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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 total capitalization. In addition to long term debt, we have a significant amount of other fixed obligations under operating leases related to our aircraft, airport terminal space, other airport facilities and office space. As of December 31, 2003, future minimum lease payments under non-cancelable operating leases with initial or remaining terms in excess of one year were approximately $1.8 billion for 2004 through 2024, not including commitments for the Airbus narrowbody aircraft we intend to acquire.

     Future operating lease commitments for the 10 leased Airbus aircraft are expected to be approximately $308 million and our purchase commitment for 15 additional Airbus aircraft are expected to be approximately $550 million over the next three years, including estimated amounts for contractual price escalations. We will incur additional debt and other fixed obligations as we take delivery of new

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aircraft and other parts and equipment and continue to expand into new markets. The leases for the narrowbody aircraft will require security deposits to be held by the lessors in addition to payments of monthly rent and maintenance reserves. The purchase agreement for the narrowbody aircraft will require progress payments to be made for each aircraft as the delivery date approaches. We have historically funded the majority of our aircraft acquisitions by entering into off-balance sheet financing arrangements known as leveraged leases, in which third parties provide equity and debt financing to purchase the aircraft and simultaneously enter into long-term agreements to lease the aircraft to us. In the future, we may elect to finance our aircraft through secured debt, leveraged leases, or operating leases. We are exposed to interest rate risks that can affect our costs under any of these financing techniques. Although we believe that debt and/or lease financing should be available for the 15 firm aircraft to be purchased from an affiliate of Airbus, there can be no assurance that we will be able to secure such financing on terms acceptable to us or at all.

     Our outstanding indebtedness and significant fixed obligations could have important consequences. For example, they could:

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adversely affect our ability to obtain additional financing to support our planned growth and for working capital and other general corporate purposes;

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divert substantial cash flow from our operations and expansion plans in order to service our fixed obligations;

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require us to incur significantly more interest or rent expense than we currently do; and

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place us at a possible competitive disadvantage compared to less leveraged competitors and competitors that have better access to capital resources.

     We have no lines of credit, other than letters of credit collateralized by cash, and will rely on our existing cash balances, cash flow from operations and other sources of capital to satisfy our obligations. There can be no assurance that we will be able to generate sufficient cash flow from our operations to pay our debt and other fixed obligations as they become due, and our failure to do so could harm our business. If we are unable to make payments on our debt and other fixed obligations we could be forced to renegotiate those obligations or obtain additional equity or debt financing. To the extent we finance our activities with additional debt, we may become subject to financial and other covenants that may restrict our ability to pursue our growth strategy. There can be no assurance that our renegotiation efforts would be successful or timely or that we could refinance our obligations on acceptable terms, if at all.

     Our business plan for Independence Air is heavily dependent on the metropolitan Washington, D.C. market, including Northern Virginia, and a reduction in demand for air travel in this market or the inability for Washington Dulles to accommodate our operations would harm our business. Our growth will focus on adding flights to and from our planned primary base of operations at Washington Dulles International Airport, where we intend to operate approximately 350 flights per day. As a result, we will be highly dependent upon the Washington, D.C. and Northern Virginia markets. Our business would be harmed by any circumstances causing a reduction in demand for air transportation in the Washington, D.C. and Northern Virginia metropolitan area, such as adverse changes in local economic conditions, political disruptions or violence (including any terrorist attacks), negative public perception of the city or region, significant price increases linked to increases in airport access costs and fees imposed on passengers or the impact of past or future terrorist attacks. If United replaces some or all of the flights we conduct for them today, Washington Dulles could experience significant congestion. As a

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result, we would be subject to delays and those delays may frustrate passengers, reduce aircraft utilization and increase costs, all of which could negatively affect our business.

     We will face competition as a low-fare airline from legacy carriers as well as low-fare airlines to which we have not been previously exposed. The airline industry is highly competitive, primarily due to the effects of the Airline Deregulation Act of 1978, which substantially eliminated government authority to regulate domestic routes and fares, and increased the ability of airlines to compete with respect to destination flight frequencies and fares. When we transition to Independence Air, we will operate in a new sector of the airline industry that is highly competitive and is particularly susceptible to price discounting because airlines typically incur only nominal costs to provide service to passengers occupying otherwise unsold seats. We expect that our competition will include legacy carriers and low-fare carriers, which may attempt to protect their markets and expand into new ones by adding service in markets we plan to serve, reducing fares to these markets or both. Several legacy carriers, including United, have introduced low-fare carriers to their operations, and we will face competition from these new airlines at Washington Dulles. In addition, because of the nature of our past relationship with United and because we will offer service between key United hubs, we anticipate that United’s response to our operation as Independence Air will be highly competitive and unpredictable. Our new brand Independence Air also will be competing against established brands used by both legacy carriers and low-fare carriers that carry greater name recognition, both at Washington Dulles and at the other cities that we serve. Both legacy carriers and low-fare carriers also continue to take delivery of regional jets, and we may face increased competition from regional jets at Washington Dulles, including the use of new 70 or 90 seat regional jets, which would be larger than those we currently have in our regional jet fleet. The use of new, larger scale regional jets will allow competitors to serve markets smaller than can now be served by low-fare carriers using larger aircraft, with a seat mile cost that may be lower than ours. In addition, competitors with greater financial resources than ours may price their fares below our fares or increase their service, which could adversely affect our profitability.

     Our planned base of operations for Independence Air will be Washington Dulles International Airport, which is serviced by a number of larger airlines who have greater name recognition and greater resources than we do. These larger airlines may commence or increase their capacity and service at Washington Dulles because there are no slots restricting access at this airport. We will compete against routes and fares offered by airlines at other airports that currently serve the Washington, D.C. metropolitan area, including Reagan National Airport and Baltimore Washington International Airport. We may also face competition from other airlines that may begin serving any of the markets we serve and from ground transportation alternatives. Other airlines also may meet or price their fares below our fares or introduce new nonstop service between cities served by our flights to and from Washington Dulles, and prevent us from attaining a share of the passenger traffic necessary to operate profitably. We expect that competition will exist in all the direct markets that we will serve, as well as in the market for flights that connect through Washington Dulles. We further expect that the competition for passengers connecting through Washington Dulles will be both from airlines offering service through Washington Dulles and from the large number of alternative hubs throughout the U.S., instead of Washington Dulles, through which connecting passengers can elect to route their travel.

     Our business model is dependent on our ability to successfully take delivery of, place into service and integrate new Airbus narrowbody aircraft into our operations. We are in the process of finalizing arrangements for the purchase or lease of 25 new Airbus narrowbody aircraft with options for an additional 50 aircraft. The Airbus narrowbody aircraft will operate in markets that are important

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to serving a broad selection of cities from Washington Dulles, and providing that service is critical to attracting customers to our airline. The narrowbody aircraft will also allow us to connect passengers to and from markets served by the regional jets to additional long haul markets, and we will thus rely on the Airbus narrowbody aircraft to generate incremental revenues for the regional jet fleet.

