compensation expense upon the adoption of SFAS 123R.  The reduction in compensation expense inthe future, based on our implementation date of January 1, 2006, was approximately $3.1 million.  

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**Note 10 –– Employee Benefit Plans**

            Effective December 31, 2002, theExpressJet Airlines, Inc. 401(k) Savings Plan (“401(k) Plan”) was adopted.  Substantially all our domesticemployees are covered by this plan.  Under the plan, we offered the following benefits:

         

• 

a retirement match up to 5.0% of pay per person (which vests over five years); and

• 

a service-based match (which vested immediately), depending on years of service and the terms of thecollective bargaining agreements, as applicable.

            Effective October 1, 2004 forAirlines’ mechanics, who are represented by the International Brotherhood of Teamsters, and January 1, 2005 for all otheremployees, the 401(k) Plan was amended.  Under the amended plan, we offer the following benefits:

         

• 

a service-based retirement match from 4.0% up to 6.0% of pay per person (which vests over fiveyears) depending on years of service; and 

• 

a service-based retirement contribution (with 5-year cliff vesting) depending on years of serviceand the terms of the collective bargaining agreements, as applicable.

            For the years ended December 31,2006, 2005 and 2004, our total expense for the defined contribution plan was $19.5 million, $18.2 million and $14.5 million,respectively.

            The ExpressJet Airlines, Inc.Profit Sharing Plan (the “Profit Sharing Plan”) was adopted effective January 1, 2002 and amended on February 17,2005.  Under this plan, if Airlines achieves a 10% operating margin, the Profit Sharing Plan will pay out 5% of eligible basepay received during the year to our eligible employees, which excludes employees whose collective bargaining agreements provideotherwise and employees who participate in our management bonus program or any other bonus program designated by the HumanResources Committee of our Board.  Profit sharing expense for the years ended December 31, 2006, 2005 and 2004 was $9.2million, $11.0 million, and $10.0 million, respectively.

            We also provide medical bridgecoverage for employees between the ages of 60 to 65, with at least 10 years of service who have retired from the company.  OnDecember 31, 2006 we adopted the recognition and disclosure provisions of Statement 158.  Statement 158 required therecognition of fund status (i.e., the difference between the fair value of plan assets and projected benefit obligations) of itspension plan in the December 31, 2006 statement of financial position, with a corresponding adjustment to accumulated othercomprehensive income, net of tax.  The adjustment to accumulated other comprehensive income at adoption represents the newunrecognized actuarial gain and unrecognized prior service costs.  

            The incremental effects ofadopting the provisions of Statement 158 on the statement of financial position at December 31, 2006 is an increase to accumulatedother comprehensive income and a decrease to accrued payroll and related cost of $0.6 million ($0.4 million, net of tax).  Theadoption of Statement 158 had no effect on the consolidated statement of income for the year ended December 31, 2006, or for anyprior periods presented, and it will not affect the operating results in future periods.  

**Note 11 –– Commitments and Contingencies**

            ***Capacity PurchaseAgreement.***  So long as Continental is our largest customer, if we enter into a capacity purchase or economicallysimilar agreement with another major airline (defined as any airline with annual revenues greater than $500 million, prior toadjustment for inflation since 2000) to provide regional airline service for more than 10 aircraft on terms and conditions thatare, in the aggregate, less favorable to us than those in the capacity purchase agreement, the capacity purchase agreement has aprovision that may allow Continental to amend its agreement with us to conform to the terms and conditions of our newagreement.

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            In addition, there are provisionsin the capacity purchase agreement that require us to use commercially reasonable efforts to transfer, subject to applicable laws,to Continental or its designee any of our airport take-off or landing slots, route authorities or other regulatory authorizationsused for Airlines’ scheduled flights under the agreement.

            Continental is generallyresponsible for all capital and start-up costs for airport terminal facilities at its hub airports and at any other facilitieswhere it elects to provide baggage handling services to us.  If Continental elects to provide baggage handling services at anyfacility where we previously provided baggage handling services, Continental will reimburse us for most of the capital and start-upcosts we incurred at that facility.  We are generally responsible for any capital and start-up costs associated with anyairport terminal facilities at other airports where we fly and any non-terminal facilities not regularly used by Continental. If we exit a market at the direction of Continental (and we do not re-enter that market under our own code or that of an airlineother than Continental within six months), Continental will reimburse us for certain losses incurred in connection with the closureof the related facility.  If the capacity purchase agreement is terminated, we may be required to vacate the terminalfacilities (or all facilities if the termination results from our material breach of the agreement) that are subleased to us byContinental, and to use commercially reasonable efforts to assign to Continental or designee any lease in our name for thesefacilities.

            In September 2006, Airlines begandiscussions with Continental to adjust the scheduled block hour rates for 2007 under the Continental CPA.  Although theagreement contemplates a November 1 deadline for setting the rates each year, the parties extended that deadline in an attempt toreach agreement.  In January 2007, the parties submitted their disagreements to binding arbitration in accordance with theterms of the agreement, which provides that it will be conducted pursuant to the Federal Arbitration Act.  Each party hasselected one arbitrator, and those two will select a third arbitrator to complete the panel.  The agreement sets forthprocedures and a schedule that will likely result in a hearing and issuance of a final decision by late in the second or early inthe third quarter of 2007.  Airlines will continue to be paid under the 2006 block hour rates during the arbitration processand expects the decision setting the revised rates to be retroactive to January 1, 2007.  We do not intend to issue anyreports on the progress of the arbitration until the panel issues its final decision.  We cannot predict the outcome of thearbitration.  If decided adversely to us, the arbitration could have a material adverse effect on our results of operations,liquidity and financial position.  See Item 1A. “Risk Factors.

