Category: TURNAROUND MANAGEMENT Now five years into its remarkable about-face, Continental Airlines continues to soar.


Life is easier these days, admits Larry Kellner. After all, says the executive vice president and CFO of Continental Airlines Inc., which is in the fifth year of its remarkable turnaround, "Everything gets a lot easier if you have a good operation and things are going well."

And, indeed, things are going quite well at the nation's fifth-largest airline. For a company that almost disappeared in 1995, Houston-based Continental posted some pretty impressive numbers last year. For example, the airline had a $770 million pretax profit, compared with its $204 million pretax loss in 1994. Operating cash flow was an astounding $1.1 billion, up from $269 million in 1994. In addition, earnings per share excluding non- recurring items increased almost 20 percent from 1997 to 1998, from $5.03 to $6.03.

Those numbers are a far cry from the ones that greeted Kellner when he joined Continental in 1995, fresh from a stint as executive vice president and CFO of American Savings Bank in Irvine, California. At that time, Continental, which was on the verge of its third bankruptcy, was more than $500 million in debt, stood in default on $2.7 billion in loan and lease obligations, and had a cost of capital in excess of 12 percent. Things were so bad then, says the 40-year-old Kellner, that if the first cash-flow forecast he saw had been "low by the amount it was high, we would have run out of money."

The recovery at Continental was dramatic and relatively quick. And much of the credit for the airline's current financial strength goes to Kellner, the winner of the 1999 CFO Excellence Award for Turnaround Management. Says Gordon M. Bethune, chairman and CEO of Continental and the architect of the "Go Forward" plan that mapped the airline's recovery, "The operational turnaround we achieved at Continental during the past three years would not have been possible without the financial stewardship of Larry Kellner."

Not-So-Ancient History

What happened at Continental Airlines, says Kellner, is relatively easy to explain. "Anytime you are in a company that is broken, often what's been ignored are three things: the people, the training of those people, and the systems," he says. And nowhere was this more true than at Continental.

When Kellner arrived, for example, no significant investments had been made in systems in 10 years. "The company didn't even have E-mail," he says. And instead of being a "low-cost airline, we were a low-labor-rate airline. We would just figure out what our costs needed to be and jam our employees to that level." Moreover, the company had lost all credibility on Wall Street--a situation that essentially cut off access to new capital.

The latter problem consumed Kellner at the outset. But his philosophy of "underpromising and overdelivering," as well as his candid style, struck a chord with investors and analysts. In addition, he quieted his most vocal creditors by pioneering the large-scale use of enhanced equipment trust certificates -- a tool that allows Continental to borrow at spreads as low as 90 basis points above the 10- year Treasury rate.

Consequently, in January 1996, he completed the first of 11 transactions, totaling more than $4.7 billion, for new and used aircraft financing in the public debt markets. Since then, the numbers tell the story: Continental's annual net interest expense, for example, has fallen from $204 million in 1994 to $64 million at the end of 1998, and its net debt-to-equity ratio has dropped from 37.3-to- 1 in March 1995 to 4.9-to-1 at the end of 1998.

In the wake of such success, Kellner says he doesn't remember many low points, but he knows when he realized it was going to work. "Right after we had gotten most of our major creditors resolved," he recalls, "we started looking to refinance a large batch of aircraft. At the same time, Air Canada, one of our original investors, was pretty eager to get some money back." So Kellner cut a deal in September 1995 whereby Air Canada sold back warrants on over 12 million shares giving Continental the ability to raise equity without significant dilution. More important, "we were able to convince them to take a note for 75 percent of the purchase price until we could get financing to pay them off," says Kellner. "The day that closed, I felt pretty comfortable that we had changed people's perceptions."

No Rest for the Weary

Far from resting on his laurels, Kellner is working hard to sustain the turnaround. It's like maintaining your weight after a successful diet, he says. "You may have lost a lot of weight, but the real challenge is to keep it off."

There are still costs to be wrung out. A 1997 benchmarking project found that Continental's non-labor costs were about $200 million more than its competitors'. In an effort to reduce that differential, Continental cut more than $100 million from its cost structure in 1998, and has $190 million targeted this year. "We are extremely focused on what we are throwing away; where our natural inefficiencies are; how we can gain from consolidating vendors; and how we can use technology to automate," he says. In its whole and liability insurance costs, for example, "we've gone from the worst in the industry in 1995 to the best, on a benchmark basis." The only area that remains sacred, he says, is passenger service.

Still, making the turnaround permanent "means getting the right facilities and the right fleet" going forward, says Kellner. Consequently, to date, Kellner has secured more than $473 million in financing to revamp Continental's hub operations in Houston, Newark, and Cleveland. In addition, the airline has embarked on a project that will guarantee it the youngest fleet of any major U.S. airline by year-end.

That latter decision, he points out, is a prudent one. "Conventional wisdom three or four years ago," he says, "would have been to 'hush kit' our older planes in order to meet federal noise requirements." But the problem at Continental was compounded by the fact that the fleet was extremely complex -- consisting of DC9s, 727s, and 737s. And when the analytics were run, says Kellner, "the financially positive course" was to replace all the older DC9s and 727s with 737s. The younger fleet will save Continental millions of dollars in fuel and maintenance costs, as well as help employees, because "it takes a lot of the complexity out of the system," he explains.

The financing of the new fleet, says Kellner, will give Continental a beneficial capital structure for the next 20 years. "Sixty-five percent of those purchases will be leased on 18-to-20-year leases at a time when interest rates are very low." In fact, he says, "we've done $4.6 billion worth of aircraft financing at an average interest rate of 6.9 percent. When I got here, we were taking aircraft at 12 to 12.5 percent. And that's really the trick -- locking in very effective interest rates for the long term on a large portion of our fleet."

Kellner is spending prudently on other fronts, too. By next year, Continental is "committed to bringing everyone -- pilots, flight attendants, baggage handlers--up to industry- average compensation rates." In addition, Kellner has increased Continental's pension- plan assets more than threefold in the past four years, to nearly $1 billion. And on an ongoing basis, a pay-for-performance program has been established so that each employee receives $65 in each month that the carrier ranks as one of the top-three airlines for on- time arrivals; $100 if it reaches the top.

Finally, in the area of systems, Kellner has worked from the beginning of his tenure for more control of information. "We had a daily cash report about four days after I got here," he says. Since then, he has implemented what is known as the Flight Profitability System, which monitors the contribution to the bottom line of each of Continental's 2,250 daily flights. "In 1995, I could tell you how much we made on our Houston to Newark route on a monthly basis, but the numbers included a lot of cost averaging. Today, I can tell you by flight how much we made."


Having such data, says Kellner, allows Continental to be more nimble, and convinces him that the company will never be in turnaround mode again. "I feel much more confident about the future of the business," he says.

In the end, though, says Kellner, a turnaround is never truly complete. "The company is obviously in great shape today," he admits, cautioning that trouble can brew "the second you try to put it on cruise control."

Continental has been a winner for almost 5 years now. But Kellner says, "I want us to be able to say we're a winner for the next 25 years."


Read next:

Finance At BeyondCore