     If we are unable to reach definitive agreements on acceptable terms to lease and acquire the Airbus narrowbody aircraft, or if we, Airbus or the aircraft lessors thereafter are unable or unwilling to satisfy contractual obligations relating to the aircraft, we would be required to obtain alternative aircraft. A number of factors could limit or preclude our ability to obtain the aircraft from Airbus, including:

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We could fail to negotiate mutually acceptable terms for the definitive agreements with Airbus, and our MOUs could terminate;

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Airbus could refuse, or may not be financially able, to perform its obligations as set forth in the MOUs; and

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Airbus could experience a disruption to its operations that affects its ability to complete or timely fulfill its obligations.

     Boeing is the only other manufacturer from whom we could purchase new alternate aircraft of the size of the Airbus A319 or A320. If we had to purchase new aircraft from Boeing or used aircraft from other third parties, we cannot be certain that we could obtain those aircraft in the same time frame as currently expected or at comparable prices, or that they would be compatible with our operational structure, which may already be oriented around any Airbus A319 aircraft that have been delivered. Our ability to execute our business plan could be materially impaired if we were required to order alternate aircraft, or if the delivery schedule for the Airbus aircraft were delayed for any meaningful period.

     Acquisition of an all-new type of aircraft, such as the Airbus narrowbody aircraft, involves a variety of risks relating to our ability to successfully place those aircraft into service, including:

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difficulties or delays in obtaining approval from the FAA for the Company to operate these aircraft;

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delays in meeting the agreed upon aircraft delivery schedule;

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difficulties in obtaining financing on acceptable terms to complete our purchase or lease of all of the firm ordered aircraft;

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inability of the aircraft and all of its components to comply with agreed upon specifications and performance standards; and

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inability of the Company to successfully complete the required training of flight crews and maintenance staff.

     We do not have experience operating and maintaining the Airbus narrowbody aircraft, and we therefore face risks in integrating a new type of aircraft into our existing infrastructure and operations, including among other things, the additional costs, resources and time needed to hire and/or

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train new or existing pilots, technicians and other skilled support personnel. Our failure to successfully take delivery of, place into service and integrate into our operations the new Airbus narrowbody aircraft could harm our business.

     In the event that our Airbus aircraft are removed from scheduled service for repairs or other reasons (other than routine maintenance), we could experience a disruption in our scheduled service that would have an adverse effect on our operations. Similarly, our operations could also be harmed by the failure or inability of Airbus to provide sufficient parts or related support services on a timely basis.

     We will rely on maintaining a high daily aircraft utilization rate to keep our costs low, which makes us especially vulnerable to delays. One of the key elements of our business strategy for Independence Air is to maintain a high daily aircraft utilization rate, which is the amount of time that our aircraft spend in the air carrying passengers. High daily aircraft utilization allows us to generate more revenue from our aircraft and is achieved in part by reducing turnaround times at airports so we can fly more hours on average in a day. Aircraft utilization is reduced by delays from various factors, many of which are beyond our control, including, among others, air traffic and airport congestion, inclement weather, security requirements, crew availability, fueling and ground handling and unscheduled maintenance. Because many of our areas of operations are located in the Northeast, which is susceptible to bad weather conditions and air traffic and airport congestion, our aircraft utilization rates are vulnerable to delays from these factors in particular. In addition, air traffic control for flights we operate is currently controlled by United and Delta, not by us, and is managed on a system-wide basis that often results in our flights being delayed in favor of larger aircraft operated by our code-share partners. The experience of customers on our current United Express and Delta Connection flights, and the on-time records of our flights as United Express and Delta Connection, could result in negative customer perceptions regarding our operations. Once we commence operations as Independence Air, we will for the first time be responsible for managing our air traffic control delays with the FAA and, accordingly, may not manage such operations as efficiently as other low-fare carriers. The expansion of our business to include new destinations and more frequent flights on current routes could increase these risks. Furthermore, a schedule that contemplates high aircraft utilization is subject to the increased risk that once an aircraft falls behind schedule during the day, it could remain behind schedule during the remainder of that day and potentially into the next day, which can result in disruption in operating performance leading to passenger dissatisfaction and missed connections. All of the foregoing delays may increase our costs as well as diminish our reputation among our customers.

     Our business model foregoes marketing systems used by many of our competitors. In order to reduce costs, we do not plan to participate in conventional computerized reservation systems that are owned, operated or utilized by most of the major airlines even though travel agents regularly book flights through such systems. Instead, we intend to rely on reservations by customers or travel agents who contact us directly (either by phone or via our website) to book a flight. Our failure to participate in a conventional computerized reservations system may decrease public awareness of our airline and flight and fare schedule and therefore may cause us a competitive disadvantage. Similarly, many airlines have marketing alliances with other airlines under which they market and advertise their status as marketing alliance partners. Among other things, they share the use of flight designator codes to identify their flights and fares in the computerized reservation systems and permit reciprocity in their frequent flyer programs. In recent years, alliance activity among major carriers has significantly expanded within the airline industry, increasing the scope of operations and resources of our competitors, which, in turn, could adversely affect our ability to compete. Our Independence Air operations will not be a member of any marketing alliance. Our lack of a marketing alliance could harm

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our business and competitive ability. We also do not intend to participate in interairline baggage handling agreements, under which we forward and receive customer baggage to and from other airlines that may operate flights with which our customers may be connecting, which may discourage potential customers from flying on Independence Air.

     We will rely heavily on automated systems to operate our business and any failure of these systems could harm our business. We will depend on automated systems to operate our business as Independence Air, including our computerized airline reservation system, our telecommunication systems, kiosks, and our website. Our website and reservation and check-in systems must be able to accommodate a high volume of traffic and deliver important flight information. Substantial or repeated website, reservations system, kiosk, or telecommunication systems failures could reduce the attractiveness of our services and could cause our customers to purchase tickets from another airline. While we have backup systems for some aspects of our operations, our systems have not been fully tested and are not fully redundant and our disaster recovery planning may not be sufficient for all eventualities. In order to provide a reservations system and the infrastructure to receive customer calls, we will contract with third party vendors to provide the software, hardware, and technical support of the reservations system and the physical location and staffing for a call center. We also may need to rely on third-party vendors to implement our back-up systems, which would place aspects of maintaining important data beyond our control. Any disruption in our or our third parties’ systems or in the ability of the third party vendors to provide their services could result in the loss of customer bookings or important data, increase our expenses and generally harm our business.

     Our inability to obtain approval to operate more aircraft from the FAA and the DOT would materially restrict our growth and harm our business plan. We possess all the FAA and Department of Transportation, or DOT, approvals we require to perform the air transportation services we currently provide. We will be required, however, to obtain additional authority from the FAA to operate and maintain the Airbus narrowbody aircraft that are scheduled to be added to the fleet for Independence Air. In addition, the DOT will be required to conclude that we are considered statutorily “fit” to engage in air transportation with these larger jet aircraft and otherwise to operate without a major code share partner as we have in the past. There can be no assurance that such authorizations, when they are sought, will be granted. The failure of the FAA and the DOT to grant these approvals to us or delays in such approvals would materially restrict our ability to grow, to increase revenues and cash flow and to offer a service to a broad network of cities to attract customers.

