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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

Commission file number 0-21976

ATLANTIC COAST AIRLINES HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (703) 650-6000

     Securities registered pursuant to Section 12(b) of the Act:

     Securities registered pursuant to Section 12(g) of the Act:

Common Stock par value $.02
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  X     No    

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes  X     No    

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.       

The aggregate market value of voting stock held by nonaffiliates of the registrant as of June 30, 2003 was approximately $593.5 million.

As of February 09, 2004, there were 50,404,787 shares of common stock of the registrant issued and 45,333,810 shares of common stock were outstanding.

Documents Incorporated by Reference

Certain portions of the document listed below have been incorporated by reference into the indicated part of this Form 10-K.

(to be filed subsequently)

     Table of Contents

Forward Looking Statements

     This Annual Report on Form 10-K contains forward-looking statements. Statements in the Business and Management’s Discussion and Analysis of Results of Operations and Financial Condition sections of this filing, together with other statements beginning with such words as “believes”, “intends”, “plans”, and “expects” include forward-looking statements that are based on management’s expectations given facts as currently known by management on the date this Form 10-K was first filed with the SEC. Actual results may differ materially. Factors that could cause the Company’s future results to differ materially from the expectations described here include: United’s option under bankruptcy rules to assume or reject the existing United Express Agreement; the timing of any disengagement by the Company as a United Express carrier under the United Express Agreement or pursuant to bankruptcy court proceedings and impact on the Company’s ability to operate an independent airline; the ability to successfully implement a transition from United Express service; the ability to effectively implement its low-fare business strategy utilizing a mix of narrowbody aircraft and regional jets; the ability to acquire and obtain financing for the narrowbody aircraft; the ability to compete effectively as a low-fare carrier, including passenger response to the Company’s new service, and the response of United or other competitors with respect to service levels and fares in markets to be operated by the Company; the Company’s ability to collect pre-petition obligations from United or to offset pre-petition obligations due to United; unexpected costs arising from the Company’s response to United’s bankruptcy proceedings; the effects of United’s bankruptcy proceedings; the continued financial health of Delta Air Lines, Inc., and the ability and willingness of Delta to continue to deploy the Company’s aircraft and to utilize and pay for scheduled service at agreed upon rates; changes in levels of service agreed to by the Company with United and Delta; the ability to meet performance standards under our code share agreements; availability and cost of product support for the Company’s 328Jet aircraft; the ability of the Company to recover or realize its claims against Fairchild Dornier in its insolvency proceedings, and unexpected costs arising from the insolvency of Fairchild Dornier; satisfactory resolution of union contracts with the Company’s aviation maintenance technicians/ground service equipment mechanics and flight attendants; potential service disruptions due to labor actions by employees of the Company, Delta Air Lines or United Airlines; the ability to successfully retire turboprop aircraft and to remarket them; changes in and satisfaction of regulatory requirements including requirements relating to maintenance and fleet expansion; the effects of high fuel prices on the Company and on its major airline partners; general economic and industry conditions; adverse weather conditions; additional acts of war or terrorism; willingness of the U.S. government to continue to provide war risk insurance at favorable rates, or increased cost and reduced availability of insurance; the costs and other effects of enhanced security measures and other possible government orders; and risks and uncertainties arising from the events of September 11, any of which may impact the Company, its aircraft manufacturers and its other suppliers in ways that the Company is not currently able to predict. The statements in this Annual Report are made as of the date this Form 10-K was first filed with the SEC and the Company undertakes no obligation to update any of the forward-looking information included in this document, whether as a result of new information, future events, changes in expectations or otherwise.

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PART I

Item 1. Business

Overview

     Atlantic Coast Airlines Holdings, Inc., a Delaware corporation (“ACAI”), is a holding company with its primary subsidiary being Atlantic Coast Airlines (“ACA”), a regional airline serving 85 destinations in 30 states in the Eastern and Midwestern United States and Canada, with 850 scheduled non-stop flights system-wide every weekday. The Company has operated as a regional airline since 1992. Unless the context indicates otherwise, the terms “the Company”, “we”, “us”, or “our” refer herein to Atlantic Coast Airlines Holdings, Inc.

     ACA operates under code-share agreements as a United Express carrier with United Airlines, Inc. (“United”) and as a Delta Connection carrier with Delta Air Lines, Inc. (“Delta”). The Company derived approximately 83% of its 2003 passenger revenue from its United Express operations. Until December 2000, ACA operated as a United Express carrier pursuant to an agreement that made the Company responsible for, among other things, route planning, scheduling, pricing, revenue management, revenue accounting and certain marketing functions including advertising and local promotions. In 2000, the Company and United amended the arrangement to provide that the Company would be compensated on a fee-per-departure basis, and that United would be responsible for most of these functions. In addition, the Company entered into a fee-per-block hour code share agreement with Delta in 1999.

     On July 28, 2003 the Company announced that it anticipates that its longstanding relationship with United Airlines will end as a part of United’s reorganization in bankruptcy, and that the Company intends to utilize its assets to operate as an independent low-fare airline. The airline will operate as “Independence Air” from the Company’s hub at Washington Dulles International Airport (“Washington Dulles”). The Company intends to offer scheduled service to the traveling public using a relatively new, all-jet fleet of narrowbody and regional jet aircraft, a low and simple fare structure and the convenience of frequent flights. The Company intends to launch an all-encompassing branding and marketing campaign targeting technology-savvy travelers and emphasizing low fares, frequent flights and a faster and easier travel experience. The timing and terms of the Company’s commencement of operations as Independence Air depends, among other things, on the terms and timing of its disengagement as a United Express carrier, which cannot be projected at this time. Under the terms of its code-share agreement with the Company, Delta has a right to terminate the agreement on 180 days notice, and may do so in connection with the Company’s plan to operate as Independence Air.

Existing Code-Share Agreements

     The Company currently derives substantially all of its revenues through its code-share agreements with United and Delta, operating under their United Express and Delta Connection brands, respectively.

United Express Operation

     The Company’s United Express Agreements (“UA Agreements”) define the Company’s relationship with United. In November 2000, the Company and United amended and restated the UA Agreements, effectively changing from a revenue sharing arrangement to a fee-per-departure

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arrangement. Under the UA Agreements in effect prior to December 2000, the Company was responsible for, among other things, scheduling, pricing, and marketing its flights, in coordination with United’s operations, for which it paid United a portion of its revenues. Under the fee-per-departure arrangement in effect as of December 1, 2000, the Company operates a flight schedule designated by United, for which United pays the Company an agreed amount per departure regardless of the number of passengers carried, with the Company being able to receive additional incentive payments based on operational performance. The Company thereby assumes the risks associated with operating the flight schedule and United assumes the risk of scheduling, marketing, and selling seats to the traveling public. Pursuant to the restated UA Agreements, United, at its own expense, provides a number of additional services to the Company. These include reservations, route planning, scheduling, pricing, revenue management, revenue accounting, marketing, frequent flyer administration, and the provision of ticket handling services, customer service, and ground support services at most of the airports where both companies operate flights concurrently.

