SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended: March 31, 2004
or

For the transition period from                     to                    

Commission File Number 0-26582

WORLD AIRWAYS, INC.

The HLH Building, 101 World Drive, Peachtree City, GA 30269
(Address of Principal Executive Offices)

(770) 632-8000
(Registrant’s telephone number, including area code)

     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 Exchange 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  o

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

Yes   o    No  x

     The number of shares of the registrant’s Common Stock outstanding on April 30, 2004 was 11,488,898.

WORLD AIRWAYS, INC.

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

TABLE OF CONTENTS

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ITEM 1. FINANCIAL STATEMENTS

ASSETS
(in thousands)
(unaudited)

(Continued)

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WORLD AIRWAYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(continued)

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY)
(in thousands except share amounts)
(unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements

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WORLD AIRWAYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2004 and 2003
(in thousands except per share data)
(unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements

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WORLD AIRWAYS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES
IN STOCKHOLDERS’ EQUITY (DEFICIENCY)
Three Months Ended March 31, 2004
(in thousands except share amounts)
(unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements

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WORLD AIRWAYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2004 and 2003
(in thousands)
(unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements

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WORLD AIRWAYS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.		Management believes that all adjustments necessary for a fair statement of results have been included in the unaudited Condensed Consolidated Financial Statements for the interim periods presented. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and the results of operations for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004.
		The Condensed Consolidated Balance Sheet for December 31, 2003 is derived from the audited Consolidated Financial Statements included in the Company’s 2003 Form 10-K.
		These interim period Condensed Consolidated Financial Statements and accompanying footnotes should be read in conjunction with the Consolidated Financial Statements contained in World Airways’ Annual Report on Form 10-K for the year ended December 31, 2003.
2.		Earnings per Share
		The following table sets forth the computations of basic and diluted earnings per share (in thousands except per share data):

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At March 31, 2004, the Company had three stock-based compensation plans. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net earnings, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation (in thousands, except per share data):

     The per share weighted-average fair value of stock options granted during the first quarters of 2004 and 2003 was $4.06 and $0.77, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions:

4.		Sub-lease Obligation
		The Company is obligated under an operating lease for office space at its former headquarters in Herndon, Virginia, through April 2006. The Company received rental income, sufficient to offset its lease expense through March 2002, after which time no rental income was received except for a total of $0.4 million received in the fourth quarter of 2003 and the first quarter of 2004. The Company is currently seeking a new sub-lessee for this office space. During the first quarter of 2004, the Company used $0.4 million of the accrual, reviewed its estimates and assumptions at March 31, 2004, and determined that an additional $0.4 million should be added to the accrual, resulting in a $2.0 million balance at March 31, 2004. The fair value of the liability was determined based on the remaining lease rentals, reduced by estimated sublease rentals that can be reasonably obtained for the property. The liability is included in other accrued liabilities on the accompanying consolidated balance sheets. The Company’s total remaining obligation at March 31, 2004 under the lease was $3.3 million.
		If the Company is not successful in finding a suitable sub-lessee in the anticipated time or if the sublease rentals from a new sub-lessee are less than anticipated, the Company will be required to recognize an additional liability for these costs. This liability will be adjusted for changes, if any, resulting from revisions to estimated cash flows, measured using the credit-adjusted risk-free rate of 8% that was initially used to measure the liability.
5.		Union Negotiations
		The Company’s cockpit crewmembers, who constitute approximately 28% of the Company’s employees and are represented by the International Brotherhood of Teamsters (the “Teamsters”), are subject to a collective bargaining agreement that became amendable June 30, 2003. In December 2003, the Company announced that it would begin