     We are subject to risks arising from fuel costs. Fuel costs constitute a significant portion of our total operating expenses (19% of operating expenses, excluding aircraft early retirement charges for the year ended December 31, 2003). Significant increases in fuel costs would harm our financial condition and results of operations. We estimate that for 2003, a one cent increase in the price per gallon of fuel expense would have increased our fuel expense by $1.3 million. We have historically obtained a portion of our fuel through contracts with our code share partners and will need to contract independently at certain stations to purchase fuel for our Independence Air operations. Under the terms of our fee-for-service agreements with United and Delta, those parties had the risks and benefits of changes in fuel prices and so we were not exposed to fluctuations in fuel prices. We will be exposed to increases in fuel prices once we begin operating as Independence Air, and currently have no fuel hedges in place to mitigate that exposure. We cannot predict the future cost and availability of fuel. Both fuel costs and availability are subject to many economic and political factors and events occurring throughout the world over which we have no control. Fuel availability is also subject to periods of market surplus and shortage and is affected by demand for both home heating oil and gasoline. In the event of a fuel supply shortage, higher fuel prices or the curtailment of scheduled service could result. Some of our

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competitors may have more leverage than we do in obtaining fuel. There can be no assurance that increases in the price of fuel can be offset by higher fares.

     We may not be able to achieve access to suitable airports located in our targeted geographic area. Our future growth as Independence Air is materially dependent on our ability to access suitable airports located in our targeted geographic markets for both our larger, narrowbody aircraft and our regional jets at costs that are consistent with our low-fare strategy. Any condition that would deny, limit or delay our access to airports we serve or seek to serve in the future would constrain our ability to grow. A change in the terms of our access to existing facilities or any increase in the relevant charges paid by us as a result of the expiration or termination of such arrangements and our failure to renegotiate comparable terms or rates could have a material adverse effect on our results of operations. We plan to base our operations predominantly at Washington Dulles Airport. There can be no assurance that such airport will not impose higher airport charges in the future or that such increases would not adversely affect our operations.

Other Risk Factors Affecting the Company

     We are under pressure to control and reduce our costs. The economic downturn reduced demand for air travel and the success of low-fare carriers has resulted in increased emphasis in the airline industry on controlling and reducing expenses. In this environment, if we are unable to align our costs with our business plan or to control and reduce our costs in general, we may not be able to effectively compete against other regional carriers or low-fare carriers to maintain or expand our existing operations and carry out our business plan.

     Our current operations benefit from government support for insurance costs. Following the September 11 terrorist attacks, the aviation insurance industry imposed a worldwide surcharge on aviation insurance rates as well as a reduction in coverage for certain war risks. In response to the reduction in coverage, the Air Transportation Safety and System Stabilization Act provides U.S. air carriers with the option to purchase certain war risk liability insurance from the United States government on an interim basis at rates that are more favorable than those available from the private market. Prior to December 2002, we purchased hull war risk coverage through the private insurance market, and purchased liability war risk coverage through a combination of U.S. government provided insurance and private insurance. In December 2002, the U.S. government offered to provide additional war risk coverage that included certain risks previously covered by private insurance. We have purchased, at rates that are significantly lower than those charged by private insurance carriers, hull and liability war risk coverage from the U.S. government through August 31, 2004. Due to the cost and difficulty in obtaining insurance in the commercial markets, we anticipate renewing the insurance through the FAA for so long as it is available. The inability to obtain insurance at any cost or the availability of insurance only at excessive rates, could affect our ability to operate.

     Our contracts with two of our unions currently are amendable. Our contract with Aircraft Mechanics Fraternal Association (“AMFA”), which was ratified in June 1998, became amendable in June 2002, and our contract with the Association of Flight Attendants-Communications Workers of America (“AFA-CWA”), which was ratified in October 1998, became amendable in October 2002. The AMFA contract covers all aviation maintenance technicians and ground service equipment mechanics working for us and the AFA-CWA contract covers all flight attendants working for us. We have entered into discussions with AFA-CWA regarding a new agreement, and have been in negotiations with AMFA during 2003 and recently both sides have agreed to mediation under the Railway Labor Act. Although there can be no assurances as to the outcome of these negotiations and mediation, we anticipate ultimately being able to reach agreement with both unions on mutually

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satisfactory contracts with no material effect on its results of operations or financial position. However, the failure to resolve these negotiations on appropriate terms could affect our ability to compete effectively.

     Our results of operations will fluctuate. We expect our quarterly operating results to fluctuate in the future based on many factors including competition, changes in aircraft fuel costs, security costs, weather, the timing and amount of maintenance and our ability to successfully develop the “Independence Air” brand, including costs related to marketing expenditures in this effort. Because a substantial portion of airline travel (both business and personal) is discretionary, the industry tends to experience adverse financial results during general economic downturns. Any prolonged general reduction in airline traffic may particularly affect us because our business plan is more dependent, in part, on the stimulation of discretionary air travel. In addition, seasonal variations in weather and traffic affect our operating results from quarter to quarter. Given our high proportion of fixed costs, this seasonality affects our profitability from quarter to quarter. Our base of operations is located in the Washington, D.C. area, and many of our areas of operations are located in the Northeast, which makes our operations susceptible to air traffic and airport congestion as well as bad weather conditions in the winter, causing increased costs associated with deicing aircraft, cancelled flights and accommodating displaced passengers. Due to our geographic area of operations and our use of regional jets, we are more susceptible to adverse weather conditions along the East Coast than some of our competitors, who may be better able to spread weather-related risks over more diverse route systems. As we enter new markets, we could be subject to additional seasonal variations. Due to the factors described above, quarter-to-quarter comparisons of our operating results may not be good indicators of our future performance. In addition, it is possible that in any future quarter our operating results could be below the expectations of investors and any published reports or analyses regarding Independence Air. In that event, the trading prices of our common stock could decline, perhaps substantially.

     Our business would be harmed if we lost the services of any key personnel. Our success depends to a large extent on the continued service of our executive management team. Although we have employment agreements with certain executive officers, it is possible that members of management may resign. We may incur unexpected expenses and have difficulty replacing management or other key personnel who leave and, therefore, the loss of the services of any of these individuals could harm our business. We maintain key-man life insurance on certain executive officers only to the extent necessary to fund life insurance commitments under employment agreements in the event of death.

Risk Factors Affecting the Airline Industry

     The U.S. airline industry is experiencing significant restructurings and bankruptcies. The recent U.S. airline industry environment has probably been the worst in its history. Beginning in early 2001, the industry has experienced depressed demand and shifts in passenger demand, lower unit revenues, increased insurance costs, increased fuel costs, increased government regulations and taxes, and tightened credit markets, evidenced by higher credit spreads and reduced capacity to borrow. These factors are directly affecting the operations and financial condition of participants in the industry including aircraft manufacturers. Several major airlines have used the bankruptcy process to reduce their expenses and streamline their operations. Our contractual relationships with others may continue to be affected by other companies’ bankruptcies or by concerns regarding potential bankruptcies. The bankruptcy or prospect of bankruptcy among other companies which operate in our industry may result in unexpected expenses and create other risks or uncertainties that we are not able to anticipate or plan around.