     On December 9, 2002, UAL, Inc. and its subsidiaries, including United, filed for protection under Chapter 11 of the United States bankruptcy code. UAL continues operating and managing its business and affairs as a debtor in possession. In bankruptcy, United has the right to assume or reject all executory agreements including the Company’s UA Agreements. No deadline has been set by United to assume or reject the Company’s UA Agreements. Until a decision is announced by United to assume or reject the Company’s UA Agreements, the Company expects to continue to fulfill its obligations under the UA Agreements. In July 2003, the Company reached agreement with United on new fee-per-departure rates that were effective retroactively to January 1, 2003 and are to be utilized until such time as the UA Agreements are affirmed or rejected by United or modified by agreement of United and the Company. The 2003 rate agreement provides an aircraft utilization guarantee and includes an annual CPI-based rate increase if the UA Agreements are not assumed, rejected or modified by June 30, 2004.

     If United were to affirm the UA Agreements, the Company would be required to perform its obligations under the UA Agreements through the remainder of their term, which is December 2010. In such circumstance, the Company would continue to pursue its plans to operate Independence Air as a low-fare airline using the narrowbody jets that the Company is in the process of acquiring and any regional jets that are not deployed in the United Express operations. United has taken various steps that give the Company reason to believe United will reject the UA Agreements as part of its reorganization in bankruptcy, including the following: United has replaced or is in the process of replacing the Company’s employees at Chicago and other stations, United announced that it is building a new regional terminal at Washington Dulles and United has stated in a filing with the bankruptcy court that “[i]t is unlikely at present than any consensual renegotiation of the contract with [the Company] can be achieved.” The Company is seeking to engage United in discussions regarding an orderly exit of the Company’s fleet from the United Express program. See “Business; Independence Air – Our Operational Transition from the United Express Program,” below.

Delta Connection Operation

     The Company’s Delta Connection operations accounted for approximately 17% of the Company’s 2003 passenger revenue. The Company’s Delta Connection Agreement (“DL Agreement”) defines the Company’s relationship with Delta for the term of the agreement, which is through March 2010. The Company is compensated by Delta on a fee-per-block hour basis at rates that are reset annually based on anticipated costs in the coming year. Under the fee-per-block hour arrangement, the Company is contractually obligated to operate a flight schedule designated by Delta, for which Delta pays the Company an agreed amount per block hour regardless of the number of

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passengers carried, with incentive payments based on operational performance. The Company thereby assumes the risks associated with operating the flight schedule and Delta assumes the risks of scheduling, marketing, and selling seats to the traveling public. Pursuant to the DL Agreement, Delta, at its expense, provides a number of support services to the Company. These include reservations, customer service, ground handling, station operations, pricing, scheduling, revenue accounting, revenue management, frequent flyer administration, marketing, a maintenance hangar facility in Cincinnati, and other passenger, aircraft and traffic servicing functions in connection with the Company’s Delta Connection operation.

     The Company is experiencing difficulties maintaining its fleet of 328 regional jets (“328Jets”) that it uses in its Delta Connection operations both as a result of a reduction in product support following the bankruptcy of Fairchild Dornier GmbH, the manufacturer of the 328Jets, in April 2002, and more recently as a result of unscheduled maintenance events to repair turbine blades in the aircraft’s Pratt & Whitney engines. These unscheduled maintenance events have caused a shortage of spare engines resulting in the Company temporarily grounding several of its 328Jet aircraft while the engines are being repaired. In seeking to mitigate difficulties maintaining its fleet of 328Jets, the Company has deployed three 328Jet aircraft that were originally used in the Company’s “Private Shuttle” charter operation to its Delta Connection operations. While Pratt & Whitney is responsible for repairing the engines under the Company’s maintenance agreement, the Company does not get paid by Delta for flights that are cancelled or not scheduled as a result of these or similar issues. As a result of these unscheduled maintenance events, the Company has cancelled some of its flights and has reduced its scheduled flights for Delta. Under the terms of the DL Agreement, Delta has the right to terminate the agreement if the Company fails to meet certain performance standards over a period of five or more months. The Company anticipates returning all of its 328Jets into service for the Delta Connection operations in March of 2004. Although Delta has indicated that it is concerned about the operational issues that have arisen as a result of the unscheduled maintenance events for the engines on a number of the 328Jets, the Company believes these concerns would not form a basis for Delta to terminate the DL Agreement for failure to meet the performance standards. In the event Delta terminates the DL Agreement for failure to meet the performance standards, the Company would not have a right to require Delta to assume the leases on the 328Jets used in its Delta Connection operation.

     Delta also has the right to terminate the DL Agreement at any time without cause, subject to certain rights of the Company, by providing 180 days notice to the Company. Delta has informed the Company that the operation by the Company of jets with more than 70 seats would be in conflict with Delta’s pilot agreement (although the Company’s DL Agreement does not prohibit this activity) and with Delta’s business plan for Delta Connection partners. Delta has indicated that under these circumstances it may seek alternatives to the services provided by the Company and may seek to terminate the relationship. Under the terms of the DL Agreement, should Delta exercise its right to terminate without cause, the Company would have the right to require Delta to assume the leases on some or all of the 30 328Jet aircraft used in the Company’s Delta Connection operations. If Delta chooses to exercise its early termination right without cause, the Company currently expects that it would exercise its right to require Delta to assume the leases and would work with Delta to provide a smooth transition for both carriers. In such a case, the Company believes it may benefit from fleet simplification and the ability of management to focus exclusively on Independence Air. The Company may incur one-time costs in connection with any termination of the Delta relationship.

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Independence Air

     The Company will operate Independence Air as a low-fare airline with a hub at Washington Dulles International Airport (“Washington Dulles”). Independence Air’s strategy is to capitalize on and stimulate demand for air travel to, from and through its planned Washington Dulles hub, utilizing Airbus narrowbody aircraft that the Company is in the process of acquiring to serve high-demand and short- and long-haul markets and the Company’s 50-seat regional jets to offer frequent service primarily to short haul markets from Washington Dulles. Independence Air will seek to offer faster and easier service while utilizing a low-fare business model to obtain high productivity and lower costs.

     The Company’s decision to operate independently as a low-fare carrier is the result of an extensive evaluation of changes in the passenger airline industry that the Company commenced in 2001. The Company believes that recent trends – including increased use of the Internet, the willingness of customers to try new brands and the reduction in amenities offered by the traditional, “legacy” carriers, coupled with the legacy carriers’ high ticket prices and complex fare structures – provide an opportunity to compete in the low-fare segment of the industry. The Company also believes that the business environment and options available to the Company as a fee-per-departure regional carrier are less attractive than operating in the low-fare segment of the industry as an independent carrier. Since the airline industry began incurring significant loses in 2001, the legacy carriers such as United have taken steps to restructure their relationships with their regional carrier partners, including seeking to reduce regional carriers’ operating margins and shifting greater risks to the regional carrier. The Company believes that these lower margin/higher risk contracts, combined with the growing number of competitors in the regional carrier segment and the reliance on legacy carriers as counter-parties in long-term agreements, makes the fee-per-departure business model less attractive than independently operating as a low-fare airline. The Company believes that its dedicated employees, relatively new jet fleet, Washington Dulles facilities, strong capital base and extensive operational and market planning and scheduling experience represent a substantial competitive advantage and provide a strong foundation on which to develop Independence Air as a low-fare airline.

Our Strategy

     The Company is continuing to refine and implement its business strategy for Independence Air. The Company intends to operate approximately 350 flights per day to and from our planned primary base of operations at Washington Dulles. The Company’s Independence Air operations will use both its existing fleet of Canadair Regional jets (“CRJs”) and Airbus narrowbody aircraft that the Company is in the process of acquiring. As discussed below under “Business; Independence Air – Our Operational Transition from the United Express Program,” the timing and nature of the Company’s implementation of the Independence Air business plan using its CRJ regional jet aircraft is dependent on a number of factors beyond its control, primarily including the timing and terms of the Company’s disengagement as a United Express carrier. The Company expects to commence operations as Independence Air using Airbus narrowbody aircraft by November 1, 2004, if not earlier, regardless of when it disengages as a United Express carrier. The Company’s business plan for Independence Air includes the following elements:

     Move to a High Productivity and Lower-Cost Business Model

     The Company will employ business practices that increase output relative to the Company’s current fee-per-departure operations. Independence Air’s schedule will be designed to significantly increase average aircraft utilization (measured as block hours per aircraft per day)

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resulting in lower unit costs. The Airbus narrowbody aircraft schedule is planned to produce significantly higher aircraft utilization than legacy carriers such as United achieve in their mainline operations. Because the Company’s flights will be scheduled to arrive and depart Washington Dulles on a continuous basis throughout each day, in contrast to the Company’s current United Express schedule of four major departures times, or banks, gate utilization and the number of flights handled per ground personnel will likewise increase. By scheduling aircraft more efficiently and reducing the turn-time between flights, the Company believes that it can significantly increase the number of flights departing from the Company’s 36-gate terminal at Washington Dulles compared to the number of United Express flights currently departing from the same terminal on a daily basis.

     In addition to improving productivity, Independence Air will have lower expenses than legacy carriers in a number of areas. For example, the Company has contracted with Navitaire, Inc. to utilize its “Open Skies” reservation system. By avoiding the fees associated with traditional ticket distribution systems and relying on ticket distribution through the Company’s own website and reservation centers, Independence Air will seek to achieve lower distribution costs than legacy carriers. Other aspects of the Independence Air operating model, such as baggage handling, call centers, and ticket processing, are likewise anticipated to enable it to realize lower costs.

     The Company has reached an agreement on a revised contract with the Air Line Pilots Association (ALPA). The agreement has been fully ratified and will go into effect as the Company achieves certain milestones in the implementation of Independence Air. The agreement establishes pay rates and work rules for pilots operating narrowbody jets that the Company believes are competitive with those enjoyed by other low-fare carriers and includes terms that are designed to decrease costs and increase productivity in the operation of the Company’s 50-seat CRJ regional jets. The Company believes that this agreement will provide it with competitive pilot costs and therefore allow it to compete with other carriers in the low-fare market.

     The Company believes that the increases in productivity and reductions in certain operating expenses will ultimately enable Independence Air to compete with lower unit costs relative to legacy carriers, which will be passed on to consumers in the form of lower fares.

     Operate a Hub at Washington Dulles

     The Company expects to operate an all-jet fleet consisting of the 25 Airbus narrowbody aircraft that the Company is in the process of acquiring and its existing fleet of 50-seat CRJs. The Company intends to operate its narrowbody aircraft in larger, long haul markets in which the Company will seek to take advantage of the low-fare per seat mile of these aircraft, and will operate its regional jet aircraft in short haul markets with additional frequencies that will take advantage of the lower per-trip cost of this aircraft relative to larger aircraft. Independence Air will utilize its fleet of CRJs and Airbus aircraft in a hub-and-spoke schedule that will allow it to offer non-stop service to approximately 50 cities from Washington Dulles and connecting service to more than 1,200 other city pairs. The Company believes that this structure will allow it to attract greater traffic by capturing the business of passengers connecting through the Washington Dulles hub.

     Stimulate Demand with Low Fares

     Independence Air anticipates that it will offer fares that are up to 70% lower than walk-up fares charged in the past by United and other carriers from Washington Dulles. The

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Company intends to make its Independence Air fares easy to book and understand with no round trip requirements and no minimum stays. When low-fare carriers have expanded service in other markets they have typically stimulated passenger growth in percentages greater than their fare reduction percentages. The Independence Air business model will seek to stimulate similar growth in the markets it will serve. In addition to lowering fares for travelers to and from the Washington DC region, 55% of the city pairs that Independence Air will serve on a connecting basis over Washington Dulles did not have service from low-fare carriers in 2003.

     Capitalize on Metropolitan Washington, D.C. Market Presence

     The Company believes the Northern Virginia region surrounding Washington Dulles airport offers attractive demographics and is underserved by low fare competition. In 2002, metropolitan Washington, D.C. represented the fifth largest market in the United States on the basis of local traffic, with more than 41 million passengers originating in or destined to one of the area’s three major airports. Moreover, households in the Washington, D.C. region are rated as having among the highest disposable income in the United States, and a significant portion of those families with high disposable incomes live in the counties geographically close to Washington Dulles. The largest carrier at Washington Dulles is United Airlines and its United Express operation and a large percentage of that service has been focused on premium fare passengers who connect onto United’s worldwide route network. As of January 2004, low-fare carriers represented only 5% of the domestic flights from Washington Dulles.

     The Company also believes that Washington Dulles presents a unique opportunity for the Company to launch its independent airline. The Company has long-term leases for its existing regional jet terminal at Washington Dulles, which will allow Independence Air to operate from the convenience and comfort of the 36-gate A-terminal built specifically for regional jet operations. In addition, the Company has leases on 7 additional gates at the T-terminal. Washington Dulles is also attractive as the airport represents one of the few major airports on the East Coast with room to expand. The airport is currently undergoing a $2.8 billion expansion that includes the addition of covered parking, a fourth runway, and state-of-the-art underground train system for moving passengers between terminals. Renovation of ticket counter space and baggage sorting facilities in the main terminal for use by the Company has begun and is anticipated to be completed by April 2004.

     Enhanced Customer Experience

     The Company believes that an important competitive strength will lie in its ability to provide a faster and easier travel experience. The Company has embarked on several initiatives it believes will enhance the customer experience it will provide as Independence Air. These initiatives focus on improving operating reliability, simplifying operating procedures and automating processes to make ticketing, check-in and boarding faster and easier, reducing aircraft turn times, and improving its ability to respond to disruptions caused by weather, air traffic control delays and other irregular operations.

     Independence Air will provide passengers on its Airbus narrowbody aircraft with all-leather Spectrum™ seats and broadcast television in every seatback. The CRJ aircraft will be refitted with new all-leather Spectrum™ seats featuring a new slim line design that will produce additional leg room to each row without reducing the number of seats per aircraft. Independence Air also will utilize customer service systems designed by IBM’s Global Services Division that will assist in

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speeding passengers through the airport check-in process. Independence Air does not plan to set inventory levels above seat capacity; therefore it will be easier for passengers to secure a seat assignment when they make their reservation.

Our Operational Transition from the United Express Program

     The commencement of Independence Air’s operations will require the Company to implement substantial new infrastructure to address, among other things, scheduling and marketing, flight operations and information systems. These services will require a substantial investment in new equipment, information and technology systems and personnel. The transition to Independence Air using the CRJ regional jet aircraft will be affected by the terms and timing upon which the Company ceases to operate as a United Express carrier. The Company expects to commence operations as Independence Air using Airbus narrowbody aircraft by November 1, 2004, if not earlier, regardless of when it disengages as a United Express carrier.

     Implementation of Substantial New Infrastructure

     The transition from being a United Express carrier to an independent low-fare carrier will require the Company to schedule and market transportation services directly to the traveling public. The Company has established a marketing department that includes schedule planning, marketing and sales. The schedule planning group is responsible for establishing the planned route network by identifying and scheduling markets suited for the CRJs and the Airbus narrowbody jets in conjunction with the Company’s planned disengagement from United. The marketing group has been tasked with re-branding the Company and creating and implementing the marketing, advertising and promotions plan to attract customers to Independence Air. On November 19, 2003, the Company hosted a naming ceremony in which it revealed its new name as Independence Air to over 2,000 airport and government officials, stockholders, media, Company partners and employees.

     Operation of Airbus narrowbody aircraft will require the Company to establish the training and maintenance capability necessary to operate a different fleet type. Operation of the Airbus narrowbody aircraft will require the development of pilot training programs and the hiring and training of pilot instructors in order to train a large number of pilots the Company anticipates it will need for the Airbus narrowbody fleet. However, the Company estimates that it may not have to initially hire additional pilots above its normal levels to fulfill the requirement for Airbus narrowbody aircraft as it expects to fill its pilot requirements through pilot reassignment as it ceases to operate other aircraft under its United Express and/or Delta Connection operations. In addition, the Company will need to acquire, or contract for, crew training equipment including flight training devices, cabin mockups, and simulator capacity from third parties to the extent these functions are not provided by Airbus. Line maintenance of the new Airbus narrowbody aircraft will be performed by Company mechanics, but most heavy maintenance checks and component repairs will be outsourced to third party specialists. The Company anticipates that it will need to acquire significant spare parts inventories, including spare engines, special tools and ground handling equipment in order to support operation of the Airbus narrowbody aircraft. As the Company transitions to Independence Air, it also will need to secure suitable slots, gates, ticket counter positions and other facilities at airports in the Company’s targeted geographic markets.

     The Company will depend heavily on automated systems to operate as an independent carrier and to streamline many of its operating and customer processes. Unlike legacy airlines which issue paper tickets to some or all of their passengers, Independence Air will rely solely on electronic

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tickets and allow passengers to book reservations, check flight information, and print boarding passes from their personal computers. At airports where Independence Air operates, the Company will rely heavily on kiosks for check-in and printing boarding passes, and will use kiosks in some gate areas to re-accommodate passengers during irregular operations. The Company is installing a new centralized airline reservation system and building a new website and server infrastructure that will be designed to handle the expected on-line bookings and flight information requests. At each station the Company will operate, it will install new IT infrastructure including computer terminals at ticket counters and gates, passenger kiosks, and telecommunication systems to handle new data and voice requirements. To enhance the reliability of its critical systems, the Company has begun upgrading its backup systems by installing new hardware and software and developing a new disaster recovery site. In addition to on-line bookings through the Company’s new website, the Company is in the process of establishing an in-house call center to handle special customer transactions and complaints, and will outsource most standard calls to well-established overseas companies engaged in similar call center work.

     Disengagement from United

     The Company’s commencement of service as an independent airline depends, among other things on the terms and timing of its disengagement as a United Express carrier, which cannot be projected at this time.

     If the UA Agreements are rejected by United, the Company plans to transition its regional jet aircraft currently operated under the UA Agreements into an independent operation. This plan includes exiting from certain existing airports, beginning operations at other airports, operating a scheduled airline under the Company’s own brand name and marketing and selling transportation service under that brand name to the general public, refurbishing and re-painting the regional aircraft currently being operated under the UA Agreements before placing them into service, and acquiring and operating narrowbody aircraft. The Company’s J-41 turboprop aircraft (J-41s) would be retired as they are transitioned out of the United Express program. This early retirement will result in the Company taking a charge for the present value of future lease payments for leased aircraft and a charge for the projected future cost of storage and maintenance as each J-41 is permanently removed from service. The Company estimates this charge, assuming no remarketing benefits, will be approximately $50 million.

     To date, the Company and United have transitioned station handling responsibilities at six cities, including Chicago O’Hare, from ACA to United and other United Express carriers. These transition steps to date have resulted only in a new party assuming the Company’s role in staffing ground operations at the affected stations as the Company continues to operate its United Express flights to those cities.

     United has the option under U.S. bankruptcy rules either to assume the existing UA Agreements by agreeing to honor all terms in full or to reject the UA Agreements. The Company’s plan to operate its CRJs, together with the Airbus narrowbody aircraft, as part of an independent low-fare airline is based on its belief that United will seek to reject the UA Agreements in connection with its bankruptcy reorganization. Until any rejection becomes effective or until the Company is otherwise released from its obligations under the UA Agreements, the Company intends to continue to fulfill its obligations under the present UA Agreements. The Company anticipates that there will be an interruption in its services and, potentially, its ability to generate revenues during a transition period, the length of which would be dependent on several factors, including how soon United rejects the UA Agreements and how much advance notice the Company is given before such rejection. As long as a

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complete transition plan is not agreed to by the Company and United, and the possibility of unilateral rejection by United exists, the Company will continue to prepare to transition the aircraft either in phases or all at one time. If the transition is phased, the Company anticipates that it will take regional jet aircraft out of service for exterior re-painting and interior modifications and return them as Independence Air aircraft on a consistent pace. If the transition results in the entire fleet being returned at one time or in large numbers, the Company anticipates that it would make temporarily modifications to its aircraft livery and interiors sufficient to remove the United Express trade marks and operate the aircraft until the aircraft could be scheduled for re-painting and interior modifications and then returned to operation. The Company expects to incur operating losses for at least the first three quarters after it commences operations of Independence Air. The extent and duration of such losses depends upon the terms and timing of the Company’s disengagement as a United Express carrier, including whether the Company experiences an extended period without conducting any revenue operations.

Agreements with Other Airlines

     As of March 1, 2003 the Company has implemented code-sharing arrangements with Lufthansa German Airlines (“Lufthansa”), Air Canada, Scandinavian Airlines, British Midland/BMI, Austrian Airlines and All Nippon Airways involving certain United Express flights. Such international code-sharing arrangements permit these foreign air carriers to place their respective airline codes on certain flights operated by the Company, and provide a wide range of benefits for passengers including schedule coordination, through ticketing and frequent flyer participation. The revenue benefits from these arrangements accrue to United, and any such arrangements as may be made in the future with respect to the Company’s Delta Connection flights would accrue to Delta, due to the nature of the Company’s agreements with these two airlines. The Company’s primary role under these arrangements is to obtain regulatory approvals for the relationships and to operate the flights. The Company anticipates that its code-sharing arrangements involving its United Express flights will terminate if the UA Agreements are terminated, and that its Independence Air operations will not operate under code sharing arrangements with other airlines.

Charter Operations

     The Company established a charter operation in February 2002. The charter business, which originally operated three 328Jets and currently uses CRJ and J-41 turboprop aircraft, utilizes the Company’s operations and maintenance services. The Company is presently providing regular charter service with a major corporation pursuant to an agreement that will end in March 2004, and is performing ad hoc charter services secured through brokers and other means. In March 2003, the Company decided to continue to service its existing clients but to de-emphasize the solicitation of new charter business due to uncertainties regarding the bankruptcy of Fairchild Dornier, the manufacturer of the 328Jet.

Fleet Description

     As of February 15, 2004, the Company operated a fleet of 87 50-seat Canadair Regional Jets (“CRJs”), 33 Fairchild Dornier 328 regional jets (“328Jets”), and 24 British Aerospace Jetstream-41 (“J-41s”) turboprop aircraft. Thirty-three 328Jets are operated in the Delta Connection program, 86 CRJs and 24 J-41s are operated in the United Express program, and one CRJ is currently flown in charter operations.

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     During the second quarter of 2003, the Company entered into an agreement with Bombardier to amend its aircraft purchase agreement. Under the revised agreement, the Company took delivery of eight CRJs in 2003 and has future commitments for six additional CRJs to be delivered in late 2004 and 28 CRJs to be delivered in 2005. These commitments are subject to certain conditions that, unless waived by the Company, would not be satisfied unless the Company has an agreement with United to operate these aircraft in the United Express program. In the event these conditions are not met and not waived by April 2005, deposits and progress payments for any then undelivered aircraft would be first used to repay any outstanding debt on two CRJs delivered in October 2003 with any remaining balance converted into credit memoranda for the purchase of other aircraft, goods and services from Bombardier. Currently, the Company has $38.8 million on deposit with Bombardier for aircraft orders.

     The Company had agreed with United to retire early from service its fleet of J-41 turboprop aircraft by the middle of 2004. Due to uncertainty over the Company’s contractual relationship with United, the Company delayed the retirement schedule of its J-41s. Due to customer preference for jet aircraft, high per-trip cost per mile flown and rising maintenance costs due to aircraft age the Company has determined that the J-41 aircraft do not fit into the low fare airline business model. For these reasons, the Company intends to retire the J-41s when they are transitioned out of the United Express program.

     In November 2003 the Company signed Memoranda of Understanding (“MOU”) for the lease of ten Airbus A319 aircraft from two separate operating lessors and the purchase of ten A319 and five A320 aircraft directly from an affiliate of the manufacturer. The order for five Airbus A320 aircraft is convertible into an order for five A319 aircraft at the option of the Company with certain notice required prior to delivery. The Company has executed the lease agreements for four of the ten leased aircraft and is currently negotiating the final lease and purchase agreements for the remaining aircraft covered by the MOUs. The first A319 aircraft is scheduled to be delivered in September 2004 with three more to follow, one each succeeding month, for the remainder of 2004. Sixteen are scheduled to be delivered in 2005, and the five A320 aircraft are scheduled to be delivered in 2006.

Employees

     As of February 1, 2004, the Company had 3,751 full-time and 361 part-time employees, classified as follows:

     The Company’s pilots are represented by the Airline Pilots Association (“ALPA”), flight attendants are represented by the Association of Flight Attendants-Communications Workers of America (“AFA-CWA”), and aviation maintenance technicians and ground service equipment mechanics are represented by the Aircraft Mechanics Fraternal Association (“AMFA”).

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     In January 2001, the Company agreed to a new four-and-a-half year collective bargaining agreement with ALPA that was subsequently ratified and became effective on February 9, 2001. The collective bargaining agreement covers pilots flying for the United Express, Delta Connection, and charter operations. The agreement provided for overall pilot costs that were, at the time, comparable to other similarly situated regional carriers with recently negotiated contracts who were operating under similar agreements with major airlines. The Company had previously finalized a separate agreement with ALPA on pay reductions and work rule changes that are contingent on reaching an agreement with United to continue operation as a fee-per-departure carrier in the United Express system. In October 2003, the Company reached an agreement on a revised contract with its pilots and ALPA. This agreement has been fully ratified and will go into effect if and when the Company achieves certain milestones in the implementation of Independence Air. The agreement, which would extend the term of the collective bargaining agreement such that it will next be amendable as of December 31, 2007, establishes pay rates and work-rules for pilots operating narrow-body jets that the Company believes are competitive with other low-fare carriers. The new agreement also includes terms designed to decrease costs and increase productivity for operating its regional jets. If the conditions for either agreement with the Company’s pilots to become effective are not satisfied, the agreement which has been effective since February 2001 will continue to be applicable.

     The Company’s collective bargaining agreement with AMFA, which was ratified in June 1998, became amendable in June 2002. The Company has been in negotiations with AMFA during 2003 and recently both sides have agreed to mediation under the Railway Labor Act. The Company’s collective bargaining agreement with the AFA-CWA, which was ratified in October 1998, became amendable in October 2002. The Company has entered into negotiations with AFA-CWA regarding a new agreement. The Company is continuing to negotiate with both unions, and management does not anticipate that there will be a material effect on the Company’s operations for the foreseeable future as a result of these discussions.

     In the airline industry, labor relations are regulated by the Railway Labor Act (“RLA”). Under the RLA, collective bargaining agreements do not expire but, rather, become amendable. The wage rates, benefits and work rules contained in a contract that has become amendable remain in place and represent the status quo until a successor agreement is in place. The parties may not resort to self-help, such as strikes or lockouts, until the RLA processes for collective bargaining have been exhausted. It is impossible to predict how long the RLA processes will take.

     Certain of the Company’s unrepresented labor groups are from time to time approached by unions seeking to represent them. In 2002, the International Association of Machinists and Aerospace Workers (“IAM”) unsuccessfully tried to organize the Company’s customer service employees. The Company was informed by the National Mediation Board (“NMB”) that the IAM did not receive a sufficient showing of interest from customer service employees to merit holding an election. Because of this, the NMB will not accept any application seeking representation of the Company’s customer service employees prior to March 2004.

     During 2003, the Transport Workers Union (“TWU”) sought election to represent the Company’s dispatch employees. The Company was informed by the National Mediation Board (“NMB”) that the TWU did not receive a sufficient showing of interest from dispatch employees to merit holding an election. Because of this, the NMB will not accept any application seeking representation of the Company’s dispatch employees prior to May 2004.

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     The Company’s business plan to implement Independence Air will require the relocation of certain flight crews from Chicago domiciles to a Washington Dulles base, and will result in the Company incurring relocation expenses. In addition, the Company will be hiring additional station agents at Washington Dulles and at various outstations, as well as a reservations staff in the Dulles area. This will require a substantial increase in recruiting efforts, although the Company anticipates that it will be able to recruit and hire the employees it needs.

Pilot Training

     The Company has entered into agreements with Pan Am International Flight Academy (“PAIFA”), which allow the Company to train CRJ, J-41 and 328Jet pilots at PAIFA’s facility near Washington Dulles. This facility currently houses three CRJ simulators, a 328Jet simulator, and a J-41 simulator. The Company has agreements to purchase an annual minimum number of CRJ simulator training hours at agreed rates through 2010. The Company’s payment obligations for CRJ simulator usage over the remaining years of the agreements total approximately $8.7 million.

     In 2001, PAIFA, CAE Schreiner and the Company executed a simulator provision and service agreement providing for 328Jet training at the PAIFA facility. Under this agreement, the Company has committed to purchase all of its 328Jet simulator time from PAIFA at agreed upon rates, with no minimum number of simulator hours guaranteed.