            ***PurchaseCommitments.***  As of December 31, 2006, we had options for 100 ERJ-145XR aircraft that may be exercised for other typesof aircraft within the ERJ-145 Family.  During 2005, Continental declined the right to exercise any of these options.  Weretain the right to exercise them and fly these aircraft for other airlines or under our own code, subject to some restrictions;however, we will have to finance our acquisition of these aircraft independently.  Currently, we do not have any firmcommitments for aircraft purchases. 

            Prior to December 2005, under ourpower-by-the-hour agreement with Rolls Royce, we were obligated to acquire up to three spare engines to support our existingaircraft and the remaining eight aircraft on firm order.  In December 2005, we negotiated the sale of eight engines to RollsRoyce and, in exchange, entered into seven new engine leases with a Rolls Royce subsidiary.  The engines leased have greaterinterchangeability than the engines sold. As a result, we have satisfied our engine obligations and are no longer obligated topurchase the three engines.  These leases are classified as operating leases; hence they are not reflected as assets andliabilities on our balance sheet. 

            We also have other contractualobligations of approximately $1.4 billion under our power-by-the-hour contracts with various service providers.  Thepower-by-the-hour contracts dictate the method by which we pay a vendor based on our actual level of operations in exchange forvendor coverage on specific parts and equipment on our aircraft when those parts and equipment are in need of repair orreplacement.  Each contract varies in term and payment procedure.  The estimated amount of our future commitment is basedon assumptions related to future level of operations and forecasted payment rates.  Our level of operations is determined byContinental, which has exclusive scheduling authority over our fleet under the capacity purchase agreement.  The level ofoperations inherent in the estimate is based on Continental’s most recent operating plan for us, which can be altered atContinental’s sole discretion and included operations for the 69 aircraft exiting the Continental CPA.  Forecastedpayment rates are based on actual rates as of December 31, 2006 and increased annually according to the particular inflationindices detailed in each contract.  Contractual rate increases at actual time of occurrence may be different than theforecasted rates.

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            See a summary of all ourcontractual obligations in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results ofOperations – Liquidity and Capital Commitments – Contractual Obligations and Commercial Commitments.”

            ***General Guarantees andIndemnifications.***  Pursuant to the capacity purchase agreement, we indemnify Continental for certain of our actionsand it indemnifies us for some of its actions.  During 2004, we incurred $4.0 million in other operating expenses relating toa claim by Continental for costs incurred during the post-retirement storage of certain turboprop aircraftengines. 

            Additionally, we are party tomany contracts, in which it is common for us to agree to indemnify third parties for tort liabilities that arise out of or relateto the subject matter of the contract.  In some cases, this indemnity extends to related liabilities arising from thenegligence of the indemnified parties, but typically excludes liabilities caused by gross negligence or willful misconduct. We cannot estimate the potential amount of future payments under these indemnities until events arise that would trigger aliability under the indemnities.  However, we expect to be covered by insurance for a material portion of these liabilities,subject to deductibles, policy terms and condition.

           ***Employees.*****  As of December 31, 2006, approximately 70% of our employees are covered by collectivebargaining agreements.  Our contracts with our pilots, dispatchers, flight attendants, and mechanics will be amendable inDecember 2010, July 2009, August 2010 and August 2009, respectively.  Our other employees are not covered by collectivebargaining agreements.

            ***LegalProceedings.***  We are a defendant in various lawsuits and proceedings arising in the ordinary course of ourbusiness.  While the outcome of these lawsuits and proceedings cannot be predicted with certainty and could have a materialadverse effect on our financial position, results of operations or cash flows, we do not believe that the ultimate disposition ofthese proceedings will have a material adverse effect on our financial position, results of operations or cash flows.

**Note 12 –– Related Party Transactions**

            The following is a summary ofsignificant related party transactions that occurred during the three years ended December 31, 2006, other than those discussedelsewhere in the Notes to Consolidated Financial Statements.

            Continental controls thescheduling, ticket prices and seat inventories with respect to Airlines’ operations under the Continental CPA.  Inconnection with this activity, Continental performs all sales and ticketing functions for Airlines on Continental ticket stock andreceives cash directly from the sale of Airlines’ tickets.  Continental purchases or provides payment of certain itemson our behalf, including fuel, certain payroll expenditures (including related benefits) and insurance, and charges us amounts asstipulated in the agreement.  In general, transfers or sales of assets between us and Continental are recorded at net bookvalue.

            Continental provides variousservices to us and charges us amounts at rates in accordance with the Continental CPA and other agreements.  The servicesprovided to us by Continental are as follows.

         

• 

Certain customer services such as ground handling.  Charges related to these services wereapproximately $78.7 million, $75.3 million and $106.5 million for the years ended December 31, 2006, 2005 and 2004,respectively.

• 

Centralized services and infrastructure costs, such as technology, transaction processing, treasuryand risk management.  Charges related to these services were approximately $8.1 million, $8.7 million and $13.8 million forthe years ended December 31, 2006, 2005, and 2004, respectively.

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            During 2004, we amended ouradministrative support and information services provisioning agreement with Continental, which primarily extended the agreement forthe term of the agreement.  We also amended the agreement to incorporate the amendment to our power-by-the-hour agreement withRolls Royce that was signed in September 2004.

            Under our amended master facilityand ground handling agreement with Continental, rent expenses are allocated to us at the airport locations where Airlinesoperates.  Additionally, all terminal facility rents at the hub airports are now borne by Continental and Airlines pays forincremental rent at other Continental–managed locations unless Continental does not operate any aircraft there.  Inthese situations, Airlines is responsible for the rent expense.  At locations Airlines manages, rent is allocated betweenContinental and Airlines based on the number of respective passengers.