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     The travel industry has been materially adversely affected by the September 11, 2001 terrorist attacks and on-going security concerns. The U.S. airline industry continues to recover from the events of September 11, 2001 and increased concerns over additional acts of terrorism. The major carriers continue to experience losses or operate near break-even levels of profitability even after reducing capacity, negotiating wage and work rule concessions and, for certain carriers, filing for bankruptcy protection. Passenger traffic continues to be negatively impacted by the general economic situation in the United States, threats of terrorist activities, terrorist alerts, violence in the Middle East, and increased security measures at the nation’s airports. Instability in the Middle East and other parts of the world has increased the risk that the industry will continue to be adversely affected by reduced demand, increased security costs, increased fuel costs, and other factors. While our code share agreements currently allow us to recover certain of these additional expenses from our partners, no such cost recovery arrangements will be available for our Independence Air operations, and the effects of any new terrorist attacks and/or security measures could impair our ability to operate profitably.

     Airlines are often affected by factors beyond their control, including weather conditions, traffic congestion at airports and increased security measures, any of which could harm our operating results and financial condition. As with other airlines, we are subject to delays caused by factors beyond our control, including adverse weather conditions, air traffic congestion at airports and increased security measures. Delays frustrate passengers, reduce aircraft utilization and increase costs, all of which negatively affect profitability. During periods of fog, snow, rain, storms or other adverse weather conditions, flights may be cancelled or significantly delayed. Cancellations or delays due to weather conditions, traffic control problems and breaches in security could harm our operating results and financial condition.

     Changes in government regulations imposing additional requirements and restrictions on our operations could increase our operating costs and result in service delays and disruptions. Airlines are subject to extensive regulatory and legal requirements, both domestically and internationally, that involve significant compliance costs. In the last several years, Congress has passed laws, and the DOT and the FAA have issued regulations relating to the operation of airlines that have required significant expenditures. We expect to continue to incur expenses in connection with complying with government regulations. Additional laws, regulations, taxes and airport rates and charges have been proposed from time to time that could significantly increase the cost of airline operations or reduce the demand for air travel. If adopted, these measures could have the effect of raising ticket prices, reducing revenue and increasing costs. There can be no assurance that these and other laws or regulations enacted in the future will not harm our business.

     The airline industry is characterized by low profit margins and high fixed costs, and we may be unable to establish our brand or to compete effectively against other airlines with greater financial resources or lower operating costs. The airline industry is characterized generally by low profit margins and high fixed costs, primarily for personnel, aircraft fuel, debt service and rent. The expenses of an aircraft flight do not vary significantly with the number of passengers carried. As a result, a relatively small change in the number of passengers or in pricing could have a disproportionate effect on an airline’s operating and financial results. Accordingly, a minor shortfall in expected revenue levels could harm our business. In addition, the airline industry is highly competitive and is particularly susceptible to price discounting because airlines incur only nominal costs to provide service to passengers occupying otherwise unsold seats. We will compete with other airlines on substantially all of our routes. Many of these airlines are larger and have greater financial resources and name recognition or lower operating costs or both than we do. Some of these competitors may chose to add service, reduce their fares or both, in some of our markets following or in anticipation of our entry. Therefore,

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we may be unable to compete effectively against other airlines that introduce service or discounted fares in the markets that we serve which could harm our business.

     Our reputation and financial results could be harmed in the event of an accident or incident involving our aircraft. An accident or incident involving one of our aircraft could involve repair or replacement of a damaged aircraft and its consequential temporary or permanent loss from service, and significant potential claims of injured passengers and others. We are required by the DOT to carry liability insurance. Although we believe we currently maintain liability insurance in amounts and of the type generally consistent with industry practice, the amount of such coverage may not be adequate and we may be forced to bear substantial losses from an accident. Substantial claims resulting from an accident in excess of our related insurance coverage would harm our business and financial results. Moreover, any aircraft accident or incident, even if fully insured, could cause a public perception that we are less safe or reliable than other airlines, which would harm our business.

Internet Website

     The Company’s Internet website can be found at www.atlanticcoast.com, with additional material related to Independence Air at www.flyi.com. The Company makes available free of charge on or through its Internet website under the heading “For Investors”, access to its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is filed with, or furnished to, the Securities and Exchange Commission. The contents of these websites are not a part of this Form 10-K.

Item 2. Properties

     Fleet Composition: The following table describes the Company’s fleet of aircraft, scheduled firm deliveries and options as of February 15, 2004:

     The Company plans to retire early its remaining British Aerospace J-41 turboprop aircraft (“J-41s”) in the fleet. Under the plan, J-41s would be removed from service as they transition out of the United Express program. The Company’s commitment to purchase 34 CRJ aircraft on order is subject to certain conditions which, 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. The Airbus A319/A320 aircraft identified above are based on a firm lease agreement for four aircraft, and on Memoranda of Understanding for other aircraft, and assume that the Company will be able to finalize lease or purchase agreements. 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.

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     Sixteen are scheduled to be delivered in 2005, and the five A320 aircraft are scheduled to be delivered in 2006. The order for five A320 aircraft is convertible into an order for five A319 aircraft at the option of the Company with certain notice required prior to delivery.

     Leased Facilities

     Airports

     The Company enters into agreements for the use of passenger terminals at most of the airports the Company serves and leases ticket counter and office space at those locations where ticketing and the Company’s aircraft are handled by Company personnel. Payments to airport authorities for ground facilities are generally based on a number of factors, including space occupied as well as flight and passenger volume. The Company occupies a 69,000 square foot passenger concourse at Washington Dulles dedicated solely to regional airline operations. The 36-gate concourse, designed to support the Company’s United Express operation, is owned by the Metropolitan Washington Airports Authority and leased to the Company under a lease with a termination date of September 30, 2014. The Company also occupies 7 additional gates at Washington Dulles, and is negotiating arrangements for the exchange of these gates for up to 8 gates suitable for narrowbody operations in an area adjacent to its 36-gate concourse. Finally, the Company is working with the various airports to arrange for gate and terminal space at locations to be serviced by Independence Air.

     Corporate Offices

     The Company’s executive, administrative and system control departments are located in a three-story office building encompassing 77,000 square feet of space under an operating lease ending December 2010. The Company’s employee training and services center is located in a nearby 79,000 square foot building under a lease ending December 31, 2007. Together, these properties provide the necessary administrative facilities for the Company’s operations.

     Maintenance Facilities

     The FAA’s safety regulations mandate periodic inspection and maintenance of commercial aircraft. The Company performs most line maintenance, service and inspection of its aircraft and engines at its own maintenance facilities using its own personnel.

     The Company performs maintenance functions at a 112,000 square foot aircraft maintenance facility at Washington Dulles, a 34,000 square foot hangar facility in Columbia, South Carolina, and a 53,000 square foot hangar at Chicago O’Hare airport. The Washington Dulles aircraft maintenance facility is comprised of 60,000 square feet of hangar space and 52,000 square feet of support and administrative space. The lease term for the Washington Dulles aircraft maintenance facility expires December 24, 2024. The lease term for the Columbia facility expires on June 1, 2005 or earlier on 90 days notice. The Chicago O’Hare facility is subleased from United, with the Company obligated to pay United’s cost related to the operation of the building including ground rent. This sublease expires on December 31, 2007 although United has the right to reject this lease in bankruptcy and either party in any case has the right to terminate on 90 days notice. In addition to these maintenance facilities, the Company performs maintenance functions utilizing hangar space at Cincinnati’s Northern Kentucky International Airport provided by Delta at no cost to the Company.