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		negotiations with the cockpit crewmembers in January 2004. It also announced that the Teamsters had requested mediation services from the National Mediation Board. In January 2004, the Company and representatives of the Teamsters reached a tentative agreement for a contract extension. However, on February 27, 2004, the Company received notification that the tentative agreement was not ratified by a majority of the Teamsters membership. The Company will reconvene negotiations with the Teamsters at a later date, which has not yet been determined.
6.		Corporate Headquarters
		In March 2004, the company that owned the building containing World Airways’ corporate headquarters, of which World Airways’ former Chairman and CEO is a principal, sold the building to a real estate investment trust. In conjunction with this transaction, the Company executed a new 15-year lease that provides for reduced rental rates and increased flexibility for expansion. Before approving the terms of the new lease, the Company’s Board of Directors retained both an independent outside law firm to provide a comparative analysis as well as a national commercial real estate firm to independently verify that the new lease terms did not have a material incremental financial impact on the Company.
7.		TM Travel Services, Inc.
		The Company entered into a contract with TM Travel Services, Inc. (“TM Travel”) in September 2003, to provide air services between Honolulu, Hawaii, and Las Vegas, Nevada. From the inception of the program, TM Travel did not meet its financial obligations to the Company on a timely basis. In March 2004, the Company and TM Travel entered into an agreement that would have enabled TM Travel to become current in its payments. However, TM Travel failed to make any of these rescheduled payments. Further, the Company was advised by the Department of Transportation (“DOT”) that it was not going to renew TM Travel’s public charter prospectus beyond May 2, 2004. The DOT required World Airways to operate all scheduled flights through that date. For the first quarter of 2004, the Company provided $0.8 million in bad debt expense related to TM Travel. In the second quarter of 2004, the Company will provide an additional $1.7 million in bad debt expense related to revenues generated in the second quarter from this program. In connection with this program, the Company issued a letter of credit, totaling $1.0 million, which was provided to an insurance company to support two surety bonds issued to the DOT and the State of Hawaii. These bonds were necessary for TM Travel to qualify as a public charter operator. These bonds are currently subject to any passenger refunds not paid by TM Travel, and will terminate in the first half of July 2004. No provision for loss has been recorded in the Company’s Condensed Consolidated Financial Statements for any loss that the Company might incur related to these bonds.
8.		Post-Retirement Health Care Benefits Plan
		World Airways’ cockpit crewmembers and eligible dependents are covered by a post-retirement health care benefits plan. A summary of the net periodic post-retirement benefit costs is as follows:

The Company still anticipates to contribute approximately $230,000 to fund its health care obligations in 2004, as was previously disclosed in its financial statements for the year ended December 31, 2003. As of March 31, 2004, $22,175 of contributions has been made.

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ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Part I, Item 2 of this report should be read in conjunction with Part II, Item 7 of World Airways, Inc. (“World Airways” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2003. The information contained herein is not a comprehensive management overview and analysis of the financial condition and results of operations of the Company, but rather updates disclosures made in the aforementioned filing.

The Company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 (the “Act”). Therefore, this report contains forward looking statements that are subject to risks and uncertainties, including, but not limited to, the reliance on key strategic alliances, fluctuations in operating results and other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission (the “Commission”). These risks could cause the Company’s actual results for 2004 and beyond to differ materially from those expressed in any forward looking statements made by, or on behalf of, the Company.

The Financial Accounting Standards Board (“FASB”) issued a revised FASB Interpretation No. 46 (“FIN 46R”), Consolidation of Variable Interest Entities, which took effect in the first quarter of 2004. The Company currently does not have any interests in variable interest entities or special interest entities.

OVERVIEW

General

For the first quarter of 2004, the Company’s earnings before income taxes were $11.6 million compared to $6.6 million for the same period in 2003. The Company recorded income tax expense of $3.7 million in the first quarter of 2004, compared to no income tax expense for the comparable period of last year. The Company utilized all of its unrestricted federal net operating loss carry-forwards in 2003. For the first quarter of 2004, the Company’s net earnings were $7.9 million compared to $6.6 million for 2003.

The following table provides statistical data, used by management in evaluating the operating performance of the Company, for the quarters ended March 31, 2004 and 2003.

For 2004, the Company expects to:

•

be profitable for a third consecutive year;

•

further diversify the revenue mix by adding more commercial customers;

•

on a per block hour basis, hold flat or reduce major cost categories (flight, maintenance, fuel and aircraft costs);

•

work on concluding a new collective bargaining agreement with its pilots; and

•

initiate plans to introduce Boeing 767 aircraft to the fleet in 2005.