            In December 2005, we recorded acurrent receivable from Continental in the amount of $1.7 million related to the reimbursement of the life-limited parts used onseven of the eight engines sold to Rolls Royce.  This receivable is included in “Amounts due from Continental Airlines,Inc., net” on the face of the balance sheet.

            During 2003, we finalized our2002 income tax returns reflecting the tax impact of our spin-off from Continental.  Upon reconciling the tax impact of thespin-off in our deferred tax accounts, a deferred tax asset of approximately $6.7 million remained.  At the end of 2003, thisasset was included in our deferred tax accounts.  In 2004, based on Continental’s agreement with our reconciliation andthe conclusion that this asset was related to our spin-off from Continental, the item was reclassified as a receivable fromContinental.  In December 2004, we reached an agreement with Continental under which it agreed to pay half of thisbalance.  As a result, in the fourth quarter we recorded a $3.4 million charge in Other Operating Expenses.  Continentalpaid us the remaining balance as full and final satisfaction of this matter in January 2005.

            We also have related-partytransactions between us (including our subsidiaries) and our equity investees or Continental.  The following quantifies suchactivities:

        

• 

During 2006, InTech, a wholly owned subsidiary of Holdings, reported sales to Continental totaling$1.1 million.

• 

During 2006, Wing Holdings, in which Holdings owns a non-controlling interest, providedapproximately $0.9 million worth of services to Airlines.

• 

During 2006, Flight Services & Systems, in which Holdings owns a non-controlling interest,provided approximately $1.4 million worth of services to Airlines.

            We had approximately $1.0 millionand $0.7 million of receivables from our employees as of December 31, 2006 and 2005, respectively.  These receivables arerelated to uniforms, flight benefit charges and membership fees that are paid back to us through payroll deductions and do notinclude any of our officers. 

**Note 13 –– Subsequent Event**

****

            In January 2007, Continental soldsubstantially all of its remaining interest in ExpressJet.  Continental's disposition of our shares did not have an adverseimpact on our results of operations or financial position.

            In September 2006, Airlines begandiscussions with Continental to adjust the scheduled block hour rates for 2007.  Although the Continental CPA contemplates aNovember 1 deadline for setting the rates each year, the parties extended that deadline in an attempt to reach agreement.  InJanuary 2007, the parties submitted their disagreements regarding 2007 rates to binding arbitration in accordance with the terms ofthe Continental CPA, which provides that it will be conducted pursuant to the Federal Arbitration Act.  Each party hasselected******one arbitrator, and those two will select a third arbitrator to complete the panel.  The Continental CPAsets forth procedures and a schedule that will likely result in a hearing and issuance of a final decision by late in the second orearly in the third quarter of 2007.  Airlines will continue to be paid under the 2006 block hour rates during the arbitrationand expects the decision setting the revised rate structure to be retroactive to January 1, 2007.  We do not intend to issueany reports on the progress of the arbitration until the panel issues its final decision.  We cannot predict the outcome ofthe arbitration.  If decided adversely to us, the arbitration could have a material adverse effect on our results ofoperations, liquidity and financial position.

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            On February 22, 2007 we agreedwith Continental to defer the transition date for three ERJ-145XR aircraft from the first half of June to August 28, 2007. Until then, these aircraft will remain as covered aircraft under the terms of the Continental CPA.

**Note 14 –– Selected Quarterly Financial Data (Unaudited)**

            Unaudited summarized financialdata by quarter for 2006 and 2005 is as follows (in millions, except per share data):

**March 31,**

**June 30,**

**September 30,**

**December 31,**

**                                                        **
****************
**2006**

Operating revenue

$

404.2

 

$

419.4

 

$

428.6

 

$

425.8

Operating income

37.3

35.6

34.6

33.6

Non-operating expense, net

0.7

1.6

1.8

1.3

Net income

23.8

23.3

22.7

22.8

Basic earnings per share(1)

$

0.44

$

0.43

$

0.42

$

0.42

Diluted earnings per share(2)

$

0.40

$

0.39

$

0.38

$

0.39

  

**2005**

Operating revenue

$

375.4

$

388.7

$

393.8

$

404.9

Operating income

38.8

40.2

38.0

39.5

Non-operating expense, net

(1.2

)

(0.8

)

(0.5

)

0.2

Net income

23.3

24.3

25.5

24.9

Basic earnings per share(1)

$

0.43

$

0.45

$

0.47

$

0.46

Diluted earnings per share(2)

$

0.39

$

0.41

$

0.43

$

0.42

(1)  

The sum of the individual quarterly earnings per share does not agree with year-to-date net incomeper share as each quarterly computation is based on the weighted average number of shares outstanding during thatperiod.

(2)  

See detailed reconciliation of the numerator and denominator of Basic EPS to the numerator anddenominator of Diluted EPS at - Note 1 - Summary of Significant Accounting Policies - (o) Earnings per Share."

**Item 9. Changes in and Disagreement with Accountants on Accounting andFinancial Disclosure**

            There were no changes in ordisagreements on any matters of accounting principles of financial statement disclosure between us and our independentauditors.

**Item 9A. Controls and Procedures**

*           **(a)* *Evaluation of disclosure controls and procedures*.  Based on their evaluation of our disclosure controlsand procedures as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures are effective.

            *(b) Changes in internalcontrol over financial reporting.*  We have not identified any material weakness in our internal control over financialreporting as of December 31, 2006.  We continue working to correct a significant deficiency disclosed in 2005. Management expects to successfully complete the remediation during the first half of 2007.  

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            There have been no changes in ourinternal control over financial reporting during our most recent fiscal quarter that have materially affected our internal controlover financial reporting for the year ended December 31, 2006.  Beginning January 1, 2007, we have an integrated humanresources, payroll and financial system of record, a Lawson application software. This will result in a significant change to ourinternal control over financial reporting for the year ending December 31, 2007. 

            *(c)* The Board ofDirectors, acting through its Audit Committee, is responsible for the oversight of our accounting policies, financial reporting andinternal control.  The Audit Committee is comprised entirely of outside directors who are independent and approves decisionsregarding the appointment or removal of the Director of Internal Audit.  It meets periodically with management, theindependent auditors and the internal auditors to ensure that they are carrying out their responsibilities.  The AuditCommittee is also responsible for performing an oversight role by reviewing the Company’s financial reports.  Theindependent auditors and the internal auditors have full and unlimited access to the Audit Committee, with or without management,to discuss the adequacy of internal control over financial reporting, and any other matters which they believe should be brought tothe attention of the Audit Committee.

**Item 9B. Other Information**

****

None

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**PART III**

****

**Item 10. Directors and Executive Officers of the Registrant**

            The information required by Item10 is incorporated herein by reference to the information set forth in the definitive proxy statement for our 2007 annual meetingof stockholders.

**Item 11. Executive Compensation**

            The information required by Item11 is incorporated herein by reference to the information set forth in the definitive proxy statement for our 2007 annual meetingof stockholders.

**Item 12. Security Ownership of Certain Beneficial Owners andManagement**

            The information required by Item12 is incorporated herein by reference to the information set forth in the definitive proxy statement for our 2007 annual meetingof stockholders.

**Item 13. Certain Relationships and Related Transactions**

            The information required by Item13 is incorporated herein by reference to the information set forth in the definitive proxy statement for our 2007 annual meetingof stockholders.

**Item 14. Principal Accounting Fees and Services**

            The information required by Item14 is incorporated herein by reference to the information set forth in the definitive proxy statement for our 2007 annual meetingof stockholders.

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**PART IV**

**Item 15. Exhibits, Financial Statement Schedules **

The following financial statements are included in Part II, Item 8. "Financial Statements andSupplementary Data":

(a)

  

(1)

  

Financial Statements

 

• 

Report of Management

• 

Report of Independent Registered Public Accounting Firm

• 

Report of Independent Registered Public Accounting Firm on Internal Control over FinancialReporting

• 

Consolidated Statements of Operations for each of the Three Years in the Period Ended December 31,2006

• 

Consolidated Balance Sheets as of December 31, 2006 and 2005

• 

Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended December 31,2006

• 

Consolidated Statements of Common Stockholders' Equity for each of the Three Years in the PeriodEnded December 31, 2006

• 

Notes to Consolidated Financial Statements

 

(2)

Financial Statement Schedules:

  

• 

Report of Independent Registered Public Accounting Firm

• 

Schedule II - Valuation and Qualifying Accounts

            All other schedules have beenomitted because they are inapplicable, not required or the information is included elsewhere in the consolidated financialstatements or notes thereto.

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**Exhibit Number**

**Description**

  

  

3.1

 

—

 

Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company'sreport on Form 10-Q for the quarter ended March 31, 2005, File No. 1-31300, the “Q105 10-Q”).

 3.2

 —

 

 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company's report on Form 10-K for the year endedDecember 31, 2002, file No. 1-31300).

 4.1

 —

 

 Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement onForm S-1, Reg. No. 333-64808, the “S-1”).

 4.2

 —

 

 Rights Agreement among the Company, Continental Airlines, Inc. ("Continental") and Mellon Investor Services LLC, as Rights Agent,including form of Rights Certificate, dated April 1, 2002 (incorporated by reference to Exhibit 4.2 to the Company's report on Form10-Q for the quarter ended March 31, 2002, File No. 1-31300, the "Q102 10-Q").

 4.2

 (a)

 —

 

 First Amendment to Rights Agreement, dated December 13, 2006 .(3)

 4.3

 —

 

 Indenture among the Company, ExpressJet Airlines, Inc., ("Airlines") and Bank One, N.A., dated August 5, 2003, relating to theCompany's 4.25% Convertible Notes due 2023 (incorporated by reference to Exhibit 10.1 to the Company's report on Form 8-K datedSeptember 2, 2003, File No. 1-31300).

 4.3

 (a)

 —

 

 Form of 4.25% Convertible Note due 2023 (included with Exhibit 4.3).

 4.3

 (b)

 —

 

 Form of Notation of Guarantee (included with Exhibit 4.3).

 4.4

 —

 

 Registration Rights Agreement among the Company and Citigroup Global Markets Inc., Credit Suisse First Boston LLC, Morgan Stanley& Co. Incorporated, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Goldman Sachs & Co. and UBS Securities LLC, asinitial purchasers, dated August 5, 2003 (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on FormS-3 dated September 25, 2003, Reg. No. 333-109108).

 10.1

 —

 

 Amended and Restated Capacity Purchase Agreement (the "CPA") among the Company, XJT Holdings, Inc. ("XJT"), Airlines andContinental (incorporated by reference to Exhibit 10.1 to the S-1).(1)

 10.1

 (a)

 —

 

 First Amendment to the CPA dated March 27, 2003 (incorporated by reference to Exhibit 10.1 to the Company's report on Form 10-Qfor the quarter ended March 31, 2003, File No. 1-31300, the "Q103 10-Q").

 10.1

 (b)

 —

 

 Second Amendment to the CPA dated December 9, 2003 (incorporated by reference to Exhibit 10.1(b) to the Company's report on Form10-K for the year ended December 31, 2003, File No. 1-31300, the "2003 10-K").

 10.1

 (c)

 —

 

 Third Amendment to the CPA dated September 28, 2004 (incorporated by reference to Exhibit 10.2 to the Company’s report onForm 10-Q for the quarter ended September 30, 2004, File No. 1-31300, the “Q304 10-Q”).

 10.1

 (d)

 —

 Fourth Amendment to the CPA dated March 11, 2005 (incorporated by reference to Exhibit 10.1(d) to the Company’s Report onForm 10-K for the year ended December 31, 2004, File No. 1-31300, the “2004 10-K”).(1)

 10.1

 (e)

 —

 

 Fifth Amendment to the CPA dated April 14, 2006 (incorporated by reference to the Company’s Report on Form 10-Q for thequarter ended March 31, 2006).

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 10.2

 —

 

 Master Facility and Ground Handling Agreement (the "Facility Agreement") among the Company, Airlines and Continental dated January1, 2001 (incorporated by reference to Exhibit 10.2 to the S-1).

 10.2

 (a)

 —

 

 First Amendment to the Facility Agreement dated November 1, 2003 (incorporated by reference to Exhibit 10.2(a) to the 200310-K).

 10.2

 (b)

 —

 

 Revised Exhibit D, dated as of December 1, 2006, to Master Facility and Ground Handling Agreement. (3)(5)

 10.3

 —

 

 Amended and Restated Administrative Support and Information Services Provisioning Agreement dated March 11, 2005(incorporated by reference to Exhibit 10.1(d) to the 2004 10-K).

 10.4

 —

 

 Initial Public Offering Agreement between the Company and Continental dated April 17, 2002 (incorporated by reference to Exhibit10.4 to the Q102 10-Q).

 10.5

 —

 

 Employee Benefits Separation Agreement (the "Separation Agreement") among the Company, XJT, Airlines and Continental dated April17, 2002 (incorporated by reference to Exhibit 10.6 to the Q102 10-Q).

 10.5

 (a)

 —

 

 First Amendment to the Separation Agreement dated March 27, 2003 (incorporated by reference to Exhibit 10.5 to the Q10310-Q).

 10.5

 (b)

 —

 

 Second Amendment to the Separation Agreement dated December 9, 2003 (incorporated by reference to Exhibit 10.6(b) to the 200310-K).

 10.5

 (c)

 —

 

 Third Amendment to the Separation Agreement dated June 24, 2005 (incorporated by reference to Exhibit 10.1 to the Company’sreport on Form 10-Q for the quarter ended June 30, 2005, File No. 1-31300).

 10.6

 —

 

 Amended and Restated Tax Agreement among the Company, Airlines and Continental dated April 17, 2002 (incorporated by reference toExhibit 10.6 to the Company’s report on Form 10-Q for the quarter ended June 30, 2002, File No. 1-31300).

 10.7

 —

 

 2002 Stock Incentive Plan ("SIP") (incorporated by reference to Exhibit 10.8 to the Q102 10-Q). (2)

 10.7

 (a)

 —

 

 Form of Employee Stock Option Agreement pursuant to SIP (incorporated by reference to Exhibit 10.8(a) to the S-1).(2)

 10.7

 (b)

 —

 

 Form of Outside Director Stock Option Agreement pursuant to SIP (incorporated by reference to Exhibit 10.8(b) to the S-1).(2)

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 10.7

 (c)

 —

 

 Form of Employee Restricted Stock Option Agreement pursuant to SIP (incorporated by reference to Exhibit 10.1 to theCompany’s report on Form 10-Q for the quarter ended June 30, 2004, File No. 1-31300, the “Q204 10-Q”).(2)

 10.7

 (d)

 —

 

 Form of Outside Director Restricted Stock Agreement pursuant to SIP (incorporated by reference to Exhibit 10.2 to the Q204 10-Q).(2)

 10.8

 —

 

 Management Bonus Plan as amended and restated through February 17, 2005 (incorporated by reference to Exhibit 99.1 to theCompany's report on Form 8-K dated February 17, 2005, File No. 1-31300). (2)

 10.9

 —

 

 Supplemental Retirement Plan as amended and restated effective May 5, 2004 (incorporated by reference to Exhibit 10.3 to the Q20410-Q). (2)

 10.10

 —

 

 Employment Agreement among the Company, Continental and James B. Ream (incorporated by reference to Exhibit 10.9 to the S-1).(2)

 10.10

 (a)

 —

 

 Letter Agreement among the Company, Continental and Mr. Ream dated April 24, 2002 (incorporated by reference to Exhibit 10.9(a) tothe Q102 10-Q). (2)

 10.10

 (b)

 —

 

 Amendment to Mr. Ream's Employment Agreement dated March 14, 2005 (incorporated by reference to Exhibit 10.12(b) to the 200410-K). (2)

 10.11

 —

 

 Employment Agreement among the Company, Continental and Frederick S. Cromer (incorporated by reference to Exhibit 10.10 to theS-1). (2)

 10.11

 (a)

 —

 

 Letter Agreement among the Company, Continental and Mr. Cromer dated April 24, 2002 (incorporated by reference to Exhibit 10.10(a)to the Q102 10-Q). (2)

 10.11

 (b)

 —

 

 Amendment to Mr. Cromer's Employment Agreement dated March 14, 2005 (incorporated by reference to Exhibit 10.13(b) to the 200410-K). (2)

 10.12

 —

 

 Employment Agreement among the Company, Continental and Jerry E. Losness (incorporated by reference to Exhibit 10.10 to the S-1).(2)

 10.12

 (a)

 —

 

 Letter Agreement among the Company, Continental and Mr. Losness dated April 24, 2002 (incorporated by reference to Exhibit10.10(a) to the Q102 10-Q). (2)

 10.12

 (b)

 —

 

 Amendment to Mr. Losness's Employment Agreement dated March 14, 2005 (incorporated by reference to Exhibit 10.14(b) to the 200410-K). (2)

 10.13

 —

 

 Employment Agreement between the Company Scott R. Peterson as amended and restated through March 14, 2005 (incorporated byreference to Exhibit 10.15 to the 2004 10-K). (2)

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 10.14

 —

 Form of Amended and Restated Letter Agreement relating to certain flight benefits between the Company and each of its non-employeedirectors (incorporated by reference to Exhibit 10.1 to the 3Q04 10-Q). (2)

 10.15

 —

 Schedule of compensation payable to the Company’s non-employee directors (incorporated by reference to Exhibit 10.1 to theQ105 10-Q). (2)

 10.16

 —

 ExpressJet Holdings, Inc. Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s report onForm 8-K dated January 31, 2006, File No. 1-31300). (2)

 10.16

 (a)

 —

 Form of Participation Agreement under the ExpressJet Holdings, Inc. Long Term Incentive Plan (included with Exhibit 10.26).(2)

 21.1

 —

 

 Subsidiaries of the Company. (3)

 23.1

 —

 Consent of Independent Registered Public Accounting Firm. (3)

 24.1

 —

 Powers of Attorney. (3)

 31.1

 —

 Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer. (3)

 31.2

 —

 Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer. (3)

 32.1

 —

 Section 1350 Certification by Chief Executive Officer. (4)

 32.2

 —

 Section 1350 Certification by Chief Financial Officer. (4)

 

  

(1)

The SEC has granted confidential treatment for portions of these exhibits.  Omitted materialfor which confidential treatment has been granted has been filed separately with the SEC.

(2)

Management contract or compensatory plan or arrangement in which a director or executive officerparticipates.

(3)

Filed herewith.

(4)

Furnished herewith.

(5)

The Company has applied to the SEC for confidential treatment for portions of this exhibit. Omitted material for which confidential treatment has been requested has been filed separately with the SEC.

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SIGNATURES

            Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, ExpressJet Holdings, Inc. has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized.

 

 

EXPRESSJET HOLDINGS, INC. (Registrant)

 Date:  February 22, 2007             

         

 By:

 /s/ Frederick S.Cromer                                         

Frederick S. Cromer Vice President and Chief Financial Officer

            Pursuant to the requirements ofthe Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and inthe capacities indicated on February 22, 2007.

Signatures                                                    

Capacity

   /s/ JAMES B.REAM                              James B. Ream

      

 President, Chief Executive Officer and Director (Principal Executive Officer)

   /s/ FREDERICK S.CROMER                 Frederick S. Cromer

 Vice President and Chief Financial Officer (Principal Financial Officer)

   /s/ PHUNGNGO-BURNS                       Phung Ngo-Burns

 Staff Vice President and Controller (Principal Accounting Officer)

   /s/ SALVATORE J. BADALAMENTI *      Salvatore J. Badalamenti

 Director

   /s/ GEORGE R. BRAVANTE, JR. *         George R. Bravante, Jr.

 Director

   /s/ JANET M.CLARKE*                         Janet M. Clarke

 Director

   /s/ KIM A.FADEL*                                 Kim A. Fadel

 Director

   /s/ JUDITH R.HABERKORN*                  Judith R. Haberkorn

 Director

   /s/ BONNIE S.REITZ*                            Bonnie S. Reitz

 Director

   /s/ RICHARD F.WALLMAN*                   Richard F. Wallman

 Director

                                                          

  

* By:

 /s/ SCOTT R.PETERSON                 

Scott R. Peterson Attorney in Fact February 22, 2007

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

            We have audited the consolidatedfinancial statements of ExpressJet Holdings, Inc. (the “Company”) as of December 31, 2006 and 2005, and for each of thethree years in the period ended December 31, 2006, and have issued our report thereon dated February 21, 2007 (included elsewherein this Form 10-K).  Our audits also included the financial statement schedule listed in Item 15(a)(2) of this Form10-K.  This schedule is the responsibility of the Company’s management.  Our responsibility is to express anopinion based on our audits.

In our opinion, the financial statement schedule referred to above, when considered in relation tothe basic financial statements taken as a whole, presents fairly in all material respects the information set forththerein.

                                                                                   

                                                                                                           ERNST & YOUNG LLP

Houston, Texas

February 21, 2007

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**EXPRESSJET HOLDINGS, INC.SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTSFor the Years Ended December 31, 2004, 2005, and 2006(In thousands)**

**Allowance for Doubtful Receivables**

**Allowance for Obsolescence**

**Deferred Tax Asset Valuation Allowance (1)**

                                                                      

Balance, December 31, 2003

$

99

$

6,907

$

420,668

   Additions charged to expense

147

  

1,825

  

—

   Deductions from reserve (2)

(147

)

(793

)

(56,964

)

   Other (3)

—

519

(1,666

)

Balance, December 31, 2004

99

8,458

362,038

   Additions charged to expense

7

1,840

—

   Deductions from reserve (2)

(7

)

(1,350

)

(25,266

)

   Other (3)

—

153

(1,966

)

Balance, December 31, 2005

99

9,101

334,806

   Additions charged to expense

24

1,496

—

   Deductions from reserve (2)

—

(837

)

(23,853

)

   Other

826

Balance, December 31, 2006

$

123

$

9,760

$

311,779

 

(1) 

The deferred tax asset valuation allowance includes the net tax agreement obligation toContinental.

(2) 

“Deductions from reserve” related to the allowance for obsolescence consists of entriesmade to remove spare parts with zero net book value from our general ledger.  “Deductions from reserve” related tothe deferred tax asset valuation allowance are related to payments made to Continental under the tax agreement.

(3) 

“Other” related to the deferred tax asset valuation allowance for 2004 and 2005 isrelated to the adjustment of the fair value of the tax basis of our tangible and intangible assets as described in Item 8.“Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note7.”

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**INDEX TO EXHIBITS**

**OF EXPRESSJET HOLDINGS, INC.**

**ExhibitNumber**

**Description**

  

  

3.1

 

—

 

Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company'sreport on Form 10-Q for the quarter ended March 31, 2005, File No. 1-31300, the “Q105 10-Q”).

 3.2

 —

 

 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company's report on Form 10-K for the year endedDecember 31, 2002, file No. 1-31300).

 4.1

 —

 

 Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement onForm S-1, Reg. No. 333-64808, the “S-1”).

 4.2

 —

 

 Rights Agreement among the Company, Continental Airlines, Inc. ("Continental") and Mellon Investor Services LLC, as Rights Agent,including form of Rights Certificate, dated April 1, 2002 (incorporated by reference to Exhibit 4.2 to the Company's report on Form10-Q for the quarter ended March 31, 2002, File No. 1-31300, the "Q102 10-Q").

 4.2

 (a)

 —

 

 First Amendment to Rights Agreement, dated December 13, 2006 .(3)

 4.3

 —

 

 Indenture among the Company, ExpressJet Airlines, Inc., ("Airlines") and Bank One, N.A., dated August 5, 2003, relating to theCompany's 4.25% Convertible Notes due 2023 (incorporated by reference to Exhibit 10.1 to the Company's report on Form 8-K datedSeptember 2, 2003, File No. 1-31300).

 4.3

 (a)

 —

 

 Form of 4.25% Convertible Note due 2023 (included with Exhibit 4.3).

 4.3

 (b)

 —

 

 Form of Notation of Guarantee (included with Exhibit 4.3).

 4.4

 —

 

 Registration Rights Agreement among the Company and Citigroup Global Markets Inc., Credit Suisse First Boston LLC, Morgan Stanley& Co. Incorporated, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Goldman Sachs & Co. and UBS Securities LLC, asinitial purchasers, dated August 5, 2003 (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on FormS-3 dated September 25, 2003, Reg. No. 333-109108).

 10.1

 —

 

 Amended and Restated Capacity Purchase Agreement (the "CPA") among the Company, XJT Holdings, Inc. ("XJT"), Airlines andContinental (incorporated by reference to Exhibit 10.1 to the S-1).(1)

 10.1

 (a)

 —

 

 First Amendment to the CPA dated March 27, 2003 (incorporated by reference to Exhibit 10.1 to the Company's report on Form 10-Qfor the quarter ended March 31, 2003, File No. 1-31300, the "Q103 10-Q").

 10.1

 (b)

 —

 

 Second Amendment to the CPA dated December 9, 2003 (incorporated by reference to Exhibit 10.1(b) to the Company's report on Form10-K for the year ended December 31, 2003, File No. 1-31300, the "2003 10-K").

 10.1

 (c)

 —

 

 Third Amendment to the CPA dated September 28, 2004 (incorporated by reference to Exhibit 10.2 to the Company’s report onForm 10-Q for the quarter ended September 30, 2004, File No. 1-31300, the “Q304 10-Q”).

 10.1

 (d)

 —

 Fourth Amendment to the CPA dated March 11, 2005 (incorporated by reference to Exhibit 10.1(d) to the Company’s Report onForm 10-K for the year ended December 31, 2004, File No. 1-31300, the “2004 10-K”).(1)

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 10.1

 (e)

 —

 

 Fifth Amendment to the CPA dated April 14, 2006 (incorporated by reference to the Company’s Report on Form 10-Q for thequarter ended March 31, 2006).

 10.2

 —

 

 Master Facility and Ground Handling Agreement (the "Facility Agreement") among the Company, Airlines and Continental dated January1, 2001 (incorporated by reference to Exhibit 10.2 to the S-1).

 10.2

 (a)

 —

 

 First Amendment to the Facility Agreement dated November 1, 2003 (incorporated by reference to Exhibit 10.2(a) to the 200310-K).

 10.2

 (b)

 —

 

 Revised Exhibit D, dated as of December 1, 2006, to Master Facility and Ground Handling Agreement. (3)(5)

 10.3

 —

 

 Amended and Restated Administrative Support and Information Services Provisioning Agreement dated March 11, 2005(incorporated by reference to Exhibit 10.1(d) to the 2004 10-K).

 10.4

 —

 

 Initial Public Offering Agreement between the Company and Continental dated April 17, 2002 (incorporated by reference to Exhibit10.4 to the Q102 10-Q).

 10.5

 —

 

 Employee Benefits Separation Agreement (the "Separation Agreement") among the Company, XJT, Airlines and Continental dated April17, 2002 (incorporated by reference to Exhibit 10.6 to the Q102 10-Q).

 10.5

 (a)

 —

 

 First Amendment to the Separation Agreement dated March 27, 2003 (incorporated by reference to Exhibit 10.5 to the Q10310-Q).

 10.5

 (b)

 —

 

 Second Amendment to the Separation Agreement dated December 9, 2003 (incorporated by reference to Exhibit 10.6(b) to the 200310-K).

 10.5

 (c)

 —

 

 Third Amendment to the Separation Agreement dated June 24, 2005 (incorporated by reference to Exhibit 10.1 to the Company’sreport on Form 10-Q for the quarter ended June 30, 2005, File No. 1-31300).

 10.6

 —

 

 Amended and Restated Tax Agreement among the Company, Airlines and Continental dated April 17, 2002 (incorporated by reference toExhibit 10.6 to the Company’s report on Form 10-Q for the quarter ended June 30, 2002, File No. 1-31300).

 10.7

 —

 

 2002 Stock Incentive Plan ("SIP") (incorporated by reference to Exhibit 10.8 to the Q102 10-Q). (2)

 10.7

 (a)

 —

 

 Form of Employee Stock Option Agreement pursuant to SIP (incorporated by reference to Exhibit 10.8(a) to the S-1).(2)

 10.7

 (b)

 —

 

 Form of Outside Director Stock Option Agreement pursuant to SIP (incorporated by reference to Exhibit 10.8(b) to the S-1).(2)

Table of Contents

 10.7

 (c)

 —

 

 Form of Employee Restricted Stock Option Agreement pursuant to SIP (incorporated by reference to Exhibit 10.1 to theCompany’s report on Form 10-Q for the quarter ended June 30, 2004, File No. 1-31300, the “Q204 10-Q”).(2)

 10.7

 (d)

 —

 

 Form of Outside Director Restricted Stock Agreement pursuant to SIP (incorporated by reference to Exhibit 10.2 to the Q204 10-Q).(2)

 10.8

 —

 

 Management Bonus Plan as amended and restated through February 17, 2005 (incorporated by reference to Exhibit 99.1 to theCompany's report on Form 8-K dated February 17, 2005, File No. 1-31300). (2)

 10.9

 —

 

 Supplemental Retirement Plan as amended and restated effective May 5, 2004 (incorporated by reference to Exhibit 10.3 to the Q20410-Q). (2)

 10.10

 —

 

 Employment Agreement among the Company, Continental and James B. Ream (incorporated by reference to Exhibit 10.9 to the S-1).(2)

 10.10

 (a)

 —

 

 Letter Agreement among the Company, Continental and Mr. Ream dated April 24, 2002 (incorporated by reference to Exhibit 10.9(a) tothe Q102 10-Q). (2)

 10.10

 (b)

 —

 

 Amendment to Mr. Ream's Employment Agreement dated March 14, 2005 (incorporated by reference to Exhibit 10.12(b) to the 200410-K). (2)

 10.11

 —

 

 Employment Agreement among the Company, Continental and Frederick S. Cromer (incorporated by reference to Exhibit 10.10 to theS-1). (2)

 10.11

 (a)

 —

 

 Letter Agreement among the Company, Continental and Mr. Cromer dated April 24, 2002 (incorporated by reference to Exhibit 10.10(a)to the Q102 10-Q). (2)

 10.11

 (b)

 —

 

 Amendment to Mr. Cromer's Employment Agreement dated March 14, 2005 (incorporated by reference to Exhibit 10.13(b) to the 200410-K). (2)

 10.12

 —

 

 Employment Agreement among the Company, Continental and Jerry E. Losness (incorporated by reference to Exhibit 10.10 to the S-1).(2)

 10.12

 (a)

 —

 

 Letter Agreement among the Company, Continental and Mr. Losness dated April 24, 2002 (incorporated by reference to Exhibit10.10(a) to the Q102 10-Q). (2)

 10.12

 (b)

 —

 

 Amendment to Mr. Losness's Employment Agreement dated March 14, 2005 (incorporated by reference to Exhibit 10.14(b) to the 200410-K). (2)

 10.13

 —

 

 Employment Agreement between the Company Scott R. Peterson as amended and restated through March 14, 2005 (incorporated byreference to Exhibit 10.15 to the 2004 10-K). (2)

Table of Contents

 10.14

 —

 Form of Amended and Restated Letter Agreement relating to certain flight benefits between the Company and each of its non-employeedirectors (incorporated by reference to Exhibit 10.1 to the 3Q04 10-Q). (2)

 10.15

 —

 Schedule of compensation payable to the Company’s non-employee directors (incorporated by reference to Exhibit 10.1 to theQ105 10-Q). (2)

 10.16

 —

 ExpressJet Holdings, Inc. Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s report onForm 8-K dated January 31, 2006, File No. 1-31300). (2)

 10.16

 (a)

 —

 Form of Participation Agreement under the ExpressJet Holdings, Inc. Long Term Incentive Plan (included with Exhibit 10.26).(2)

 21.1

 —

 

 Subsidiaries of the Company. (3)

 23.1

 —

 Consent of Independent Registered Public Accounting Firm. (3)

 24.1

 —

 Powers of Attorney. (3)

 31.1

 —

 Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer. (3)

 31.2

 —

 Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer. (3)

 32.1

 —

 Section 1350 Certification by Chief Executive Officer. (4)

 32.2

 —

 Section 1350 Certification by Chief Financial Officer. (4)

 

  

(1)

The SEC has granted confidential treatment for portions of these exhibits.  Omitted materialfor which confidential treatment has been granted has been filed separately with the SEC.

(2)

Management contract or compensatory plan or arrangement in which a director or executive officerparticipates.

(3)

Filed herewith.

(4)

Furnished herewith.

(5)

The Company has applied to the SEC for confidential treatment for portions of this exhibit. Omitted material for which confidential treatment has been requested has been filed separately with the SEC.