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     Going forward the Company will be performing the majority of its maintenance function for CRJs at the facility at Washington-Dulles. Line station maintenance for the Independence Air operation will be provided by contract maintenance. Some high frequency stations could be minimally staffed by ACA personnel. Routine overnight maintenance for the Airbus aircraft will be performed by contract maintenance at line stations and by Company mechanics at Washington Dulles. The heavier overnight checks will be done at a hangar location that has not yet been selected.

Item 3. Legal Proceedings

     The Company is involved in legal proceedings related to the insolvency of Fairchild Dornier GmbH (“Fairchild”), which was initiated in 2002. The Company holds a bond in the amount of $1.2 million from an independent insurance company, which secures deposits placed with Fairchild for undelivered aircraft, and has made a demand for payment under this bond. Fairchild’s insolvency trustee has made a claim for the collateral posted with the insurance company, and the insurance company has withheld payment of the bond. The matter is presently with the U.S. Bankruptcy Court for the Western District of Texas.

     On October 14, 2003, the Company commenced arbitration proceedings against GE Engine Services, Inc. (“GE”). In the proceeding, the Company seeks a ruling by an arbitrator that it has the right to remove any or all engines from the scope of an engine services agreement with GE governing the scheduled and unscheduled repair of ACA’s CRJ jet engines. GE has also requested that the arbitration also address the issue of whether GE is owed certain amounts it claims it is owed pursuant to the agreement. The parties are presently addressing preliminary procedures in advance of proceeding with this arbitration. The Company believes that it has adequately reserved for GE’s counterclaim in the event that an arbitrator rules in favor of GE’s counterclaim. If the arbitrator were to rule against the Company’s interpretation of the agreement, covered engines will remain subject to the agreement for the balance of the term of the agreement.

     The Company has been named in several lawsuits arising from the terrorist activities of September 11, 2001. These actions were commenced by or on behalf of individuals who were injured or killed as a result of the hijackings of the four flights. These actions seek compensatory and punitive damages. However, pursuant to the Air Transportation Safety and System Stabilization Act, the Company’s liability for these claims is limited to the Company’s liability insurance. In each case, the plaintiffs have named the airlines operating at the airports from which the flights originated, including the Company, under the theory that all of the airlines are jointly responsible for the alleged security breaches by the airport security contractor. The court recently denied the motion of American Airlines and other defendants, including the Company, seeking dismissal of all ground victim claims on the basis that the airline defendants do not owe a duty as a matter of law to individuals injured or killed on the ground. The Company anticipates that it will raise other defenses including its assertion that it is not responsible for the incidents as it had no control over the security checkpoints through which the hijackers allegedly gained access to the hijacked aircraft. Numerous lawsuits alleging this claim were filed during the third quarter of 2003 as a result of the possible expiration of certain statutes of limitations. A total of 81 complaints against the Company are known to be pending. Of the 81 complaints, 37 are active, as the claimants have formally opted out of the Victim Compensation Fund. The remaining 44 claimants are required to elect whether or not to opt out of the Victim Compensation Fund. The claimants who have filed are required to serve their complaints by March 7, 2004 if they wish to proceed. The Company anticipates that other similar lawsuits could be filed on behalf of other victims.

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     From time to time, claims are made against the Company with respect to activities arising from its airline operations. Typically these involve injuries or damages incurred by passengers and are considered routine to the industry. On April 1, 2002, one of the Company’s insurers on its comprehensive aviation liability policy, Legion Insurance Company, a subsidiary of Mutual Risk Management Ltd. (“Legion”), was placed into rehabilitation by the Commonwealth of Pennsylvania, its state of incorporation. The rehabilitation proceeding is styled Koken v. Legion Insurance Company, No. 183 M.D. 2002 (Pa. Commw. Ct.), and is before Judge Leavitt. Currently, Legion can pay no claims, expenses or other items of debt without approval from Pennsylvania, resulting in the Company directly carrying the corresponding exposure related to Legion’s contribution percentage for payouts of claims and expenses that Legion represented on the Company’s all-risk hull and liability insurance for the 1999, 2000, 2001 and 2002 policy years. Those contribution percentages are 15% for claims arising from incidents occurring in 1999, 19% for 2000, 15% for 2001, and 8.5% for the first quarter of 2002. Legion ceased to be an insurer for the Company as of April 1, 2002, and there is, therefore, no exposure with respect to Legion for claims arising after that date.

     The insurance held by Legion on the Company’s policy was fully covered by reinsurance, which means that other carriers are contractually obligated to cover all claims that are direct obligations of Legion. It is additionally believed that a “cut-through” provision exists that causes funds to pass directly from the reinsurers to the Company in situations such as the rehabilitation or insolvency of a primary insurer. Other companies, including American Airlines, Inc. (“American”), have similar policy provisions. American and others intervened in the Legion rehabilitation and moved to have the cut-through provisions enforced. However, other creditors of Legion and the Pennsylvania Insurance Commissioner maintained that the funds should apply to Legion’s other obligations. On June 26, 2003, the Pennsylvania Commonwealth Court ruled in American’s favor and entered an order enforcing the cut-through provisions. The Court ruled that the reinsurance contract proceeds at issue were not general assets of the Legion estate. On July 25, 2003, the Court entered an Order of Liquidation that incorporated the June 26, 2003 ruling. The Order provided a means whereby the Company could intervene to assert rights to its own reinsurance. The Company filed a motion to intervene which remains outstanding. The Insurance Commissioner and others appealed the Court’s ruling regarding reinsurance and the Pennsylvania Supreme Court entered an automatic supersedeas that stayed the matter at the trial level. If upheld on appeal, the ruling provides an avenue whereby the Company can seek to have its cut-through provision enforced. However, if the ruling is overturned on appeal, the Company will likely be underinsured for these claims at the percentages set forth above. This underinsurance would include September 11 related lawsuits and any other similar lawsuits that are brought against the Company. The Company has accrued reserves for its likely exposure on claims known to date. No reserves have been accrued for the September 11 related claims.

     The Company is currently involved in litigation against Mesa Air Group, Inc. (“Mesa”) arising from Mesa’s proposed exchange offer and consent solicitation to replace the Company’s board of directors, both of which Mesa announced in October 2003. In its complaint filed with the United States District Court for the District of Columbia on October 27, 2003, and as subsequently amended, the Company alleged that Mesa made materially false and misleading statements and omissions in violation of Sections 14(a) and (e) of the Securities Exchange Act of 1934 in connection with its consent solicitation and potential exchange offer. The complaint alleged, among other things, that (i) Mesa concealed its own direct and material interests in seeking to remove the Company’s board of directors; (ii) Mesa made several false and misleading statements about its November 12, 2003 memorandum of understanding with United Air Lines, Inc. (the “United MOU”); (iii) Mesa failed to disclose United Air Lines (“United”) as a participant in its consent solicitation and proposed transaction; (iv) Mesa made materially false and misleading statements about the independence,