Significant Customer Relationships

The Company is highly dependent on revenues from the U.S. Air Force (“USAF”). The loss of the USAF as a customer would have a material adverse effect on the Company. The Company’s largest customers, and the percent of revenues from those customers, for the quarters ended March 31, 2004 and 2003, are as follows:

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RESULTS OF OPERATIONS

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

Operating Revenues. Revenues from operations increased $6.0 million, or 4.8%, to $129.6 million in the first quarter of 2004 from $123.6 million in the first quarter of 2003. The revenue increase in the first quarter of 2004 was due principally to significant growth in both military passenger flying for the USAF and commercial passenger flying. This increase was partially offset by a reduction in military cargo revenue for the USAF. Two key variables that impact the amount of operating revenues are listed below:

     Operating Expenses. Total operating expenses remained flat at $115.9 million for the first quarter of 2004, compared $116.0 million for the comparable quarter in 2003. Below is information on the Company’s operating expense per block hour:

     Flight expenses include all costs related directly to the operation of the aircraft other than maintenance, aircraft rent, insurance and fuel. Also included are expenses related to flight dispatch and flight operations administration. Flight operations expenses increased $6.4 million, or 18.5%, to $40.8 million in the first quarter of 2004 compared to $34.4 million in the same period of 2003. Flight costs were higher primarily due to increases in the following areas:

•

$2.0 million in cockpit crew costs;

•

$2.9 million in flight attendant costs; and

•

$0.8 million in catering costs.

These higher costs are directly attributable to increased military and full-service commercial passenger flights, as well as pilot and flight attendant headcount increases. The first quarter of 2004 included a higher accrual for contractual profit sharing payments to flight employees for the 2004 period, compared to the amount accrued in same quarter of 2003 for that fiscal year.

Maintenance expenses decreased $5.4 million, or 23.1%, to $17.9 million in the first quarter of 2004 compared to $23.2 million in the same period of 2003. In the first quarter of 2004, the Company had decreases in the following areas:

•

$4.5 million in MD-11 engine overhaul expense;

•

$0.8 million in MD-11 landing gear overhaul expense: and

•

$0.5 million in aircraft parts rental.

Much of this decrease is due to the timing of scheduled maintenance checks.

Aircraft costs, which include aircraft rent and insurance, decreased $2.2 million, or 10.2%, to $19.7 million in the first quarter of 2004 compared to $21.9 million in the first quarter of 2003. This decrease was due to the restructuring of several MD-11 leases, as well as the return of an expensive DC-10 cargo aircraft in the first quarter of 2004. This decrease was partially offset by aircraft rents associated with two additional MD-11 passenger aircraft. One aircraft was added at the end of the first quarter of 2003, and the other was added later in the year; both are under power-by-the-hour operating leases.

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Fuel expenses decreased $3.2 million, or 14.8%, to $18.2 million in the first quarter of 2004 from $21.4 million in the first quarter of 2003. The decrease was primarily due to the lower military cargo block hours, compared to the previous year, coupled with the fact that military cargo hours are contractually set at a higher rate per gallon. Fluctuations in the price of fuel did not have a significant impact in the first quarter of 2004 because the Company’s contracts with its customers covered 95% of fuel purchased and thereby limited the Company’s exposure to increases in fuel prices.

Commissions increased $1.6 million to $6.3 million in the first quarter of 2004, compared to $4.7 million in the first quarter of 2003. In the first quarter of 2003, the Company was not required to pay commissions on USAF missions flown during the Civil Reserve Air Fleet (“CRAF”) activation.

Subcontract flying costs increased $1.4 million in the first quarter of 2004. The increase was due to outsourced flights resulting from aircraft out of service for maintenance.

Sales, general and administrative expenses increased $1.5 million, or 16.5%, to $10.3 million in the first quarter of 2004 compared to $8.8 million in the same quarter of 2003. The increase was primarily due to:

•

$0.8 million of bad debt expense associated with air services provided to TM Travel Services, Inc. (“TM Travel”) (see Note 7 of “Notes to the Condensed Consolidated Financial Statements”); and

•

$0.6 million higher wages and benefits due to:

	•		July 2003 salary increases;
	•		increased headcount;
	•		a worker’s compensation accrual adjustment; and
	•		higher profit sharing accrual for the 2004 period.

The Company recorded $3.7 million of income tax expense in the first quarter of 2004. The Company utilized all of its unrestricted federal net operating loss carry-forwards in 2003. The Company’s estimated annual effective tax rate for the three months ended March 31, 2004, was 32%. This effective rate differs from statutory rates due primarily to use of deferred tax assets that were previously offset with a valuation allowance.

LIQUIDITY AND CAPITAL RESOURCES

The Company is highly leveraged. At March 31, 2004, the Company’s current assets were $90.8 million and its current liabilities were $75.5 million. The ratio of the Company’s current assets to its current liabilities (“current ratio”) was 1.2:1. The March 31, 2004 cash balance included $4.7 million of restricted cash, which consisted of $3.7 million as collateral for letters of credit and $1.0 million of prepayments from customers for flights which are scheduled to be flown within 30 days of the balance sheet date. A letter of credit, totaling $1.0 million, was issued on behalf of TM Travel and provided to an insurance company to support two surety bonds issued to the Department of Transportation (“DOT”) and the State of Hawaii. The DOT advised the Company that it was not going to renew TM Travel’s public charter prospectus beyond May 2, 2004. The surety bonds were necessary for TM Travel to qualify as a public charter operator. These bonds are currently subject to any passenger refunds not paid by TM Travel, and will terminate in the first half of July 2004. See Note 7 of “Notes to the Condensed Consolidated Financial Statements”.

In addition, the Company has significant long-term obligations relating to operating leases for aircraft and spare engines. In 2002 and 2001, the Company paid amounts less than its original contractual aircraft rent obligations under agreements with its lessors that amended the terms of the original aircraft lease agreements to provide for the repayment of the unpaid contractual rent obligations. At March 31, 2004, the accrual for unpaid contractual rent obligations was $8.9 million and is included as accrued rent in the current liabilities section of the Consolidated Balance Sheet. During the second quarter of 2004, the Company will repay approximately $7.2 million of this liability based on 2003 net earnings. The remaining $1.7 million of this obligation will be repaid based on a percentage of profits in future years.

Due to its high financial leverage, the Company has the following restrictions:

•

The Company is greatly limited in its ability to obtain additional financing. Its indebtedness outstanding under its $30.0 million term loan supported by a $27.0 million guarantee issued by the Air Transportation Stabilization Board (the “ATSB Loan”) is secured by substantially all of the Company’s assets. In addition, the ATSB Loan contains restrictive provisions that require prepayments in the event the Company sells any significant assets, receives proceeds from future borrowings from other sources or issuances of certain securities, or receives net proceeds from insurance or condemnation.

•

The Company’s ability to fund general corporate requirements, including capital expenditures, may be impaired.

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The Company has substantial obligations to pay principal and interest on its debt and other recurring fixed costs. Further, the Company may be required to prepay portions of the ATSB Loan under various circumstances. Accordingly, the Company may have to use its working capital to fund such payments and other recurring fixed costs instead of funding general corporate requirements.

•

The Company’s ability to respond to competitive developments and adverse conditions may be limited. With a restricted ability to obtain additional financing and with substantial fixed costs, the Company may not be able to fund the capital expenditures required to keep it competitive or to withstand prolonged adverse economic conditions.

The ATSB Loan and the operating leases relating to some of the Company’s aircraft contain restrictive covenants that impose significant operating and financial restrictions on the Company. Under the agreement governing the ATSB Loan, the Company is subject to certain covenants pursuant to which it must satisfy various financial requirements to maintain a certain amount of unrestricted cash or cash equivalents and to comply with certain financial ratios as well as certain negative covenants.

These restrictions and requirements may limit the Company’s financial and operating flexibility. In addition, if the Company fails to comply with these restrictions or to satisfy the related covenant requirements, its obligations under the ATSB Loan and its operating leases may be accelerated. The Company cannot provide assurance that it could satisfy all of these obligations upon acceleration. The failure to satisfy these obligations would materially adversely affect the Company’s business, operations and financial results.

Other items that will impact cash requirements of the Company in 2004 are:

•

The Company’s earnings will be fully subject to income taxes, with the exception of an annual net operating loss carry-forward benefit of $343,000.

•

The Company will be paying 2003 profit sharing bonuses of approximately $6.5 million to its employees in the first half of 2004.

Although there can be no assurances, World Airways believes that the combination of its existing contracts and additional business which it expects to obtain, along with its existing cash, and financing arrangements, will be sufficient to allow the Company to meet its cash requirements related to operating and capital requirements for 2004.

Cash Flows from Operating Activities

Operating activities provided $11.7 million in cash during the three months ended March 31, 2004 compared to providing $2.6 million for the comparable 2003 period. The cash provided in the 2004 period principally reflects the $7.9 million net earnings offset by a $6.9 million increase in accounts receivable, plus an $8.1 million increase in cash due to changes in other operating assets and liabilities, and net non-cash statement of operations charges of $2.6 million. The cash provided in the 2003 period principally reflects the $6.6 million net earnings, offset by a $10.2 million increase in accounts receivable, plus a $5.0 million increase in cash due to changes in other operating assets and liabilities, and net non-cash income statement charges of $1.1 million.

Cash Flows from Investing Activities

Investing activities used $0.5 million in the first three months of 2004 compared to using $1.1 million in the comparable period of 2003. In both 2004 and 2003, cash was used for the purchase of rotable spare parts and other fixed assets.

The Company’s capital expenditures for 2004 are expected to be approximately $3.0 million, principally for the purchase of aircraft related assets, which it expects to finance from working capital.

Cash Flows from Financing Activities

Financing activities used $18.5 million in cash for the three months ended March 31, 2004, which was primarily due to the $18.0 million used to pay the principal on the convertible bonds that were called on December 30, 2003, and redeemed on January 28, 2004. For the three months ended March 31, 2003, financing activities used $6.2 million, which was primarily due to a reduction in the amount owed under the Loan and Security Agreement with Wells Fargo Foothill, Inc. of $3.4 million and deferred aircraft rent payments of $2.9 million.

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ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Part I, Item 3, of this report should be read in conjunction with Part II, Item 7a of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The information contained herein is not a quantitative and qualitative discussion about market risk the Company faces, but rather updates disclosures made in the aforementioned filing.

World Airways continues to have no material exposure to market risks.

ITEM 4.	CONTROLS AND PROCEDURES

The Company’s management, with participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter ended March 31, 2004. Based on that evaluation, (i) the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the end of the quarter ended March 31, 2004 have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and (ii) no changes in the Company’s internal control over financial reporting were identified as having occurred during the quarter ended March 31, 2004, that have materially affected or are reasonably likely to materially affect the Company’s internal controls over financial reporting. The Company believes that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

PART II

ITEM 6.	EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) Exhibits

(b) Reports on Form 8-K

1.

The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission on January 16, 2004 in connection with a press release issued on January 16, 2004, announcing that it had reached a tentative agreement with the International Brotherhood of Teamsters for an extension of an agreement covering its cockpit crewmembers.

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	2.		The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission on January 21, 2004, announcing the closing of a $30.0 million term loan supported by a $27.0 million federal guarantee from the Air Transportation Stabilization Board (the “ATSB”), the termination of the Company’s existing credit facility with Wells Fargo Foothill, Inc., the issuance to the ATSB of warrants to purchase an aggregate of 2,378,223 shares of the Company’s common stock, the issuance of $25.5 million aggregate principal amount of the Company’s new convertible debentures in exchange for $22.5 million aggregate principal amount of the Company’s existing convertible debentures and $3.0 million in cash, and the redemption of $18.0 million aggregate principal amount of the existing debentures.
	3.		The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission on February 3, 2004 in connection with a press release issued on February 2, 2004, announcing the extension of an existing contract with Menlo Worldwide (formerly Emery Worldwide) valued at approximately $19 million, through December 2004.
	4.		The Company furnished a Current Report on Form 8-K to the Securities and Exchange Commission on February 5, 2004 in connection with a press release issued on February 5, 2004, announcing its financial results for the fourth quarter and the year ended December 31, 2003.
	5.		The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission on February 9, 2004 in connection with a press release issued on February 6, 2004, announcing that its Board of Directors had approved a revised fleet plan as part of the Company’s five-year strategic plan.
	6.		The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission on February 18, 2004 in connection with a press release issued on February 18, 2004, announcing the signing of a new one-year agreement with EVA Airways commencing March 6, 2004.
	7.		The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission on February 19, 2004 in connection with a press release issued on February 19, 2004, announcing the succession plan approved by the Board of Directors, with the upcoming retirement of Hollis Harris, Chairman and Chief Executive Officer.

* * * * * * * * * * * * * * *

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.