     The Company, as part of its Airbus purchase agreement, will contract with affiliates of Airbus to provide pilot training for the new Airbus narrowbody aircraft on order.

Competition

     The airline industry is highly competitive. Airline profits are sensitive to adverse changes in fuel costs, average fare levels and passenger demand. Passenger demand and fare levels have historically been influenced by, among other things, the general state of the economy, international events, industry capacity and pricing actions taken by other airlines. The principal competitive factors in the airline industry are fare pricing, customer service, routes served, flight schedules, types of aircraft, safety record and reputation, code-sharing relationships, in-flight entertainment systems and frequent flyer programs.

     Our competitors and potential competitors include major U.S. airlines, low-fare airlines, regional airlines and new entrant airlines. The major airlines are larger, generally have greater financial resources and serve more routes than we do. They also use some of the same advanced technologies that we do, such as ticketless travel, laptop computers and website bookings. We anticipate that when we operate as Independence Air, our primary competitors in the non-stop markets that we serve will be United, US Airways and, to a lesser extent, Southwest Airlines, each of which has greater financial resources and name recognition than we do.

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Industry Regulation and Airport Access

     Economic. The Department of Transportation (“DOT”) has extensive authority to issue certificates authorizing carriers to engage in air transportation, establish consumer protection regulations, prohibit certain unfair or anti-competitive practices, mandate certain conditions of carriage and make ongoing determinations of a carrier’s fitness, willingness and ability to provide air transportation. The DOT can bring proceedings for the enforcement of its regulations under applicable federal statutes, which proceedings may result in civil penalties, revocation of operating authority or criminal sanctions.

     The Company’s ACA subsidiary holds a certificate of public convenience and necessity, issued by the DOT, which authorizes it to conduct scheduled and charter air transportation of persons, property and mail between all points in the United States, its territories and possessions. In addition, ACA may conduct scheduled and charter air transportation with regional jet aircraft to points outside the United States, subject to obtaining any necessary authority from any foreign country to be so served. Were ACA to operate its to-be-acquired narrow-body aircraft outside of the United States, additional DOT authority would be required to conduct such air transportation. ACA’s certificate requires that ACA maintain DOT-prescribed minimum levels of insurance, comply with all applicable statutes and regulations and remain continuously “fit” to engage in air transportation. ACA is authorized by Canada to engage in air transportation between the United States and Canada with regional jet aircraft. The Company would not be required to obtain any additional authority from the DOT to operate narrow-body aircraft operating as Independence Air within the United States. The Company will have to demonstrate to the DOT that it is “fit” to operate such aircraft, and to do so independent of a major code share partner, which the Company expects to be able to demonstrate to the Department.

     Based on conditions in the industry, or as a result of Congressional directives or statutes, the DOT from time to time proposes and adopts new regulations or amends existing regulations that may impose additional regulatory burdens and costs on the Company. Imposition of new laws and regulations on air carriers could increase the cost of operation and or limit carrier management discretion.

     Safety. The FAA extensively regulates the safety-related activities of air carriers. The Company is subject to the FAA’s jurisdiction with respect to aircraft maintenance and operations, equipment, ground facilities, flight dispatch, communications, training, weather observation, flight personnel, the transportation of hazardous materials and other matters affecting air safety. To ensure compliance with its regulations, the FAA requires commercial airlines under its jurisdiction to obtain an operating certificate and operations specifications for the particular aircraft and types of operations conducted by such airlines. The Company’s ACA subsidiary possesses an operating certificate and related authorities issued by the FAA authorizing it to conduct operations with turboprop and regional jet equipment. The Company will be required to obtain specific FAA authority to add narrow-body aircraft to its fleet and the process for obtaining such permission has begun. FAA approval will be based on a determination that the Company has adequate training, maintenance and operating procedures necessary to conduct larger aircraft operations. ACA’s authority to conduct operations is subject to suspension, modification or revocation for cause. The FAA has authority to bring proceedings to enforce its regulations, which proceedings may result in civil penalties, which can be substantial, criminal penalties, or revocation of operating authority.

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     From time to the time and with varying degrees of intensity, the FAA conducts inspections of air carriers. Such inspections may be scheduled or unscheduled and may be triggered by specific events involving either the specific carrier being inspected or other air carriers. In addition, the FAA may require airlines to demonstrate that they have the capacity to properly manage growth and safely operate increasing numbers of aircraft.

     In order to ensure the highest level of safety in air transportation, the FAA has authority to issue maintenance directives and other mandatory orders. These relate to, among other things, the inspection of aircraft and the mandatory removal and replacement of parts or structures. In addition, the FAA from time to time amends its regulations and such amended regulations may impose additional regulatory burdens on the Company, such as the required installation of new safety-related items. Depending upon the scope of the FAA’s orders and amended regulations, these requirements may cause the Company to incur substantial, unanticipated expenses that may not be reimbursable under the Company’s code-share agreements.

     On November 19, 2001 the President signed into law the Aviation and Transportation Security Act (the “Security Act”). The Security Act requires heightened passenger, baggage and cargo security measures to be adopted as well as enhanced airport security procedures. The Security Act created the Transportation Security Administration (“TSA”) that has taken over the responsibility for conducting the screening of passengers and their baggage at the nation’s airports as of February 17, 2002. The activities of the TSA are funded in part by the application of a $2.50 per passenger enplanement security fee (subject to a maximum of $5.00 per one way trip) and payment by all passenger carriers of a sum not exceeding each carrier’s passenger and baggage screening cost incurred in calendar year 2000. The TSA has authority and is presently considering restructuring the air carriers security infrastructure fee which could impose additional costs on the Company which may not be reimbursable either under its code-share agreements or through the fares charged to passengers.

     The Security Act imposes new and increased requirements for air carrier employee background checks and additional security training of flight and cabin crew personnel. These additional and new requirements have increased the security related costs of the Company. The Security Act also mandates and the FAA has adopted new rules requiring the strengthening of cockpit doors, some of the costs of which have been reimbursed by the FAA. The Company has completed all mandatory cockpit door modifications and has been reimbursed $2.7 million under the Security Act, although the cost of such modifications exceeded this amount. At times when the aviation security threat level is elevated by the Department of Homeland Security, the Company may experience security-related disruptions, including reduced passenger demand, resulting from enhanced passenger screening at airports and possible flight cancellations. The Company believes that its exposure to such disruptions is no greater than that faced by other providers of regional air carrier services.

     Although the TSA has taken over the former responsibilities of the air carriers for the screening of all passengers and baggage, the TSA, as with the FAA before it, requires air carriers to adopt and enforce procedures designed to safeguard property, and to protect airport and aircraft against terrorist acts. The TSA, from time to time, may impose additional security requirements on air carriers and airport authorities based on specific threats or world conditions or as otherwise required. The TSA has issued a number of security directives and altered procedures upon changes in the Office of Homeland Security announcements of heightened threat levels, and the Company has adjusted its security procedures on numerous occasions in response to these directives. The Company incurred substantial expense in complying with current security requirements and it cannot predict what additional security requirements may be imposed in the future or the cost of complying with such requirements.

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     Associated with the FAA’s security responsibility is its program to ensure compliance with rules regulating the transportation of hazardous materials. The Company has policies against accepting hazardous materials or other dangerous goods for transportation. Employees of the Company are trained in the recognition of hazardous materials and dangerous goods through an FAA approved training course. The Company may ship aircraft and other parts and equipment, some of which may be classified as hazardous materials, using the services of third party carriers, both ground and air. In acting in the capacity of a shipper of hazardous materials, the Company must comply with applicable regulations. The FAA enforces its hazardous material regulations by the imposition of civil penalties, which can be substantial.

     Other Regulation. In the maintenance of its aircraft fleet and ground equipment, the Company handles and uses many materials that are classified as hazardous. The Environmental Protection Agency and similar local agencies have jurisdiction over the handling and processing of these materials. The Company is also subject to the oversight of the Occupational Safety and Health Administration concerning employee safety and health matters. The Company is subject to the Federal Communications Commission’s jurisdiction regarding the use of radio frequencies.

     Federal law establishes maximum aircraft noise and emissions limits. At the present time, all of the aircraft operated by the Company comply with all applicable federal noise and emissions regulations. Federal law generally preempts airports from imposing unreasonable local noise rules that restrict air carrier operations. However, under certain circumstances airport operators may implement reasonable and nondiscriminatory local noise abatement procedures, which could impact the ability of the Company to serve certain airports, particularly in off-peak hours.

     Slots. Slots are reservations for takeoffs and landings at specified times and are required by governmental authorities to operate at certain airports within the United States. The Company has rights to and utilizes takeoff and landing slots at New York-Kennedy, New York-LaGuardia and White Plains, New York airports. Airlines may acquire slots by governmental grant, by lease or purchase from other airlines, or by loan when another airline does not use a slot but desires to avoid governmental reallocation of a slot for lack of use. All leased and loaned slots are subject to renewal and termination provisions. Under law presently in effect, slot regulation at both Kennedy and LaGuardia airports is scheduled to end after January 1, 2007. The rules also provide that, in addition to those slots currently held by carriers, operators of regional jet aircraft and new entrant air carriers may apply for, and the Secretary of Transportation must grant, additional slots at New York-Kennedy and LaGuardia in order to permit the carriers to offer new service, increase existing service or upgrade to regional jet service in qualifying smaller communities. There is no limit on the number of slots a carrier may request. However, because demand for LaGuardia slots caused the airport to become congested at certain times of the day, the FAA has severely limited the rights of carriers to obtain additional slots at LaGuardia under this law. As the slots that the Company currently utilizes at New York-LaGuardia and New York-Kennedy airports are in the name of United, those slots may not be used by the Company once it exits from the United Express program. To the extent the Company would seek to operate either regional or narrow-body aircraft at LaGuardia or Kennedy as Independence Air, it will have to either purchase or lease slots from another air carrier or be qualified to obtain such slots under the then current regulatory regime. Slots at White Plains, New York airport are held in the name of the Company and are anticipated to be used by the Company in its Independence Air operation. The Company anticipates applying for and obtaining slots or slot exemptions for its CRJ service into New York-Kennedy airport.

     As a result of congestion at Chicago O’Hare Airport on January 21, 2004 the FAA entered an Order requiring the two largest O’Hare carriers, United Airlines and American Airlines, to reduce their O’Hare flight schedules, including the schedules operated by carriers affiliated with these

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major carriers. Under the term of the UA Agreements, United has the right to request that the Company move operations from O’Hare in order to comply with its agreement with the FAA. Furthermore, the congestion at O’Hare Airport could require the FAA to take other steps to impose limits on O’Hare operations like those which existed until June 2002. If other airports become congested, the FAA could seek to restrict the number of hourly air carrier operations.

Risk Factors Affecting the Company

     The Company’s business is subject to numerous risks and uncertainties, as described below and in the section titled, “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Liquidity and Capital Resources” and “Quantitative and Qualitative Disclosures About Market Risk”.

Risk Factors Affecting the Company’s Current Operations

     Substantially all of our revenue is currently derived under contracts with our marketing partners. The majority of our flights are currently operated under the United Express or Delta Connection brand. As such, we currently rely on United and Delta to provide numerous services such as reservations, ticketing, route planning, marketing, revenue management, revenue accounting, and, at certain stations, customer service and ground handling. Our revenue and operations are currently reliant on the ability of these partners to manage their operations and cash flow, and ability and willingness of these partners to continue to deploy our aircraft and to utilize and pay for scheduled service at agreed upon rates. We anticipate that our relationship with United Airlines will end as a part of United’s reorganization in bankruptcy, and we intend to utilize our assets to operate as an independent low-fare airline. Delta has a right to terminate our code share agreement without cause on 180 days notice, and may do so in connection with our plan to operate as Independence Air. Delta also has the right to terminate the agreement if the Company fails to meet certain performance standards over a period of five or more months. There can be no assurance that we will be able to generate the revenues or profits that we currently derive under our code share agreements with United and Delta when we operate as an independent low-fare airline.

     We have costs and possible exposure arising from the Fairchild Dornier 328 regional jet (“328Jet”). In April 2002, Fairchild Dornier GmbH (“Fairchild”), the manufacturer of the 32-seat 328Jet, was placed under the supervision of a court-appointed interim trustee and in July 2002 Fairchild opened formal insolvency proceedings in Germany. Our costs to operate our current fleet of 33 328Jets increased in 2003 and may continue to increase in the future due to the expense of obtaining product support from third parties and due to the limited availability and increasing cost of spare parts. As a result of Fairchild’s bankruptcy and its failure to satisfy its obligations to us under the 328Jet purchase agreement, we may continue to experience higher than expected or unexpected costs in our operations or may encounter consequences or risks for which we are not able to anticipate or plan. In addition, the Pratt & Whitney (“P&W”) PW306B engine that powers our fleet of 328Jet aircraft has had unscheduled maintenance events to repair turbine blades that require the engine to be removed and sent to P&W for repairs. Because of the shortage of spare engines, we have had to temporarily ground several of our 328Jet aircraft, resulting in their not being available under the Delta Connection program. While the cost of the engine repairs is covered under our maintenance agreement with P&W, a continued reduction in the number of planes we can operate under the Delta Connection program could impact our revenue and earnings, could lead to Delta seeking to terminate the DL Agreement for failure to meet the performance standards, result in other incidental expenses or otherwise adversely affect our Delta Connection operation. If the DL Agreement is terminated for failure to meet the performance standards,

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we do not have the right to require Delta to assume the leases on the 328Jet aircraft used in our Delta Connection operations. There can be no assurance that we will be able to redeploy the these aircraft in a profitable manner. In addition, even if Delta terminates the DL Agreement without cause, triggering our right to require Delta to assume the leases on the 328Jet aircraft, we may not be able to extinguish our obligations under the leases for these aircraft if Delta or its assignee fails to meet certain financial conditions under the DL Agreement at the time Delta becomes obligated to assume the leases.

     Our maintenance costs will increase as our regional jet fleet ages. As our fleet of regional jet aircraft ages, the maintenance costs for such aircraft will likely increase. Although we cannot accurately predict how much our maintenance costs will increase in the future, they may increase significantly. Any such increase could have an adverse effect on our business, financial condition and results of operations. We are vulnerable to any problems associated with the aircraft in our fleet, including design defects, mechanical problems or adverse perception by the public that would result in customer avoidance or an inability to operate our aircraft.

     We likely will incur cash charges as we retire the J-41 aircraft from our fleet. We are in the process of retiring all J-41 type aircraft from our fleet. As we remove these aircraft from service, we will be required to continue to make payments under the lease agreements for the aircraft unless we are able to sublease the aircraft. Even if we are able to sublease the J-41s, it is likely that the sublease income will be lower than our lease payments, because turboprop aircraft such as the J-41s are generally not in demand. Under accounting rules, we will estimate and record an early retirement charge for the present value of the estimated net cost of each aircraft at the time each aircraft is retired, which we currently estimate to be an aggregate charge of approximately $50 million. If and to the extent that we are unable to find suitable sublease arrangements for these aircraft that will cover our lease payments, we will incur actual cash expenditures over the remaining lease terms after the time when we retire the J-41 aircraft in our fleet.

Risk Factors Affecting the Company Relating to Independence Air

     The timing and nature of our commencement of operations as Independence Air will be affected by United and other factors that are beyond our control. The timing of our commencement of operations as Independence Air depends, among other things, on the terms and timing of our disengagement as a United Express carrier, which cannot be projected at this time in large measure due to the uncertainty surrounding when and if United will emerge from bankruptcy. While we intend to place Airbus narrowbody aircraft into service under Independence Air in the fourth quarter of 2004, our ability to utilize our fleet of CRJs in Independence Air’s operations could be significantly impacted depending upon whether United elects to reject or assume the UA Agreements, as well as the timing of any rejection and the amount of notice we receive before a rejection is to take effect. For example, absent adequate notice of United’s rejection of the UA Agreements and/or a negotiated transition with United, our efforts to proceed with certain transition steps such as establishing gate operations and refurbishing aircraft could be impaired. We anticipate that in order to implement operations as Independence Air there will be an interruption in our services during a transition period. The length of this transition period will be dependent on several factors, some of which are beyond our control, such as whether United emerges from bankruptcy or liquidates, and how soon in either case, whether our operation as a United Express carrier terminates through a negotiated arrangement with United or as a result of United rejecting the UA Agreements through its bankruptcy proceeding, and, if so, how much notice we have of such rejection and how quickly it becomes effective. We may also experience unexpected costs and/or a period during which we are not engaged in revenue operations as a result of the terms of our disengagement as a United Express carrier. If we do not have advanced notice of the rejection of the UA Agreements, we expect that we will incur losses and have negative cash flows while

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we are transitioning our fleet to Independence Air that would exceed the losses that we already anticipate incurring as a result of this transition. Any prolonged stoppage of flying would materially adversely affect our results of operations and financial position, and any failure to timely or successfully implement our transition to Independence Air could have a material adverse effect on our viability.

     Because we have no operating history as a low-fare carrier, it is difficult to evaluate our ability to succeed in this business. Although we have operated as an airline since 1992, our past results offer no meaningful guidance with respect to our future performance because we have not operated as an independent carrier to date. In addition, we have not had responsibility for route planning, scheduling, pricing, marketing, advertising, sales, revenue management or revenue accounting functions since December 2000, and we will be establishing for the first time our own distribution, reservations and ticketing functions. Also, while previous operations have been under the United and Delta brands, Independence Air is a new brand for us, and has limited market recognition. As a result, because we have not yet begun to operate as an independent, low-fare carrier, it is difficult to evaluate our future prospects. Our future performance will depend on a number of factors, including our ability to:

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establish a brand and product that will be attractive to our target customers;

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implement our business strategy with larger aircraft than we have previously operated;

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choose new markets successfully;

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secure favorable terms with airports, suppliers and other contractors;

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maintain adequate control over our expenses;

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monitor and manage major operational and financial risks;

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obtain and maintain necessary regulatory approvals;

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attract, retain and motivate qualified personnel;

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finance the necessary capital investments;

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maintain the safety and security of our operations; and

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react to responses from our competitors, including both legacy and low-fare airlines, as we transition to Independence Air.

     There can be no assurances that we will successfully address any of these factors, and our failure to do so could harm our business.

     Our transition to Independence Air will require us to develop and implement significant new infrastructures. Our business strategy involves successfully establishing Washington Dulles International Airport as the hub for a new low-fare airline, increasing the frequency of flights to markets we currently serve to and from Washington Dulles, expanding our operation into certain markets not currently served, and increasing flight connection opportunities. We will have to develop and implement significant new infrastructures that are necessary to operate as an independent airline, including scheduling, market planning and marketing, advertising, ground operations and information systems. Achieving our business strategy is critical in order for our business to create passenger

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connecting opportunities for markets to be served with our existing fleet of CRJs and with the Airbus narrowbody aircraft we will be acquiring, and to achieve economies of scale, both of which are critical to profitable operations. Increasing the number of markets we serve depends on our ability to successfully introduce the Airbus aircraft into our fleet, and to secure suitable slots, gates, ticket counter positions and other facilities at airports located in our targeted geographic markets. In some of our existing markets we will need to establish ground operations to replace services provided by United, and in the case of those we presently handle we will need to compete with United for facilities and employees as they establish their separate operations should United continue to provide services there, which based upon public statements is their present intent. Opening new markets requires us to commit a substantial amount of resources, even before the new services commence. Expansion will also require additional skilled personnel and equipment. The transition from United will require us to retain employees and facilities during the transition period. An inability to hire and retain skilled personnel or to secure the required equipment and facilities efficiently and cost-effectively or to successfully develop and implement other necessary systems may affect our ability to achieve our business strategy. In addition, implementation of Independence Air may also increase the demands on management and our operating systems and internal controls beyond levels we currently anticipate. Such expansion may strain our existing management resources and operational, financial and management information systems to the point that they may no longer be adequate to support our operations, requiring us to make larger expenditures in these areas than we currently anticipate. There can be no assurance that we will be able to develop these controls, systems or procedures on a timely or cost-effective basis, and the failure to do so could harm our business.

     Failure to successfully implement our strategy for Independence Air could harm our business. Our business strategy for Independence Air involves, among others, increasing the frequency of flights to the markets we serve, reducing unit costs and lowering fares to stimulate demand. By offering fares that are up to 70% lower than walk-up fares charged in the past by United and other carriers from Washington Dulles, we anticipate that we will stimulate passenger growth. While other low-fare carriers have typically stimulated passenger growth by reducing fares, this strategy has not been tested using regional jets on the scale that we intend to use them. There can be no assurance that we will be able to sufficiently stimulate demand to make our high frequency service profitable, and failure to do so may prevent us from successfully implementing our strategy for Independence Air.

     We have a significant amount of fixed obligations, will incur significantly more fixed obligations, and do not have established credit lines or borrowing facilities. We expect to have substantial cash needs as we establish ourselves under the new brand “Independence Air” as a low-fare carrier, including cash required to fund increases in accounts payable, prepaid expenses, prepaid maintenance, aircraft security deposits on new aircraft to be leased, pre-delivery payments on new aircraft to be purchased, as well as anticipated operating losses. As of December 31, 2003, our debt of $142.9 million accounted for 29.0% of our tot