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beliefs, intentions and qualifications of Mesa’s nominees to the Company’s board of directors; (v) Mesa failed to disclose multiple incidents of questionable trading in Mesa stock by insiders; and (vi) Mesa failed to disclose conflicts of interests and self-dealing by Mesa’s directors. On November 26, 2003, the Company amended its complaint to further allege that Mesa’s consent solicitation and proposed exchange offer violated Section 1 of the Sherman Act and Section 7 of the Clayton Act by seeking, in concert with United, to prevent the Company from entering relevant markets through launching Independence Air. For the alleged antitrust violations, the Company sought injunctive relief to prevent Mesa from proceeding with the consent solicitation or proposed exchange offer, damages, and attorneys’ fees. On December 18, 2003, the District Court entered a preliminary injunction with respect to the Company’s antitrust claim under Section 1 of the Sherman Act, enjoining Mesa from proceeding with its consent solicitation or exchange offer pending final resolution of the matter. The Court denied the Company’s separate requests for preliminary relief under Section 14(a) and 14(e) of the Securities and Exchange Act of 1934 and Section 7 of the Clayton Act. On January 9, 2004, the Company posted a $10,000,000 cash bond in connection with the preliminary injunction as required by the District Court’s order dated December 30, 2003. At the Court’s direction, the cash bond was placed in an interest bearing account invested in Treasury Bills. On January 20, 2004, Mesa filed a Notice of Appeal to the United States Court of Appeals for the District of Columbia Circuit from the District Court’s order entering a preliminary injunction under Section 1 of the Sherman Act. If the court were to determine that Mesa was wrongfully enjoined, Mesa may have a right to seek payment for costs or damages incurred as a result of the injunction. The Company believes the preliminary injunction was properly entered and that the District Court’s decision will be upheld on appeal, and will vigorously defend on appeal.

     On February 10, 2004, Mesa filed a counterclaim against the Company, alleging that the Company’s preliminary proxy statement and other public statements made in connection with Mesa’s consent solicitation and the Company’s plans to launch Independence Air were materially false and misleading, in violation of Section 14(a) of the Exchange Act. More specifically, Mesa alleged that the Company (i) failed to disclose the terms of its November 2003 memorandum of understanding with Airbus Industrie AVSA for the purchase of new aircraft, (ii) failed to disclose the risks and capital requirements of the Company’s plan to change its business model and launch a new independent low-fare airline; (iii) failed to give meaningful consideration to Mesa’s initial proposal to acquire the Company; and (iv) failed to disclose that it had arranged for the delivery from a Company employee of a consent form to Mesa’s solicitation, in order to trigger the time period for Mesa to solicit consents, even though Mesa’s solicitation materials had not been cleared by the SEC. In the counterclaim, Mesa seeks, among other things, an order (i) declaring that the Company’s public statements in connection with Mesa’s consent solicitation and the Company’s plan to launch an independent, low-fare airline violated Section 14(a) of the Exchange Act, (ii) requiring the Company to issue corrective disclosures, and (iii) enjoining the Company from making any further materially false and misleading statements in connection with Mesa’s consent solicitation and the Company’s plan to launch an independent, low-fare airline. The Company believes the counterclaim lacks merit and will, if necessary, vigorously contest the allegations set forth therein.

     On December 18, 2003, the Company received a Civil Investigative Demand (“CID”) from the Antitrust Division of the United States Department of Justice (“DOJ”) relating to an ongoing DOJ antitrust investigation. As disclosed in the CID, the investigation concerns the proposed acquisition of the Company by Mesa, and possible violations by Mesa of Section 1 of the Sherman Act and Section 7 of the Clayton Act. On December 19, 2003, the Company was advised by the DOJ that similar CIDs had been issued to both Mesa and United in connection with the same investigation. The Company is cooperating fully with the DOJ’s investigation.

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     The FAA has made the Company aware that it has reviewed and is seeking assurances with respect to certain Company maintenance program time tracking and related maintenance practices. In connection with this, the FAA previously informed the Company that it needed to satisfy the FAA’s concerns prior to adding additional aircraft to its operations. The Company has responded to the issues raised by the FAA and satisfied its concerns to the extent that the FAA permitted the Company to add two new CRJ aircraft to its operations effective October 28, 2003. The Company continues to work closely with the FAA and believes that it will be able to continue to assure the FAA that its maintenance tracking and related practices meet and exceed FAA requirements, without any interruption in its business plans. However, the FAA could seek to impose a civil penalty in connection with this matter. In addition to this matter, the Company is the subject of ongoing FAA and TSA civil penalty cases relating to alleged violations of FAA and TSA enforced rules and regulations. The Company believes that the number of such cases and the amount of the civil penalties sought by the FAA and TSA is consistent with the experience of other airlines with operations of the size and scope of those provided by the Company, and that the disposition of these cases is not likely to have a material effect on the Company’s financial position or the results of its operations.

     In addition to those matters discussed above, the Company is a party to routine litigation all of which is viewed to be incidental to its business, and none of which the Company believes are likely to have a material effect on the Company’s financial position or the results of its operations.

Item 4. Submission of Matters to a Vote of Security Holders

     No matter was submitted during the fiscal quarter ended December 31, 2003, to a vote of the security holders of the Company through the solicitation of proxies or otherwise.

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

     The Company’s common stock, par value $.02 per share (the “Common Stock”), is traded on the NASDAQ National Market (“NASDAQ/NM”) under the symbol “ACAI”. Trading of the Common Stock commenced on July 21, 1993.

     The following table sets forth the reported high and low closing sale prices of the Common Stock on the NASDAQ/NM for the periods indicated:

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     As of February 9, 2004, the closing sales price of the Common Stock on NASDAQ/NM was $8.58 per share and there were approximately 183 holders of record of Common Stock.

     The Company has not paid any cash dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. The Company intends to retain earnings to finance the growth of its operations. The payment of cash dividends in the future will depend upon such factors as earnings levels, capital requirements, the Company’s financial condition, the applicability of any restrictions imposed upon the Company subsidiaries by certain of its financing agreements, the prohibition of dividends imposed by the Company’s line of credit, and other factors deemed relevant by the Board of Directors. In addition, ACAI is a holding company and its only significant asset is its investment in its subsidiary, ACA.

     The Company’s Board of Directors has approved the repurchase of up to $40.0 million of the Company’s outstanding common stock in open market or private transactions. As of December 31, 2003, the Company has repurchased 2,182,745 shares of its common stock and has approximately $21.0 million remaining of the $40.0 million authorized for repurchase.

Item 6. Selected Financial Data

     The following selected financial data under the captions “Consolidated Financial Data” and “Consolidated Balance Sheet Data” relating to the years ended December 31, 1999, 2000, 2001, 2002 and 2003 have been derived from the Company’s consolidated financial statements. The following selected operating data under the caption “Selected Operating Data” have been derived from Company records. The data should be read in conjunction with “Management’s Discussion and Analysis of Results of Operations and Financial Condition” and the Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K.

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
(Dollars in thousands, except per share amounts and operating data)

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued)
(Dollars in thousands, except per share amounts and operating data)

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		tax benefits) to reverse a portion of the operating charge booked in 2001. In addition, in 2002, the Company reversed the remaining portion of the original 2000 operating charge of $0.2 million. In 2001, the Company recorded an operating charge of $23.5 million ($14.0 million net of income tax benefits) for the non-discounted value of future lease and other costs associated with the early retirement of nine J-41 turboprop aircraft. In 2000, the Company recorded an operating charge of $29.0 million ($17.4 million net of income tax benefits) for the present value of future lease and other costs associated with the early retirement of 28 J-32 turboprop aircraft. Upon completion of the J-32 retirement plan in 2001, the Company reversed $0.5 million of the original 2000 operating charge in 2001.
2.		In 2003, 2002 and 2001, the Company recognized $1.5 million, $0.9 million and $9.7 million respectively as non-operating income for funds received under the Air Transportation Safety and System Stabilization Act, signed into law by President Bush on September 22, 2001.
3.		In 1999, the Company recorded a charge of $888,000 for the cumulative effect, net of income taxes, of a change in accounting for pre-operating costs in connection with the implementation of Statement of Position 98-5.
4.		All per share calculations have been restated to reflect a 2-for-1 Common Stock split effected as dividends distributed on February 23, 2001.
5.		“Revenue passenger miles” or “RPMs” represent the number of miles flown by revenue passengers.
6.		“Available seat miles” or “ASMs” represent the number of seats available for passengers multiplied by the number of scheduled miles the seats are flown.
7.		“Passenger load factor” represents the percentage of seats filled by revenue passengers and is calculated by dividing revenue passenger miles by available seat miles.
8.		“Operating cost per available seat mile” or “CASM” represents total operating expenses divided by available seat miles.
9.		“Average yield per revenue passenger mile” represents the average passenger revenue received for each mile a revenue passenger is carried.
10.		“Revenue per departure” represents the revenue received for each departure and is calculated by dividing gross passenger revenue by revenue departures.

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Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition

General

     Atlantic Coast Airlines Holdings, Inc. (“ACAI”) operates through its wholly owned subsidiary, Atlantic Coast Airlines (“ACA”). In 2003, the Company recorded net income of $82.8 million compared to $39.3 million for 2002, and $34.3 million for 2001. For 2003, the Company’s available seat miles (“ASM”) increased 6.8% with the addition of 13 Canadair Regional Jet (“CRJ”) aircraft, net of the reduction of five British Aerospace Turboprop J-41 (“J-41”) aircraft during the year. The number of total passengers increased 17.5%, and revenue passenger miles (“RPM”) increased 17.4%. For 2002, the Company’s ASM increased 32% with the addition of 17 CRJ aircraft and 4 328Jet aircraft, net of the reduction of 1 J-41 aircraft during the year. The number of passengers increased 45.0% and RPM increased 49.5%.

     In early 2003, the Company implemented a cost reduction program to address decreases in aircraft utilization by its code share partners in response to industry-wide over-capacity that was affected by the war with Iraq and the outbreak of Severe Acute Respiratory Syndrome (SARS), and to respond to United’s notification that as part of its bankruptcy restructuring it intended to accept bids from both existing and new carriers for its United Express business. The Company ended the year 2003 with 145 aircraft and averaged 8.0 hours per day utilization for the year. This compares to ending the year 2002 with 137 aircraft and an average utilization of 8.8 hours per day and ending the year 2001 with 117 aircraft and an average utilization of 8.1 hours per day. The Company’s cost reduction program included reduced payroll costs through the elimination of the Company’s employee incentive programs and 5% to 10% reductions in salaries for management employees, lower training costs and lower related travel costs.

     The Company expects to begin operation of its low-fare airline, Independence Air, during 2004. The Company and United have failed to reach agreement on a revised code share agreement and in July 2003, the Company announced that it anticipates that United will end its relationship with the Company as a part of United’s reorganization in bankruptcy and that the Company intends thereafter to operate as an independent low-fare airline to be based at Washington Dulles International Airport. Under United States Bankruptcy law, United has the right to assume or reject the Company’s United Express code share agreement. Until United rejects the existing code share agreement or the Company is otherwise released from the agreement by the bankruptcy court, the Company will continue to operate for United under the terms of the existing code share agreement while preparing to transition into an independent low fare airline to be called Independence Air.

Year ended December 31, 2003 Compared to Year ended December 31, 2002

Results of Operations

     For 2003, the Company’s net income was $82.8 million or $1.82 per diluted share, compared to $39.3 million or $.85 per diluted share for 2002. The Company generated operating income of $137.9 million for 2003 compared to $62.6 million for 2002. These results reflect the Company’s increased capacity as it expanded the number of aircraft operated under its agreements with United and Delta as well as the additional items and factors discussed below.

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     The Company has long-term lease commitments for 25 J-41 aircraft and owns five J-41 aircraft. During 2002, the Company recorded aircraft early retirement operating charges totaling $24.3 million ($14.6 million net of income tax) for the non-discounted value of future lease payments and other costs associated with the planned retirement of its J-41 aircraft. During the second quarter of 2003, the Company reversed a portion of the J-41 retirement charges taken in previous years by recording a $34.6 million credit ($20.4 million after tax) to income due to delays in the Company’s retirement schedule for its J-41 turboprop fleet as a result of uncertainty over the Company’s contractual relationship with United. The Company retired 2 leased J-41 aircraft in April 2003. The charge for these aircraft was recorded in prior years. In the fourth quarter of 2003, the Company retired 2 leased and 1 owned J-41 aircraft. The Company reported an early aircraft retirement charge of $6.9 million for the leased aircraft and an impairment charge of $0.7 million for the owned aircraft. The Company presently anticipates that it will retire all of its J-41 aircraft during 2004 and will record charges upon retirement of each leased J-41 aircraft. The total pre-tax charge for the remaining aircraft will be based on the present value of the future lease obligations and, assuming no remarketing income, is estimated to be approximately $50 million.

     The Company’s net income for 2003 and 2002 includes $1.5 million (pre-tax) and $0.9 million (pre-tax), respectively in government compensation received pursuant to the Air Transportation Safety and System Stabilization Act (“Stabilization Act”).

Operating Revenues

     The Company’s operating revenues increased 15.2% to $876.4 million in 2003 compared to $760.5 million in 2002. The increase was due in part to a 3.4% increase in revenue departures to 292,722 for 2003. The increase in departures reflects the addition of 13 CRJ aircraft in 2003, net of the retirement of 5 J-41 turboprops, and the annualized effect in 2003 of adding 17 CRJ aircraft and 4 328Jet aircraft during 2002. Passenger revenue per departure increased 11.0% to $2,937 for 2003 compared to $2,646 for 2002. The increase in passenger revenue per departure resulted from increased fuel costs for which the Company receives reimbursement under its agreements with United and Delta, increases in the 2003 rates with United and Delta, and increased incentive earnings under its agreements due to improvements in operational performance.

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Operating Expenses

     A summary of operating expenses as a percentage of operating revenue and operating cost per ASM for the years ended December 31, 2002 and 2003 is as follows:

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     The Company’s operating expenses increased 5.8% to $738.5 million or cost per available seat mile (“CASM”) of 15.9 cents in 2003 compared to $697.9 million or CASM of 16.1 cents in 2002. The Company’s operating expenses increased primarily as a result of increased capacity, as available seat miles (ASMs) increased 6.8% to 4.6 billion in 2003 as compared to 4.3 billion in 2002. Operating expenses for 2003 include a credit of $26.9 million for the reversal of the J-41 retirement charges recognized in prior years of $34.6 million offset by current year retirement charges of $6.9 million and impairment charges of $0.7 million. Operating expenses for 2002 included a charge of $24.3 million for aircraft early retirement charges. Operating expenses for 2003 also include $9.6 million pre-tax in costs related to the defense by the Company against a hostile takeover bid and a credit of $1.2 million pre-tax for adjustment to the reserve recorded in 2001 related to the estimated payment to be made by the Company related to its 401K plan. The net effect of these charges and credits was to reduce CASM for 2003 by 0.4 cents and to increase CASM for 2002 by 0.5 cents. CASM changes that are not primarily attributable to the changes in capacity and the items described above are as follows:

     Salaries and related costs per ASM decreased 2.1% to 4.6 cents in 2003 as compared to 4.7 cents in 2002. The decrease is the result of the Company’s elimination of its employee incentive programs and other reductions in payroll costs. In addition, the Company recognized a $1.2 million reduction in costs related to an adjustment of the reserve for correction of operational defects found in the Company’s 401K plan during 2001 based on finalization of its voluntary compliance program application.

     The cost per ASM for aircraft fuel increased 14.8% to 3.1 cents for 2003 compared to 2.7 cents for 2002. The increase is primarily the result of the 16.5% increase in the average cost per gallon of fuel to $1.13 for 2003 from $0.97 for 2002.

     The cost per ASM for maintenance increased 5.9% due primarily to continued increases in maintenance costs on the Company’s fleet of 328Jets resulting from the bankruptcy filing of the manufacturer and the continuing expiration of manufacturer’s warranty on the CRJ fleet.

     The cost per ASM of depreciation and amortization increased 20.0% to 0.6 cents for 2003 from 0.5 cents for 2002. In absolute dollars, depreciation and amortization increased 34.4% to $28.4 million for 2003 from $21.2 million for 2002. The increase is primarily a result of the purchase of eight regional jets during the year, an impairment charge related to the retirement of one owned J-41 aircraft of $0.7 million during the fourth quarter, accelerated depreciation associated with the anticipated early retirement of J-41 aircraft owned by the Company, depreciation expense related to increased levels of rotable equipment required for regional jets, and a full year of depreciation related to the replacement of the Company’s computer software systems in the fourth quarter of 2002.

     The cost per ASM for other operating expenses remained at 2.0 cents for 2003 and 2002. In absolute dollars, other operating expenses in 2003, excluding the $9.6 million costs incurred in the defense of the hostile takeover bid, were $83.2 million or 1.8 cents per ASM. In absolute dollars, other operating expenses in 2002, excluding the $2.6 million bad debt expense for United and the $1.8 million in credits from accrual reversals, were $84.4 million or 1.9 cents per ASM. The decrease in cost per ASM resulted from a reduction in crew traveling and training costs of the Company as fewer planes were delivered in the current year and a reduction in insurance premiums as the Company participated in the FAA insurance program, offset in part by increases in costs related to

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the inclement weather experienced by the Eastern and Midwestern United States during the first quarter of 2003, increases in property taxes, costs incurred in preparation of the Company’s transition to a low-fare carrier business plan, and the $1.0 million payment to Delta to remove contractual restrictions on the use of the Company’s ACJet subsidiary and its operating certificate.

Other Income (Expense)

     Interest expense increased from $4.3 million in 2002 to $6.5 million in 2003. The increase is the result of additional debt incurred related to the delivery of six owned aircraft.

     Interest income decreased 44.9% to $2.5 million in 2003 from $4.6 million in 2002. This decrease is primarily the result of market rates earned on investments made in accordance with the Company’s investment policies, the decision to invest in lower interest rate tax free securities, and the decision to stop recording capitalized interest on aircraft deposits held by the aircraft manufacturers due to uncertainty over actual delivery, partially offset by the Company’s higher cash balances during 2003 as compared to 2002.

     On September 22, 2001, President Bush signed into law the Stabilization Act. The Stabilization Act provides cash grants to commercial air carriers as compensation for (1) direct losses incurred beginning with the terrorist attacks on September 11, 2001 as a result of any FAA mandated ground stop order issued by the Secretary of Transportation (and for any subsequent order which continues or renews such a stoppage), and (2) incremental losses incurred during the period beginning September 11, 2001 and ending December 31, 2001 as a direct result of such attacks. The Company was entitled to receive cash grants under these provisions. The Company received and recorded $1.5 million and $0.9 million in government compensation in 2003 and 2002, respectively, under the provisions of the Stabilization Act. The Company has recognized the cash grants under these provisions as non-operating income under “government compensation” in 2003 and 2002. All amounts received as government compensation are subject to audit and adjustment by the federal government for a period of up to five years.

     The Company recorded a provision for income taxes of $52.5 million for 2003 compared to a provision for income taxes of $25.1 million in 2002. The Company’s effective tax rate was 38.8% in 2003 and 39.0% in 2002. These rates reflect various state income tax credits and continuing changes in apportionment of taxable income to states in which the Company operates. The effective tax rates also reflect non-deductible permanent differences between taxable and book income.

Year ended December 31, 2002 Compared to Year ended December 31, 2001

     Results of Operations

     For 2002, the Company’s net income was $39.3 million or $.85 per diluted share, compared to $34.3 million or $.76 per diluted share for 2001. The Company generated operating income of $62.6 million for 2002 compared to $44.2 million for 2001. These results reflect the Company’s increased capacity as it expanded the number of aircraft operated under its code share agreements with United and Delta as well as the additional items and factors discussed below.

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     The Company’s net income for 2002 includes $0.9 million (pre-tax) in government compensation received pursuant to the Stabilization Act and net income for 2001 includes $9.7 million (pre-tax) for government compensation received under the Stabilization Act. The Company’s net income and operating income for 2002 also reflect the effects of $24.3 (pre-tax) million for J-41 turboprop early retirement charges, $2.6 million (pre-tax) in bad debt expense attributed to the potential write-off of net amounts due from United Airlines as a result of its bankruptcy filing and $1.8 million (pre-tax) in credits from the reversal of accruals from prior periods for estimated expenses under the Company’s code share agreements. Net income and operating income for 2001 also reflects a $23.0 million (pre-tax) operating charge related to the early retirement of J-41 turboprop aircraft.

     Operating Revenues

     The Company’s operating revenues increased 30.4% to $760.5 million in 2002 compared to $583.4 million in 2001. The increase resulted primarily from a 20.1% increase in revenue departures to 283,118 for 2002 as well as an 8.0% increase in revenue per departure to $2,646. Revenue for 2001 also included an additional $3.8 million attributable to routine subsequent period sampling adjustments to prior billed tickets under the Company’s former proration-of-fare arrangement with United that ended on November 30, 2000. The increase in departures reflects the addition of 17 CRJ aircraft and 4 328Jet aircraft in 2002, and the annualized effect in 2002 of adding 19 CRJ aircraft and 15 328Jet aircraft during 2001. Revenue passengers increased 45.0% in 2002 compared to 2001, resulting in an average load factor for the year of 65.2%.

Operating Expenses

     A summary of operating expenses as a percentage of operating revenue and operating cost per ASM for the years ended December 31, 2001 and 2002 is as follows: