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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549


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)

Delaware
    
    13-3621051(State of incorporation)
    
    (IRS Employer
Identification No.)45200 Business Court, Dulles, Virginia
    
    20166(Address of principal executive offices)
    
    (Zip Code)


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.

Documents Incorporated by Reference
    
    Part of Form 10-KProxy Statement for 2004 Annual Meeting of Shareholders
    
    Part III, Items 10-14


(to be filed subsequently)





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Table of Contents

Forward Looking
StatementsPART IItem 1.
    
    BusinessOverviewExisting Code Share AgreementsIndependence AirAgreements with Other AirlinesCharter OperationsFleet DescriptionEmployeesPilot TrainingCompetitionIndustry Regulation and Airport AccessRisk Factors Affecting the CompanyRisk Factors Affecting the Airline IndustryInternet WebsiteItem 2.
    
    PropertiesItem 3.
    
    Legal ProceedingsItem 4.
    
    Submission of Matters to a Vote of Security HoldersPART  IIItem 5.
    
    Market for Registrants Common Equity and Related Stockholder MattersItem 6.
    
    Selected Financial DataItem 7.
    
    Managements Discussion and Analysis of Results of Operations and Financial ConditionGeneralResults of OperationsOutlookLiquidity and Capital ResourcesCritical Accounting Policies and EstimatesItem 7A.
    
    Quantitative and Qualitative Disclosures About Market RiskItem 8.
    
    Consolidated Financial StatementsIndependent Auditors ReportConsolidated Balance SheetsConsolidated Statements of OperationsConsolidated Statements of Stockholders EquityConsolidated Statements of Cash FlowsNotes to Consolidated Financial StatementsItem 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial DisclosuresItem 9A.
    
    Controls and ProceduresPART IIIItem 10.
    
    Directors and Executive Officers of the RegistrantItem 11.
    
    Executive CompensationItem 12.
    
    Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder MattersItem 13.
    
    Certain Relationships and Related TransactionsItem 14.
    
    Principal Auditor Fees and ServicesPART IVItem 15.
    
    Exhibits, Financial Statement Schedules and Reports on Form 8-KSignatures






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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:

Classification
    
    Full-Time
    
    Part-TimePilots
    
    
    1,287
    
    
    
    Flight attendants
    
    
    585
    
    
    
    Station personnel
    
    
    706
    
    
    
    335Maintenance personnel
    
    
    478
    
    
    
    2Management, administrative and
clerical personnel
    
    
    695
    
    
    
    24Total employees
    
    
    3,751
    
    
    
    361


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:



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



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



| |  |  | choose new markets successfully;
| | - |  | --------------------------------



| |  |  | secure favorable terms with airports, suppliers and other contractors;
| | - |  | ----------------------------------------------------------------------



| |  |  | maintain adequate control over our expenses;
| | - |  | --------------------------------------------



| |  |  | monitor and manage major operational and financial risks;
| | - |  | ---------------------------------------------------------



| |  |  | obtain and maintain necessary regulatory approvals;
| | - |  | ---------------------------------------------------



| |  |  | attract, retain and motivate qualified personnel;
| | - |  | -------------------------------------------------



| |  |  | finance the necessary capital investments;
| | - |  | ------------------------------------------



| |  |  | maintain the safety and security of our operations; and
| | - |  | -------------------------------------------------------



| |  |  | 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:



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



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



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



| |  |  | 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

22



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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:



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



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



| |  |  | 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:



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



| |  |  | delays in meeting the agreed upon aircraft delivery
schedule;
| | - |  | -------------------------------------------------------------



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



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



| |  |  | 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

26



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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

27



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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:

Total Number of
    
    Number of Aircraft
    
    Number of Aircraft
    
    
    
    
    
    Average Age inAircraft
    
    Leased
    
    Owned
    
    Passenger Capacity
    
    Years
    
    Aircraft on Order
    
    OptionsBombardier CRJ200
    
    
    87
    
    
    
    75
    
    
    
    12
    
    
    
    50
    
    
    
    3.1
    
    
    
    34
    
    
    
    80Fairchild Dornier 328Jet
    
    
    33
    
    
    
    32
    
    
    
    1
    
    
    
    32
    
    
    
    3.0
    
    
    
    
    
    
    
    British Aerospace J-41
    
    
    24
    
    
    
    20
    
    
    
    4
    
    
    
    29
    
    
    
    9.2
    
    
    
    
    
    
    
    Airbus A319/A320
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    132/156
    
    
    
    
    
    
    
    25
    
    
    
    50144
    
    
    
    127
    
    
    
    17
    
    
    
    
    
    
    
    4.1
    
    
    
    59
    
    
    
    130


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:

High
    
    Low2002First quarter
    
    $
    29.21
    
    
    $
    23.05Second quarter
    
    $
    24.31
    
    
    $
    19.57Third quarter
    
    $
    19.61
    
    
    $
    8.69Fourth quarter
    
    $
    17.03
    
    
    $
    8.30


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High
    
    Low2003First quarter
    
    $
    14.54
    
    
    $
    5.50Second quarter
    
    $
    13.31
    
    
    $
    6.38Third quarter
    
    $
    11.16
    
    
    $
    7.02Fourth quarter
    
    $
    12.68
    
    
    $
    8.542004First quarter (through February 9)
    
    $
    10.17
    
    
    $
    8.28


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)

Consolidated Financial Data:
    
    Years ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003Operating revenues:Passenger
    
    $
    342,079
    
    
    $
    442,695
    
    
    $
    577,604
    
    
    $
    749,103
    
    
    $
    859,659Other
    
    
    5,286
    
    
    
    9,831
    
    
    
    5,812
    
    
    
    11,421
    
    
    
    16,752Total operating revenues
    
    
    347,365
    
    
    
    452,526
    
    
    
    583,416
    
    
    
    760,524
    
    
    
    876,411Operating expenses:Salaries and related costs
    
    
    84,554
    
    
    
    107,831
    
    
    
    164,446
    
    
    
    203,341
    
    
    
    211,823Aircraft fuel
    
    
    34,072
    
    
    
    64,433
    
    
    
    88,308
    
    
    
    115,801
    
    
    
    144,618Aircraft maintenance and materials
    
    
    24,357
    
    
    
    36,750
    
    
    
    48,478
    
    
    
    72,233
    
    
    
    85,701Aircraft rentals
    
    
    45,215
    
    
    
    59,792
    
    
    
    90,323
    
    
    
    112,068
    
    
    
    128,824Traffic commissions and related fees
    
    
    54,521
    
    
    
    56,623
    
    
    
    15,589
    
    
    
    19,994
    
    
    
    22,838Facility rents and landing fees
    
    
    17,875
    
    
    
    20,284
    
    
    
    32,025
    
    
    
    43,805
    
    
    
    51,111Depreciation and amortization
    
    
    9,021
    
    
    
    11,193
    
    
    
    15,353
    
    
    
    21,155
    
    
    
    28,424Other
    
    
    28,458
    
    
    
    42,537
    
    
    
    61,674
    
    
    
    85,163
    
    
    
    92,823Aircraft early retirement charges (1)
    
    
    
    
    
    
    28,996
    
    
    
    23,026
    
    
    
    24,331
    
    
    
    (27,654
    )Total operating expenses
    
    
    298,073
    
    
    
    428,439
    
    
    
    539,222
    
    
    
    697,891
    
    
    
    738,508Operating income
    
    
    49,292
    
    
    
    24,087
    
    
    
    44,194
    
    
    
    62,633
    
    
    
    137,903Other (expense) income :Interest expense
    
    
    (5,614
    )
    
    
    (6,030
    )
    
    
    (4,832
    )
    
    
    (4,332
    )
    
    
    (6,502
    )Interest income
    
    
    3,882
    
    
    
    5,033
    
    
    
    7,500
    
    
    
    4,628
    
    
    
    2,549Government compensation (2)
    
    
    
    
    
    
    
    
    
    
    9,710
    
    
    
    944
    
    
    
    1,520Other income (expense), net
    
    
    (85
    )
    
    
    (278
    )
    
    
    263
    
    
    
    552
    
    
    
    (220
    )Total other (expense) income, net
    
    
    (1,817
    )
    
    
    (1,275
    )
    
    
    12,641
    
    
    
    1,792
    
    
    
    (2,653
    )Income before income tax expense and cumulative
effect of accounting change
    
    
    47,475
    
    
    
    22,812
    
    
    
    56,835
    
    
    
    64,425
    
    
    
    135,250Income tax provision
    
    
    18,319
    
    
    
    7,657
    
    
    
    22,513
    
    
    
    25,139
    
    
    
    52,452Income before cumulative effect of accounting change
    
    
    29,156
    
    
    
    15,155
    
    
    
    34,322
    
    
    
    39,286
    
    
    
    82,798Cumulative effect of accounting change, net (3)
    
    
    (888
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    -Net income
    
    $
    28,268
    
    
    $
    15,155
    
    
    $
    34,322
    
    
    $
    39,286
    
    
    $
    82,798


37



---



##### 



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

Years ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003Income per share:Basic:Income before cumulative effect of
accounting change
    
    $
    .77
    
    
    $
    .38
    
    
    $
    .79
    
    
    $
    .87
    
    
    $
    1.83Cumulative effect of accounting change
    
    
    (.02
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    -Net income per share (4)
    
    $
    .75
    
    
    $
    .38
    
    
    $
    .79
    
    
    $
    .87
    
    
    $
    1.83Diluted:Income before cumulative effect of
accounting change
    
    $
    .68
    
    
    $
    .36
    
    
    $
    .76
    
    
    $
    .85
    
    
    $
    1.82Cumulative effect of accounting change
    
    
    (.02
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    -Net income per share (4)
    
    $
    .66
    
    
    $
    .36
    
    
    $
    .76
    
    
    $
    .85
    
    
    $
    1.82Weighted average number of shares used
in computation (in thousands) (4)Basic
    
    
    37,928
    
    
    
    40,150
    
    
    
    43,434
    
    
    
    45,047
    
    
    
    45,285Diluted
    
    
    44,030
    
    
    
    43,638
    
    
    
    45,210
    
    
    
    46,019
    
    
    
    45,398Selected Operating Data:Revenue departures (completed)
    
    
    186,571
    
    
    
    199,050
    
    
    
    235,794
    
    
    
    283,118
    
    
    
    292,722Revenue passengers carried
    
    
    3,234,713
    
    
    
    3,778,811
    
    
    
    4,937,208
    
    
    
    7,160,480
    
    
    
    8,415,824Revenue passenger miles (000s) (5)
    
    
    1,033,912
    
    
    
    1,271,273
    
    
    
    1,895,152
    
    
    
    2,833,155
    
    
    
    3,325,979Available seat miles (000s) (6)
    
    
    1,778,984
    
    
    
    2,203,839
    
    
    
    3,292,798
    
    
    
    4,345,860
    
    
    
    4,640,679Passenger load factor (7)
    
    
    58.1
    %
    
    
    57.7
    %
    
    
    57.6
    %
    
    
    65.2
    %
    
    
    71.7
    %Revenue per available seat mile
    
    $
    0.195
    
    
    $
    0.205
    
    
    $
    0.177
    
    
    $
    0.175
    
    
    $
    0.189Cost per available seat mile (8)
    
    $
    0.168
    
    
    $
    0.194
    
    
    $
    0.164
    
    
    $
    0.161
    
    
    $
    0.159Average
yield per revenue passengermile (9)
    
    $
    0.331
    
    
    $
    0.348
    
    
    $
    0.305
    
    
    $
    0.264
    
    
    $
    0.258Average passenger trip length (miles)
    
    
    320
    
    
    
    336
    
    
    
    384
    
    
    
    396
    
    
    
    395Revenue per departure (10)
    
    $
    1,851
    
    
    $
    2,231
    
    
    $
    2,452
    
    
    $
    2,646
    
    
    $
    2,937Aircraft utilization (block hours)
    
    
    8.6
    
    
    
    7.8
    
    
    
    8.1
    
    
    
    8.8
    
    
    
    8.0Average cost per gallon of fuel (cents)
    
    
    74.6
    
    
    
    111.1
    
    
    
    98.4
    
    
    
    97.0
    
    
    
    112.9Aircraft in service (end of period)
    
    
    84
    
    
    
    105
    
    
    
    117
    
    
    
    137
    
    
    
    145Destinations served (end of period)
    
    
    51
    
    
    
    53
    
    
    
    64
    
    
    
    84
    
    
    
    85Consolidated Balance Sheet Data:Working capital
    
    $
    60,440
    
    
    $
    72,018
    
    
    $
    138,659
    
    
    $
    197,631
    
    
    $
    270,849Total assets
    
    
    293,753
    
    
    
    382,700
    
    
    
    452,425
    
    
    
    575,138
    
    
    
    783,244Long-term debt and capital leases, less
current
portion
    
    
    92,787
    
    
    
    67,089
    
    
    
    60,643
    
    
    
    54,291
    
    
    
    134,327Total stockholders equity
    
    
    125,524
    
    
    
    168,173
    
    
    
    221,300
    
    
    
    275,368
    
    
    
    359,414




---

|1. |  | In 2003, the Company recorded an operating credit totaling $27.7 million
($16.9 million net of income tax) for the early retirement of J-41
turboprop aircraft. The $27.7 million credit included a reversal of $34.6
million in pretax early aircraft retirement charges that had been recorded
in prior periods, and $6.9 million of early retirement charges represents
the present value of future lease and other costs associated with the
retirement of 2 leased J-41 turboprop aircraft during the fourth quarter
2003. In 2002, the Company recorded an operating charge of $24.5 million
($14.8 million net of income tax benefits) for the non-discounted value of
future lease and other costs associated with the early retirement of 18
J-41 turboprop aircraft. In the second quarter of 2002 the Company
revised the retirement schedule for its leased J-41s. Included in the
operating charge for 2002 was a credit of $4.8 million ($2.9 million net
of income
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

38



---



##### 



|    |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

39



---



##### 



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.

40



---



##### 



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.

41



---



##### 



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:

Year Ended December 31,2002
    
    2003Percent of
    
    Cost
    
    Percent of
    
    CostOperating
    
    Per ASM
    
    Operating
    
    Per ASMRevenues
    
    (cents)
    
    Revenues
    
    (cents)Salaries and related costs
    
    
    26.8
    %
    
    
    4.7
    
    
    
    24.2
    %
    
    
    4.6Aircraft fuel
    
    
    15.2
    %
    
    
    2.7
    
    
    
    16.5
    %
    
    
    3.1Aircraft maintenance and materials
    
    
    9.5
    %
    
    
    1.7
    
    
    
    9.8
    %
    
    
    1.8Aircraft rentals
    
    
    14.7
    %
    
    
    2.6
    
    
    
    14.7
    %
    
    
    2.8Traffic commissions and related fees
    
    
    2.6
    %
    
    
    0.4
    
    
    
    2.6
    %
    
    
    0.5Facility rents and landing fees
    
    
    5.8
    %
    
    
    1.0
    
    
    
    5.8
    %
    
    
    1.1Depreciation and amortization
    
    
    2.8
    %
    
    
    0.5
    
    
    
    3.2
    %
    
    
    0.6Other
    
    
    11.2
    %
    
    
    2.0
    
    
    
    10.6
    %
    
    
    2.0Aircraft early retirement charge
    
    
    3.2
    %
    
    
    0.5
    
    
    
    (3.1
    %)
    
    
    (0.6
    )Total
    
    
    91.8
    %
    
    
    16.1
    
    
    
    84.3
    %
    
    
    15.9


42



---



##### 



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

43



---



##### 



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.

44



---



##### 



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:

Year Ended December 31,2001
    
    2002Percent of
    
    Cost
    
    Percent of
    
    CostOperating
    
    Per ASM
    
    Operating
    
    Per ASMRevenues
    
    (cents)
    
    Revenues
    
    (cents)Salaries and related costs
    
    
    28.2
    %
    
    
    5.0
    
    
    
    26.8
    %
    
    
    4.7Aircraft fuel
    
    
    15.1
    %
    
    
    2.7
    
    
    
    15.2
    %
    
    
    2.7Aircraft maintenance and materials
    
    
    8.3
    %
    
    
    1.5
    
    
    
    9.5
    %
    
    
    1.7Aircraft rentals
    
    
    15.5
    %
    
    
    2.7
    
    
    
    14.7
    %
    
    
    2.6Traffic commissions and related fees
    
    
    2.7
    %
    
    
    0.5
    
    
    
    2.6
    %
    
    
    0.4Facility rents and landing fees
    
    
    5.5
    %
    
    
    1.0
    
    
    
    5.8
    %
    
    
    1.0Depreciation and amortization
    
    
    2.6
    %
    
    
    0.4
    
    
    
    2.8
    %
    
    
    0.5Other
    
    
    10.6
    %
    
    
    1.9
    
    
    
    11.2
    %
    
    
    2.0Aircraft early retirement charge
    
    
    3.9
    %
    
    
    0.7
    
    
    
    3.2
    %
    
    
    0.5Total
    
    
    92.4
    %
    
    
    16.4
    
    
    
    91.8
    %
    
    
    16.1


The Companys operating expenses increased 29.4% to $697.9 million or cost
per available seat mile (CASM) of 16.1 cents in 2002 compared to $539.2
million or CASM of 16.4 cents in 2001. The Companys operating expenses
increased primarily as a result of increased capacity, as available seat miles
(ASMs) increased 32% to 4.3 billion in 2002 as compared to 3.3 billion in 2001.
Operating expenses included $24.3 million and $23.0 million aircraft early
retirement charges in 2002 and 2001, respectively. Operating expenses for 2002
also included $2.6 million pre-tax in bad debt expense attributed to the
potential write-off of net amounts due from United Airlines

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as a result of its bankruptcy filing in 2002, and $1.8 million pre-tax
credits from the reversal in 2002 of accruals from prior periods for estimated
expenses under the Companys code share agreements. The net effect of these
charges and credits was to increase CASM for 2002 by 0.5 cents and to increase
CASM for 2001 by 0.7 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 6% to 4.7 cents in 2002 as
compared to 5.0 cents in 2001. The Company suspended its cash employee bonus
plans during the first quarter of 2002 due to the events of September 11, 2001.
The Company reinstated its cash bonus plans effective April 1, 2002.

The cost per ASM for maintenance increased 13.3% due primarily to
increased maintenance costs on the Companys fleet of 328Jets due to the
bankruptcy filing of the manufacturer, the continuing expiration of
manufacturers warranty on the CRJ fleet, and increased cost accruals for
amounts which are being claimed by GE under a power-by-the-hour agreement for
certain engine repair work.

The cost per ASM for other operating expenses increased to 2.0 cents for
2002 compared to 1.9 cents for 2001. In absolute dollars, other operating
expenses, excluding the $2.6 million bad debt expense for United and the $1.8
million in credits from accrual reversals, increased 35.3% from $61.7 million
in 2001 to $84.4 million in 2002. The increased dollar costs result primarily
from additional property taxes, higher insurance costs associated with the
terrorist acts, increased legal costs related to the Fairchild Dornier and
United Airlines bankruptcies, and increased training costs.

Other Income (Expense)

Interest expense decreased from $4.8 million in 2001 to $4.3 million in
2002. The decrease is the result of reductions of overall debt levels as the
Company paid down existing debt on owned aircraft.

Interest income decreased 38.3% to $4.6 million in 2002 from $7.5 million
in 2001. This decrease is primarily the result of market rates earned on
investments made in accordance with the Companys investment policies and the
decision to invest in lower interest rate tax free securities, partially offset
by the Companys higher cash balances during 2002 as compared to 2001.

The Company was entitled to receive cash grants under provisions of the
Stabilization Act, as described above. The Company received and recorded $0.9
million and $9.7 million in government compensation in 2002 and 2001
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 2002 and 2001. 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 $25.1 million for
2002, compared to a provision for income taxes of $22.5 million in 2001. The
Companys effective tax rate was 39.0% in 2002 and 39.6% in 2001. These rates
reflect various state income tax credits and

46



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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.

Outlook

The Company expects to begin operation of its low-fare airline,
Independence Air, during 2004. The timing and terms of the Companys
commencement of operations as Independence Air depend, among other things, on
the terms and timing of its disengagement as a United Express carrier, which
cannot be projected at this time. If United were to affirm the existing code
share agreement with the Company, the Company would continue to pursue its
plans to operate Independence Air 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. The Company expects that first quarter operating
results relative to operating results for the fourth quarter for 2003 may be
affected by reduced aircraft utilization and reduced operational performance in
the Companys United Express operations at Chicago OHare International Airport
due to high traffic congestion and United-controlled cancellation and delays of
flights and in the Companys Delta Connection operation due to schedule
adjustments necessary to accommodate maintenance on the engines of its 328Jets.
In 2004, other operating expenses and capital expenditures will also be
affected by increased expenditures that the Company incurs in preparation of
the commencement of operations of Independence Air and by professional fees.
The Company may incur unexpected expenses in connection with any termination of
its United Express and/or Delta Connection code-share operations. 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. The Companys past financial
performance and operating results under its United Express and Delta Connection
operations will have no effect and no bearing on the financial performance or
operating results of Independence Air.

Liquidity and Capital Resources

As of December 31, 2003, the Company had cash, cash equivalents, and
short-term investments of $297.9 million and working capital of $270.8 million
compared to $242.6 million and $197.6 million, respectively, as of December 31,
2002. During the year ended December 31, 2003, cash and cash equivalents
increased $66.6 million, reflecting net cash provided by operating activities
of $99.5 million, net cash used in investing activities of $85.5 million mainly
for property and equipment, and net cash provided by financing activities of
$52.6 million. Net cash provided by financing activities was mainly related to
proceeds from issuance of long term debt incurred in financing aircraft
purchased during the year less amounts paid during the year for existing and
this new aircraft debt.

As of December 31, 2002, the Company had cash, cash equivalents, and
short-term investments of $242.6 million and working capital of $197.6 million
compared to $181.0 million and $138.7 million, respectively, as of December 31,
2001. During the year ended December 31, 2002, cash and cash equivalents
decreased $144.4 million, reflecting net cash provided by operating activities
of $106.8 million, net cash used in investing activities of $252.1 million
(primarily the results of the net increase in short term investments of $206.1
million and purchases of property and equipment of $35.7 million) and net cash
provided by financing activities of $0.8 million. Net cash

47



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provided by financing activities was mainly related to proceeds from
exercise of stock options.

Capital Commitments and Off Balance Sheet Arrangements

The Companys business is very capital intensive, requiring significant
amounts of capital to fund the acquisition of assets, particularly aircraft.
The Company historically has funded the acquisition of its aircraft 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 the
Company. The Company has entered into memoranda of understanding for the lease
of 10 Airbus A319 aircraft and the purchase of 15 Airbus A319 or A320 aircraft.
The 10 leased aircraft will be obtained from traditional aircraft lessors on
operating leases with terms ranging from five to twelve years. The Company
also often enters into long-term lease commitments to ensure access to
terminal, cargo, maintenance and other similar facilities. As can be seen in
the table below setting forth information as of December 31, 2003, these
operating lease commitments, including amounts to be due for the Airbus
aircraft which are subject to execution of definitive lease and purchase
agreements, are significant.

(in millions)
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    TotalLong term debt
    
    $
    8.9
    
    
    $
    37.7
    
    
    $
    8.7
    
    
    $
    8.4
    
    
    $
    10.5
    
    
    $
    68.7
    
    
    $
    142.9Capital lease obligations
    
    
    .2
    
    
    
    .2
    
    
    
    .1
    
    
    
    .1
    
    
    
    
    
    
    
    
    
    
    
    .6Guaranteed simulator usage commitments
    
    
    1.4
    
    
    
    1.2
    
    
    
    1.2
    
    
    
    1.2
    
    
    
    1.2
    
    
    
    2.5
    
    
    
    8.7Operating lease commitments(1)
    
    
    158.8
    
    
    
    185.8
    
    
    
    187.2
    
    
    
    180.2
    
    
    
    169.2
    
    
    
    1,229.9
    
    
    
    2,111.1Aircraft purchase commitments (1&2)
    
    
    120.0
    
    
    
    910.0
    
    
    
    200.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,230.0Other purchase commitments
    
    
    6.7
    
    
    
    .4
    
    
    
    .6
    
    
    
    .9
    
    
    
    1.2
    
    
    
    .9
    
    
    
    10.7Total contractual capital commitments
    
    $
    296.0
    
    
    $
    1,135.3
    
    
    $
    397.8
    
    
    $
    190.8
    
    
    $
    182.1
    
    
    $
    1,302.0
    
    
    $
    3,504.0




---

|1. |  | Includes estimated amounts to be due for the 25 Airbus narrowbody
aircraft which are subject to execution of definitive lease or purchase
agreements.                                                                                                
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Includes commitments for 34 CRJ aircraft which are 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.

Also see Note 4 Debt, Note 5 Obligations Under Capital Leases, Note 6
Operating Leases, Note 10 Commitments and
Contingencies, and Note 17 Recent Accounting
Pronouncements
in the Notes to
Consolidated Financial Statements for additional discussion of these items and off balance sheet arrangements.
During the year ended December 31, 2003, the Company accepted deliveries of 13
CRJs, five of which were leveraged lease transactions, six were purchased with
debt financing, and two were purchased outright by the Company.

The Company also has a variety of other long-term contractual commitments
that are of a nature that, under accounting principles generally accepted in
the United States, are not required to be reflected on the Companys balance
sheet, and that are not generally viewed as off-balance sheet financing
arrangements, such as commitments for major overhaul maintenance on the
Companys aircraft, and pilot training. See Liquidity and Capital Resources 
Other Commitments below and Business  Pilot Training above, and Note 1
Summary of Accounting Policies  (k) Maintenance and Note 10 Commitments and
Contingencies  Training in the Notes to Consolidated Financial Statements for
additional discussion of these items.

48



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##### 



Other Financing

On September 28, 2001, the Company entered into an asset-based lending
agreement with Wachovia Bank, N.A. (Wachovia) that initially provided the
Company with a line of credit for up to $25.0 million. Under the terms of the
line of credit, it was necessary for the Company to request a covenant waiver
as a result of the Chapter 11 bankruptcy filing by United Airlines. In order
to obtain this waiver, the Company agreed to reduce the size of the line of
credit to $17.5 million and to revise certain covenants. On July 31, 2003, the
Company entered into a new agreement with Wachovia which replaced the line of
credit. This new agreement, which has no expiration date, provides for the
issuance of letters of credit, and is collateralized by certificates of
deposit. Under this agreement, the Company has $14.8 million on deposit with
Wachovia as collateral for letters of credit issued on behalf of the Company.
The amounts on deposit with Wachovia are shown as restricted cash on the
Companys balance sheet as of December 31, 2003.

In September 1997, approximately $112 million of pass through certificates
were issued in a private placement by separate pass through trusts, which
purchased with the proceeds, equipment notes (the Equipment Notes) issued in
connection with (i) leveraged lease transactions relating to four J-41s and six
CRJs, all of which were leased to the Company (the Leased Aircraft), and (ii)
the financing of four J-41s owned by the Company (the Owned Aircraft). The
Equipment Notes issued with respect to the Owned Aircraft are direct
obligations of ACA, guaranteed by ACAI and are included as debt obligations in
the accompanying consolidated financial statements and in the table above. The
Equipment Notes issued with respect to the Leased Aircraft are not obligations
of ACA or guaranteed by ACAI.

Aircraft

The Company has significant lease obligations for aircraft that are
classified as operating leases and, therefore, are not reflected as liabilities
on the Companys balance sheet. The remaining terms of such leases range from
one to sixteen and three quarters years. The Companys total rent expense in
2003 under all non-cancelable aircraft operating leases was approximately
$128.8 million. As of December 31, 2003, the Companys minimum annual rental
payments for 2004 under all non-cancelable aircraft operating leases with
remaining terms of more than one year were approximately $147.3 million. In
order to minimize the total aircraft rental expense over the entire life of the
related aircraft leveraged lease transactions, the Company has uneven
semiannual lease payment dates of January 1 and July 1 for its CRJ and 328Jet
aircraft. Approximately 73% of the Companys annual lease payments for its CRJ
and 328Jet aircraft are due in January and 24% are due in July. As such, the
Company made lease payments for its CRJ and 328Jet aircraft totaling $97.2
million in January 2004.

As of February 15, 2004, the Company had firm orders for 34 Bombardier
CRJ200s (CRJs) in addition to the 87 previously delivered, and options for 80
additional CRJs. Due to the United bankruptcy, the effect of the war with
Iraq, and the state of the financing markets, the Company entered into an
agreement with Bombardier during the second quarter of 2003 regarding financing
assistance and aircraft delivery schedules. Under the revised agreement, the
Company took delivery of six CRJs in May 2003 and two CRJs in October 2003.
The Company also has future commitments for six CRJs to be delivered in late
2004 and 28 CRJs to be delivered in 2005. These post-2003 commitments are
subject to certain conditions which, unless waived by the Company,

49



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##### 



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 the Company by April 2005, deposits
and progress payments for any then undelivered aircraft would be first used to
repay any outstanding debt on the 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.

In November 2003, the Company signed Memoranda of Understanding (MOUs)
for the lease of ten Airbus A319 aircraft from two separate operating lessors
and the purchase of 15 A319 and/or A320 aircraft directly from an affiliate of
the manufacturer. The Company has finalized the lease agreements for four of
the A319 aircraft and is currently negotiating the final lease and purchase
agreements for the remaining aircraft. 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. The
Company has the option to convert the A320 aircraft orders into orders for five
A319 aircraft at the option of the Company with certain notice required prior
to delivery. The ten leased aircraft will be delivered under operating leases
with initial lease terms ranging from five to twelve years. These operating
leases will require the Company to place security deposits with the lessors,
of which the Company has already placed $3.4 million, and
to make monthly rent and airframe and engine maintenance reserve payments to
the lessors. The 15 aircraft being purchased directly from an affiliate the
manufacturer will require progress payment deposits to be made to said
affiliate prior to delivery that will peak at $121.5 million, for which the
Company has arranged financing for $37.5 million. The Company has made
deposits totaling $1.5 million to date. The 15 aircraft also have backstop
financing being provided by the manufacturer if the Company is unable to secure
commercial financing or sale-leaseback financing under certain conditions. As
part of the Airbus order, the Company is also committed to purchase three spare
V2500-A5 engines for the A319 from International Aero Engines beginning in
2006.

Capital Equipment and Debt Service

In 2004, the Company anticipates capital spending of approximately $46.6
million consisting of approximately $15.1 million for rotable spare parts and
flight equipment, $11.3 million for facilities, $5.3 million for ground and
maintenance equipment, $10.7 million for computer equipment, and $4.2 million
for other capital assets, and expects to fund these capital expenditures out of
working capital. These amounts include the Companys estimates of capital
spending for Independence Air transition and start-up costs and the initial
build-up of a spare parts inventory for the Airbus aircraft. The foregoing
amount does not include additional debt that may be required for the financing
of new A319s or additional spare parts and spare engines.

Principal payments on long term debt for 2004 are estimated to be
approximately $8.9 million reflecting borrowings related to the purchase of
five J-41s acquired in 1997 and 1998, four CRJs acquired in 1998 and 1999, and
six CRJs acquired in 2003.

Other Commitments

The Companys regional jet fleet is comprised of new aircraft with an
average age of three years. Since maintenance expense on new aircraft is
lower in the early years of operation due to manufacturers warranties and the
generally lower failure rates of major components, the Companys

50



---



##### 



maintenance expense for regional jet aircraft will increase in future periods.

In 2000, the Company executed a seven-year engine services agreement with
GE Engine Services, Inc. (GE) covering the scheduled and unscheduled repair
of ACAs CRJ jet engines, operated on the 43 CRJs already delivered or on order
at that time for the United Express operation. This agreement was amended in
July 2000 to cover 23 additional CRJ aircraft, bringing the total number of CRJ
aircraft covered under the agreement to 66. Under the terms of the agreement,
the Company pays a set dollar amount per engine hour flown on a monthly basis
to GE and GE assumes the responsibility to repair the engines when required at
no additional expense to the Company, subject to certain exclusions. The
Companys future maintenance expense on CRJ engines covered under the agreement
will escalate based on contractual rate increases, intended to match the timing
of actual maintenance events that are due pursuant to the terms. The Company
expenses aircraft maintenance based upon the amount paid to GE under the
agreement, as engine hours are flown.

Effective September 2001, the Company entered a maintenance agreement with
Air Canada covering maintenance, repair and overhaul services for airframe
components on its CRJ aircraft. Under the terms of this agreement, the Company
pays a varying amount per flight hour each month, based on the age of the
aircraft. The Company expenses the amount paid to Air Canada based on the
rates stipulated in the agreement and the hours flown each month. In February
2002, the Company entered into an agreement with Air Canada covering the
scheduled airframe C-check overhaul of its CRJ aircraft. The Company expenses
this cost as the overhaul is completed.

Effective January 2001, the Company entered into an agreement with BAE
Systems Holdings, Inc. covering repair and overhaul of airframe rotable parts
on the Companys J-41 aircraft through the remaining service life of the J-41
fleet. Under the terms of this agreement, the Company pays a fixed amount per
flight hour each month. The Company expenses the amount paid to BAE Systems
Holdings, Inc. based on the rates stipulated in the agreement and the hours
flown each month.

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 has committed to provide its senior executive officers a
deferred compensation plan which utilizes split dollar life insurance policies,
and for a certain officer, a make-whole provision for taxes, post retirement
salary based on ending salary, and post retirement benefits based on benefits
similar to those currently provided to the executive while actively employed.
The Company has estimated the cost of the deferred compensation and tax gross
up feature, future salary and future benefits and is accruing this cost over
the remaining required service time of the executive officers. The Company
expensed $1.8 million and $2.5 million for these benefits for the year ending

51



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##### 



December 31, 2002 and 2003, respectively. The Company expects to recognize
similar costs annually over the remaining service life of the senior
executives.

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. During 2003 the Company purchased 10,901 shares from
employees to satisfy income taxes due resulting from the vesting of restricted
shares. The Company has no plans to repurchase stock in 2004.

The Companys industry environment is highly uncertain and volatile at
this time. Future events could affect the industry or the Company in ways that
are not presently anticipated that could adversely affect the Companys
liquidity. The Company believes that its cash balances and cash flow from
operations together with operating lease financing and other available
equipment financing will be sufficient to enable the Company to meet its
working capital needs, expected operating lease financing commitments, other
capital expenditures, and debt service requirements as they come due for the
remainder of 2004 and into 2005 when the prepaid aircraft deposits required for
the Airbus order peak. Nevertheless, we continually evaluate opportunities to
finance the acquisition of aircraft, engage in other financing transactions,
sell additional equity or debt securities, enter into credit facilities with
lenders, or sell underutilized assets, all for either strategic reasons or to
further strengthen our financial position. The sale of additional equity or
convertible debt securities would likely be dilutive to our stockholders.

Inflation

Inflation has not had a material effect on the Companys operations
because the Companys agreements with United and Delta provide for its
fee-for-service rates to be adjusted annually and for it to be reimbursed for
the cost of fuel. Inflation, and in particular changes in the costs of fuel,
could affect the Companys Independence Air operations.

Critical Accounting Policies and Estimates

The preparation of the Companys financial statements in conformity with
generally accepted accounting principles requires the Companys management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosures of contingent
assets and liabilities in the consolidated financial statements and
accompanying notes. The U.S. Securities and Exchange Commission has defined a
companys most critical accounting policies as the ones that are most important
to the portrayal of the companys financial condition and results, and which
require the company to make its most difficult and subjective judgments, often
as a result of the need to make estimates of matters that are inherently
uncertain. Based on this definition, the Company has identified its critical
accounting policies as including those addressed below. The Company also has
other key accounting policies, which involve the use of estimates, judgments
and assumptions. See Note 1 Summary of Accounting Policies in the Notes to
Consolidated Financial Statements for additional discussion of these items.
Management believes that its estimates and assumptions are reasonable, based
upon information presently available; however, actual results may differ from
these estimates under different assumptions or conditions.

Revenue Recognition: Under the proration-of-fare arrangement in effect
with United until November of 2000, the Company recognized passenger revenue
when a flight was completed. This required various estimates about passenger
fares and other factors that were subject to

52



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subsequent adjustment and
settlement with United and other carriers. Following certain changes in
estimates, which resulted in adjustments in 2001 as described in Results of
Operations, the Company does not expect any further adjustments attributable
to the former proration-of-fare arrangement. Under the fee-per-departure and
fee-per-block hour contracts currently in place with United and Delta, respectively, revenue is the product of the agreed upon
rate and the number of departures or the number of block hours flown. Rates
are generally agreed to on an annual basis and are subject to adjustments upon
certain specified events, such as changes in cities served or in aircraft
utilization levels. Until rates are agreed to each year with United and Delta
or are adjusted in response to specified events, the Company may be required to
estimate these rates and record revenue based upon such estimates until final
rates are agreed to by either United or Delta. In addition, certain incentive
payments are recorded based upon the Companys assessment of its satisfaction
of operational performance criteria and are subject to review by United or
Delta.

Major maintenance costs: The Company has executed long-term agreements
with the engine manufacturers and other service providers covering the repair
and overhaul of its engines, airframe and avionics components, and landing
gear. These agreements generally include escalating rates per flight hour over
the term of the agreement. The escalating rates are intended to reflect the
approximate actual maintenance cost increases as the aircraft age. The Company
expenses costs based upon the current rate per hour and the number of aircraft
and engines hours for the period. As a result, maintenance costs for the
Companys existing aircraft fleet are expected to increase in future years.
The engines delivered with the last 21 CRJ aircraft are not currently covered
by a maintenance agreement due to the disagreement with GE Engine Services on
the existing maintenance agreement covering the first 66 CRJ aircraft. For the
uncovered aircraft, the Company is expensing actual costs incurred for
maintenance which is not representative of future costs as these aircraft are
still under the manufacturers warranty.

Aircraft leases: The majority of the Companys aircraft are leased from
third parties. In order to determine the proper classification of a lease as
either an operating lease or a capital lease, the Company must make certain
estimates at the inception of the lease relating to the economic useful life
and the fair value of an asset as well as select an appropriate discount rate
to be used in discounting future lease payments. These estimates are utilized
by management in making computations as required by existing accounting
standards that determine whether the lease is classified as an operating lease
or a capital lease. Substantially all of the Companys aircraft leases have
been classified as operating leases, which results in rental payments being
charged to expense over the terms of the related leases. Additionally,
operating leases are not reflected in the balance sheet and accordingly,
neither a lease asset nor an obligation for future lease payments are reflected
in the Companys consolidated balance sheet.

Aircraft Early Retirement Costs: In determining the cost of the early
retirement of leased aircraft (and thus in determining the amount of the
aircraft early retirement charge), the Company must estimate, among other
things, market lease rates, future sub-lease income, the cost of maintenance
return provisions, future interest and inflation rates, and the duration and
cost of aircraft storage. As the associated leases may extend over several
years, these costs estimates are subject to change. Prior to the Companys
adoption of FASB Statement 146, the Company recorded estimated early retirement
charges for aircraft expected to be retired in the coming twelve months under
an approved retirement plan. With the adoption of FASB 146, effective January
1, 2003, the Company now records early retirement costs at the present value of
costs and future sub-lease income noted above for its J-41 aircraft as they are
removed from service.

53



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##### 



Item 7A. Quantitative and Qualitative Disclosures about Market Risk

The Companys principal market risk results from changes in interest
rates.

The Companys exposure to market risk associated with changes in interest
rates relates to the Companys commitment to acquire regional jets. The
Company has periodically entered into a series of put and call contracts as an
interest rate hedge designed to limit its exposure to interest rate changes on
the anticipated issuance of permanent financing relating to the delivery of the
CRJ aircraft. During 2001, the Company settled one hedge transaction, paying
the counterparty $722,000. The Company had no interest rate hedge
transactions in 2002 or 2003.

The Company is in the process of finalizing commitments to acquire 10
Airbus aircraft under operating leases and 15 by acquisition from an affiliate
of the manufacturer. The aircraft to be acquired by operating leases will not
require further financing. Financing arrangements will need to be arranged for
the 15 aircraft to be acquired from an affiliate of the manufacturer. The
Company anticipates that if necessary it will be able to finance these aircraft
through debt financing with approximately a 20% downpayment requirement, and
that it will continue to explore alternative sources of financing prior to
delivery. As of February 1, 2004, the Company had firm commitments to purchase
34 additional CRJ aircraft. 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.

The Company has exposure to changes in interest rates primarily because
the cost of financing of its Airbus aircraft will be dependent on prevailing
interest rates at the time of financing (assuming fixed-rate financing is
secured), or on an ongoing basis (assuming floating-rate financing is secured).
The Company will make a decision on fixed or floating rate financing at the
time of delivery depending on market conditions. With respect to its existing
obligations, the Company does not have exposure to changing interest rates on
80% of its long-term debt as the interest rates on such debt are fixed. The
interest rates on the majority of the Companys leveraged lease transactions
are also fixed. The Companys market risk on fixed rate debt or leases is that
the Companys obligations would be above fair value of this fixed rate debt is
sensitive to changes in interest rates. If market rates decline, the required
payments will exceed those based on current market rates. The Company has
exposure to changes in interest rates for the remaining debt because this debt
has a variable rate based on the 1-month LIBOR plus 2.25%. This debt will be
outstanding until October 2005. The Company does not hold long-term interest
sensitive assets and therefore is not exposed to interest rate fluctuations for
its assets. The Company does not purchase or hold any derivative financial
instruments for trading purposes.

54



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##### 



Item 8. Consolidated Financial Statements

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

Independent Auditors Report
    
    
    56Consolidated Balance Sheets as of December 31, 2002 and 2003
    
    
    57Consolidated Statements of Operations for the years ended
December 31, 2001, 2002 and 2003
    
    
    58Consolidated Statements of Stockholders Equity for the years ended
December 31, 2001, 2002 and 2003
    
    
    59Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2002 and 2003
    
    
    60Notes to Consolidated Financial Statements
    
    
    61


55



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##### 



Independent Auditors
Report

The Board of Directors and Stockholders
Atlantic Coast Airlines Holdings, Inc.:

We have audited the accompanying consolidated balance sheets of Atlantic Coast
Airlines Holdings, Inc. and subsidiaries as of December 31, 2002 and 2003, and
the related consolidated statements of operations, stockholders equity, and
cash flows for each of the years in the three-year period ended December 31,
2003. These consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Atlantic Coast
Airlines Holdings, Inc. and subsidiaries as of December 31, 2002 and 2003, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.

As discussed in Note 17 to the consolidated financial statements, the Company
adopted, effective January 1, 2003, Statement of Financial Accounting Standards
No. 146 Accounting for Costs Associated with Disposal or Exit Activities.



KPMG LLP


McLean, VA
January 27, 2004, except as to Notes 1(f) and 13,
which are as of February 14, 2004

56



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##### 



Atlantic Coast Airlines Holdings, Inc.
Consolidated Balance Sheets

(In thousands,
except for share data and par values)December
31,
    
    2002
    
    2003AssetsCurrent:Cash and cash equivalents
    
    $
    29,261
    
    
    $
    95,879Short term investments
    
    
    213,360
    
    
    
    202,055Accounts receivable, net
    
    
    13,870
    
    
    
    9,071Expendable parts and fuel inventory, net
    
    
    14,317
    
    
    
    18,440Prepaid expenses and other current assets
    
    
    38,610
    
    
    
    58,341Deferred tax asset
    
    
    16,114
    
    
    
    14,592Total current assets
    
    
    325,532
    
    
    
    398,378Restricted cash
    
    
    
    
    
    
    14,829Property and equipment at cost, net of accumulated
depreciation and amortization
    
    
    195,413
    
    
    
    314,800Intangible assets, net of accumulated amortization
    
    
    1,741
    
    
    
    1,730Debt issuance costs, net of accumulated amortization
    
    
    3,249
    
    
    
    2,804Aircraft deposits
    
    
    44,810
    
    
    
    46,990Other assets
    
    
    4,393
    
    
    
    3,713Total assets
    
    $
    575,138
    
    
    $
    783,244Liabilities and Stockholders EquityCurrent:Current portion of long-term debt
    
    $
    4,900
    
    
    $
    8,927Current portion of capital lease obligations
    
    
    1,449
    
    
    
    159Accounts payable
    
    
    22,475
    
    
    
    24,842Accrued liabilities
    
    
    84,377
    
    
    
    90,935Accrued aircraft early retirement charge
    
    
    14,700
    
    
    
    2,666Total current liabilities
    
    
    127,901
    
    
    
    127,529Long-term debt, less current portion
    
    
    53,540
    
    
    
    133,971Capital lease obligations, less current portion
    
    
    751
    
    
    
    356Deferred tax liability
    
    
    22,384
    
    
    
    42,267Deferred credits, net
    
    
    61,903
    
    
    
    102,115Accrued aircraft early retirement charge, less current portion
    
    
    31,768
    
    
    
    15,313Other long-term liabilities
    
    
    1,523
    
    
    
    2,279Total liabilities
    
    
    299,770
    
    
    
    423,830Stockholders equity:Preferred Stock: $.02 par value per share; shares authorized
5,000,000; no shares issued or outstanding in 2002 or 2003
    
    
    
    
    
    
    -Common stock: $.02 par value per share; shares authorized
130,000,000; shares issued 50,255,184 in 2002 and
50,404,287 in 2003; shares outstanding 45,195,115 in 2002
and 45,333,310 in 2003
    
    
    1,005
    
    
    
    1,008Class A common stock: nonvoting; no par value; $.02 stated
value per share; shares authorized 6,000,000; no shares
issued or outstanding
    
    
    
    
    
    
    -Additional paid-in capital
    
    
    151,103
    
    
    
    152,485Less: Common stock in treasury, at cost, 5,060,069 shares
in 2002 and 5,070,977 in 2003
    
    
    (35,586
    )
    
    
    (35,718
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (5
    )Retained earnings
    
    
    158,846
    
    
    
    241,644Total stockholders equity
    
    
    275,368
    
    
    
    359,414Total liabilities and stockholders equity
    
    $
    575,138
    
    
    $
    783,244Commitments and Contingencies


See accompanying notes to consolidated financial statements.

57



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##### 



Atlantic Coast Airlines Holdings, Inc
Consolidated Statements of Operations

(In thousands,
except for per share data)Years
ended December 31,
    
    2001
    
    2002
    
    2003Operating revenues:Passenger
    
    $
    577,604
    
    
    $
    749,103
    
    
    $
    859,659Other
    
    
    5,812
    
    
    
    11,421
    
    
    
    16,752Total operating revenues
    
    
    583,416
    
    
    
    760,524
    
    
    
    876,411Operating expenses:Salaries and related costs
    
    
    164,446
    
    
    
    203,341
    
    
    
    211,823Aircraft fuel
    
    
    88,308
    
    
    
    115,801
    
    
    
    144,618Aircraft maintenance and materials
    
    
    48,478
    
    
    
    72,233
    
    
    
    85,701Aircraft rentals
    
    
    90,323
    
    
    
    112,068
    
    
    
    128,824Traffic commissions and related fees
    
    
    15,589
    
    
    
    19,994
    
    
    
    22,838Facility rents and landing fees
    
    
    32,025
    
    
    
    43,805
    
    
    
    51,111Depreciation and amortization
    
    
    15,353
    
    
    
    21,155
    
    
    
    28,424Other
    
    
    61,674
    
    
    
    85,163
    
    
    
    92,823Aircraft early retirement charge
    
    
    23,026
    
    
    
    24,331
    
    
    
    (27,654
    )Total operating expenses
    
    
    539,222
    
    
    
    697,891
    
    
    
    738,508Operating income
    
    
    44,194
    
    
    
    62,633
    
    
    
    137,903Other income (expense):Interest expense
    
    
    (4,832
    )
    
    
    (4,332
    )
    
    
    (6,502
    )Interest income
    
    
    7,500
    
    
    
    4,628
    
    
    
    2,549Government compensation
    
    
    9,710
    
    
    
    944
    
    
    
    1,520Other (expense) income, net
    
    
    263
    
    
    
    552
    
    
    
    (220
    )Total other income (expense), net
    
    
    12,641
    
    
    
    1,792
    
    
    
    (2,653
    )Income before income tax provision
    
    
    56,835
    
    
    
    64,425
    
    
    
    135,250Income tax provision
    
    
    22,513
    
    
    
    25,139
    
    
    
    52,452Net income
    
    $
    34,322
    
    
    $
    39,286
    
    
    $
    82,798Income per share:Basic:Net income
    
    $
    .79
    
    
    $
    .87
    
    
    $
    1.83Diluted:Net income
    
    $
    .76
    
    
    $
    .85
    
    
    $
    1.82Weighted average shares used in computation:Basic
    
    
    43,434
    
    
    
    45,047
    
    
    
    45,285Diluted
    
    
    45,210
    
    
    
    46,019
    
    
    
    45,398


See accompanying notes to consolidated financial statements.

58



---



##### 



Atlantic Coast Airlines Holdings, Inc.
Consolidated Statements of
Stockholders Equity

(In thousands, except for
share data)AccumulatedCommon stock
    
    Additional
    
    Treasury stock
    
    other
    
    
    
    
    
    Totalpaid-in
    
    
    
    comprehensive
    
    Retained
    
    stockholders'Shares
    
    Amount
    
    capital
    
    Shares
    
    Amount
    
    loss
    
    earnings
    
    equityBalance December 31, 2000
    
    
    47,704,720
    
    
    $
    954
    
    
    $
    117,284
    
    
    
    5,046,332
    
    
    $
    (35,303
    )
    
    $
    
    
    
    $
    85,238
    
    
    $
    168,173Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34,322
    
    
    
    34,322Exercise of common stock options
    
    
    1,524,482
    
    
    
    31
    
    
    
    8,145
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,176Tax benefit of stock option exercise
    
    
    
    
    
    
    
    
    
    
    9,010
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,010Amortization of deferred
compensation
    
    
    
    
    
    
    
    
    
    
    1,619
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,619Balance December 31, 2001
    
    
    49,229,202
    
    
    $
    985
    
    
    $
    136,058
    
    
    
    5,046,332
    
    
    $
    (35,303
    )
    
    $
    
    
    
    $
    119,560
    
    
    $
    221,300Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39,286
    
    
    
    39,286Exercise of common stock options
    
    
    1,025,982
    
    
    
    20
    
    
    
    7,027
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,047Tax benefit of stock option exercise
    
    
    
    
    
    
    
    
    
    
    6,634
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,634Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,737
    
    
    
    (283
    )
    
    
    
    
    
    
    
    
    
    
    (283
    )Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    1,384
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,384Balance December 31, 2002
    
    
    50,255,184
    
    
    $
    1,005
    
    
    $
    151,103
    
    
    
    5,060,069
    
    
    $
    (35,586
    )
    
    $
    
    
    
    $
    158,846
    
    
    $
    275,368Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    82,798
    
    
    
    82,798Net change in unrealized loss on
available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    82,793Exercise of common stock options
    
    
    149,103
    
    
    
    3
    
    
    
    1,108
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,111Tax benefit of stock option exercise
    
    
    
    
    
    
    
    
    
    
    251
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    251Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,908
    
    
    
    (132
    )
    
    
    
    
    
    
    
    
    
    
    (132
    )Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    23
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23Balance December 31, 2003
    
    
    50,404,287
    
    
    $
    1,008
    
    
    $
    152,485
    
    
    
    5,070,977
    
    
    $
    (35,718
    )
    
    $
    (5
    )
    
    $
    241,644
    
    
    $
    359,414


See accompanying notes to consolidated financial statements.

59



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##### 



Atlantic Coast Airlines Holdings, Inc.
Consolidated Statements of Cash Flows

(In thousands)Years ended
December 31,
    
    2001
    
    2002
    
    2003Cash flows from operating activities:Net income
    
    $
    34,322
    
    
    $
    39,286
    
    
    $
    82,798Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    16,179
    
    
    
    22,031
    
    
    
    29,013Amortization of intangibles
    
    
    193
    
    
    
    17
    
    
    
    10Provision for uncollectible accounts receivable
    
    
    227
    
    
    
    2,619
    
    
    
    -Provision for inventory obsolescence
    
    
    578
    
    
    
    596
    
    
    
    900Amortization of deferred credits
    
    
    (3,662
    )
    
    
    (4,966
    )
    
    
    (7,942
    )Amortization of deferred financing costs
    
    
    354
    
    
    
    506
    
    
    
    531Capitalized interest, net
    
    
    (1,835
    )
    
    
    (1,032
    )
    
    
    1,329Deferred tax (benefit) provision
    
    
    5,681
    
    
    
    (4,372
    )
    
    
    21,406Loss on disposal of fixed assets
    
    
    198
    
    
    
    567
    
    
    
    3,579Amortization of deferred compensation
    
    
    1,619
    
    
    
    1,384
    
    
    
    23Changes in operating assets and liabilities:Accounts receivable
    
    
    25,148
    
    
    
    2,455
    
    
    
    (477
    )Expendable parts and fuel inventory
    
    
    (4,956
    )
    
    
    (4,348
    )
    
    
    (5,022
    )Prepaid expenses and other current assets
    
    
    (5,376
    )
    
    
    (19,403
    )
    
    
    (19,692
    )Accounts payable
    
    
    9,275
    
    
    
    12,016
    
    
    
    13,938Accrued liabilities
    
    
    10,100
    
    
    
    59,477
    
    
    
    (20,925
    )Net cash provided by operating activities
    
    
    88,045
    
    
    
    106,833
    
    
    
    99,469Cash flows from investing activities:Purchases of property and equipment
    
    
    (34,903
    )
    
    
    (35,655
    )
    
    
    (78,506
    )Proceeds from sales of fixed assets
    
    
    
    
    
    
    28
    
    
    
    -Purchases of short term investments
    
    
    (76,715
    )
    
    
    (651,365
    )
    
    
    (505,480
    )Maturities of short term investments
    
    
    104,515
    
    
    
    445,305
    
    
    
    516,780Increase in restricted cash
    
    
    
    
    
    
    
    
    
    
    (14,829
    )Refund of deposits
    
    
    11,100
    
    
    
    5,800
    
    
    
    2,400Payments for aircraft and other deposits
    
    
    (9,701
    )
    
    
    (16,170
    )
    
    
    (5,826
    )Net cash used in investing activities
    
    
    (5,704
    )
    
    
    (252,057
    )
    
    
    (85,461
    )Cash flows from financing activities:Proceeds from issuance of long term debt
    
    
    
    
    
    
    
    
    
    
    60,078Payments of long-term debt
    
    
    (4,344
    )
    
    
    (4,640
    )
    
    
    (6,302
    )Payments of capital lease obligations
    
    
    (1,959
    )
    
    
    (1,361
    )
    
    
    (2,238
    )Proceeds from receipt of deferred credits and other
    
    
    4,286
    
    
    
    
    
    
    
    -Deferred financing costs
    
    
    (948
    )
    
    
    53
    
    
    
    93Proceeds from exercise of stock options
    
    
    8,176
    
    
    
    7,047
    
    
    
    1,111Purchase of treasury stock
    
    
    
    
    
    
    (283
    )
    
    
    (132
    )Net cash provided by financing activities
    
    
    5,211
    
    
    
    816
    
    
    
    52,610Net increase (decrease) in cash and cash equivalents
    
    
    87,552
    
    
    
    (144,408
    )
    
    
    66,618Cash and cash equivalents, beginning of year
    
    
    86,117
    
    
    
    173,669
    
    
    
    29,261Cash and cash equivalents, end of year
    
    $
    173,669
    
    
    $
    29,261
    
    
    $
    95,879


See accompanying notes to consolidated financial statements.

60



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

1.
    
    Summary of Accounting
Policies
    
    (a)
    
    Basis of PresentationThe accompanying consolidated financial statements include the accounts of Atlantic Coast Airlines Holdings, Inc. (ACAI) and its wholly owned subsidiaries,
Atlantic Coast Airlines (ACA) and Atlantic Coast Jet, Inc. (ACJet), (collectively, the Company), pursuant to the rules and regulations of the Securities
and Exchange Commission. Unless the context indicates otherwise, the terms we, us, or our refer herein to Atlantic Coast Holdings, Inc. On July 1,
2001, ACAI combined the operations of its ACJet subsidiary into the operations of ACA and on July 9, 2002 converted Atlantic Coast Jet, Inc. into a limited
liability corporation named Atlantic Coast Jet, LLC. Neither Atlantic Coast Jet, LLC, nor its predecessor, ACJet, have had any activity since June 30, 2001
and in December 2003, Atlantic Coast Jet, LLC voluntarily returned its dormant operating certificate to the DOT. All significant intercompany accounts and
transactions have been eliminated in consolidation. The Companys flights are operated under code sharing agreements with United Airlines, Inc. (United) and
Delta Airlines (Delta) and are identified as United Express and Delta Connection flights in computer reservation systems. As of December 31, 2003, the
Company provided scheduled air transportation service as United Express for passengers to destinations in the Eastern and Midwestern United States. The
Company provides scheduled air transportation service as Delta Connection to various destinations in the Eastern United States and Canada. The Company also
operates private shuttle service and ad hoc charter service.(b)
    
    Cash, Cash Equivalents and Short-Term InvestmentsThe Company considers investments with an original maturity of three months or less when purchased to be cash equivalents. Investments with an original
maturity greater than three months and less than one year are considered short-term investments. In addition, the Company holds investments in tax-free,
variable-rate Industrial Revenue Bonds (IRB) and General Obligation Bonds (GOB) having initial maturities up to 30 years. Pursuant to the Companys
investment policy, these bonds must have a long-term rating of at least AA by Standard & Poors or Aa by Moodys to be eligible investments. The Companys
investment policy also has issuer and geographical concentration limitations on these investments. These bonds are backed by letters of credit or insurance
and can be sold back to the remarketer at par on a weekly or monthly basis.As such, the Company considers securities of this type to be short-term investments. All short-term investments are considered to be available for sale as the
Company has no intention to hold the securities for trading


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

purposes or until maturity. Available-for-sale securities are carried at fair value, with the
unrealized gains and losses, net of tax, reported as a component of accumulated other comprehensive income in stockholders equity. As December 31, 2003, the
Company did not have significant unrealized losses on available-for-sale securities.(c)
    
    Airline RevenuesPassenger revenues are recorded as operating revenues at the time transportation is provided. Under the Companys fee-per-departure and fee-per-block hour
agreements, transportation is considered provided when the flight has been completed. All of the passenger tickets used by the Companys revenue passengers
are sold by other air carriers.Under the fee-per-departure and fee-per-block hour contracts currently in place with United and Delta, respectively, revenue is the product of the agreed upon
rate and the number of departures or the number of block hours flown. Rates are generally agreed to on an annual basis and are subject to adjustments upon
certain specified events, such as changes in cities served or in aircraft utilization levels. Until rates are agreed to each year with United and Delta or are
adjusted in response to specified events, the Company may be required to estimate these rates and record revenue based upon such estimates until final rates
are agreed to by either United or Delta. In addition, certain incentive payments are recorded based upon the Companys assessment of its satisfaction of
specific and measurable operational performance criteria and are subject to review by United or Delta. United accounted for 83% and 82% of
passenger revenue and Delta
accounted for 17% and 18% of passenger revenue for 2003 and 2002, respectively.ACA participates in Uniteds Mileage Plus frequent flyer program and in the Delta SkyMiles frequent flyer program. The Company does not accrue for incremental
costs for mileage accumulation or redemption relating to these programs because the Company operates under agreements with United and Delta, and the Companys
revenues under these agreements are not affected by the number of miles earned by its passengers or number of passengers on its flights redeeming miles.(d)
    
    Accounts and Notes ReceivableAccounts receivable are stated net of allowances for uncollectible accounts of approximately $3.1 million and $3.9 million at December 31, 2002 and 2003,
respectively. Amounts charged to expenses for uncollectible accounts in 2001, 2002 and 2003 were $227,000, $2.6 million, $0, respectively. Write-off of
accounts receivable were $386,000, $150,000,


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

and $210,000 in 2001, 2002 and 2003, respectively. Accounts receivable as of December 31, 2002 and 2003
included ticket receivables of $607,000 and $648,000, respectively, and approximately $4.3 million and $4.8 million, respectively, related to manufacturers
credits to be applied towards future spare parts purchases and training expenses. Based on the Companys estimates, the
Company believes that United owed ACA approximately $7.9 million as of the date of Uniteds bankruptcy filing for unpaid pre-petition obligations relating to
United Express services prior to the filing and that, if these pre-petition obligations are not ultimately paid by United, ACA will have the right to offset
amounts ACA owes United for pre-petition services totaling approximately $5.4 million. The Company reclassified the pre-petition amounts owed to United as a
reduction of the pre-petition receivable balance. In addition, the Company has reclassified approximately $1.0 million owed to a manufacturer currently in
bankruptcy as reserve for potentially uncollectible amounts owed to the Company for parts and training paid to third parties that were contractually required
to be reimbursed by the manufacturer.(e)
    
    Concentrations of Credit RiskAt December 31, 2002 and 2003, accounts receivable from other airlines totaled approximately $449,000 and $442,000 respectively. Of the total amount,
approximately $118,000 and $64,000 at December 31, 2002 and 2003, respectively, were due from United. Under the fee-per-departure agreements, the Company
receives payment in advance from both United and Delta. Historically, accounts receivable losses have not been significant.(f)
    
    Risks and UncertaintiesBeginning 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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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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 customer service and ground
handling at certain stations. 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. 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. We anticipate that even though our
United Express operations accounted for 83% of our passenger revenue in 2003, 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. 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. 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


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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 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.In July 2002, Fairchild Dornier GmbH (Fairchild), the manufacturer of the 32-seat Fairchild Dornier 328 regional jet (328Jet), opened formal insolvency
proceedings in Germany. Fairchild had been operating under the guidance of a court-appointed interim trustee since April 2002. 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, 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.The Pratt & Whitney (P&W) PW306B engine that powers our fleet of 328Jet aircraft has had unscheduled maintenance events to repair turbine blades that
requires the engines 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 maintenance 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, 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, 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.


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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.Delta also has the right to terminate the DL Agreement 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 Delta
Connection 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 its low-fare business model. The Company may incur one-time costs in connection with any termination of the Delta relationship.As our fleet of regional jet aircraft ages, the maintenance costs for such aircraft will likely increase. Our maintenance costs will increase on an absolute
basis, on a per seat mile basis and as a percentage of our operating expenses, as our regional jet fleet ages. 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


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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.Independence Air:The Companys decision to operate independently as a low-fare carrier, as announced in July 2003, is the result of an extensive evaluation of changes in the
passenger airline industry that the Company commenced in 2001.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: establish a brand and product that will be attractive
to our target customers; implement our growth strategy with larger aircraft than we have previously operated; react to customer and market demands and to
changes in the airline industry; choose new markets successfully; secure favorable terms with airports, suppliers and other contractors; maintain adequate
control over our expenses; monitor and manage major operational and financial risks; obtain and maintain necessary regulatory approvals; attract, retain and
motivate qualified personnel; maintain the safety and security of our operations; and react to responses from our competitors, including both legacy and
low-fare airlines, as we transition to Independence Air. There can be no assurance that we will successfully address any of these factors, and our failure to
do so could harm our business. In 2003, the Company incurred $2.7 million in expense related to the start-up of Independence Air.Collective Bargaining Agreements: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


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

aviation maintenance technicians and ground service equipment mechanics are represented by the
Aircraft Mechanics Fraternal Association (AMFA).In January 2001, the Company agreed to a new four-and-a-half year collective bargaining agreement with its pilot union 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 the Company believes were, at the time, comparable to other similarly situated regional
carriers with recently negotiated contracts who were operating under similar agreements with major airlines. In October 2003, the Company reached an
agreement on a revised contract with its pilots and the union representing those pilots, 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, 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. The Company had previously finalized a separate agreement with ALPA on pay reductions and work
rule changes that were contingent on reaching an agreement with United to continue operation as a fee-per-departure carrier in the United Express system. 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


68



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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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.Aviation InsuranceFollowing 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, the Company 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. Since that time, the
Company has 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. The Company


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

anticipates that it will renew the government insurance for as long as the coverage is available, and then obtain this coverage
through the private insurance market. Under the Companys UA and DL Agreements, the Company passes through the cost of insurance to its partners.
Independence Air will be responsible for its full insurance costs. The absence of insurance, or availability at excessive rates, could affect the Companys
ability to operate. The Company anticipates that it will follow industry practices with respect to sources of insurance.(g)
    
    Use of EstimatesThe preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make
certain estimates and assumptions regarding valuation of assets, recognition of liabilities for costs such as aircraft maintenance, differences in timing of
air traffic billings from United and other airlines, operating revenues and expenses during the period and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements. Actual results could differ from those estimated.(h)
    
    Expendable PartsExpendable parts and supplies are stated at the weighted average cost, less an allowance for obsolescence of $1.1 million and $2.0 million as of December 31,
2002 and 2003, respectively. Expendable parts and supplies are charged to expense as they are used. Amounts charged to costs and expenses for obsolescence in
2001, 2002 and 2003 were $578,000, $596,000, and $900,000, respectively.(i)
    
    Property and EquipmentProperty and equipment, including rotable spare parts, are stated at cost. Assets held under capital leases are initially recorded at the present value of the
minimum future lease payments. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets that range from
five to sixteen and one half years. Capital leases and leasehold improvements are amortized over the shorter of the estimated life or the remaining term of
the lease.Amortization of capital leases and leasehold improvements is included in depreciation and amortization expense.


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

The Company periodically evaluates whether events and circumstances have occurred which may impact the remaining estimated useful life or the recoverability of
the remaining carrying value of its long-lived assets, including rotable spare parts. If such events or circumstances were to indicate that the carrying
amount of these assets would not be recoverable, the Company would estimate the future cash flows expected to result from the use of the assets and their
eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset,
an impairment loss equal to the difference between the fair value and carrying value would be recognized by the Company.(j)
    
    Intangible AssetsGoodwill of approximately $3.2 million, representing the excess of cost over the fair value of net assets acquired in the acquisition of ACA, was previously
amortized by the straight-line method over twenty years. Costs incurred to acquire slots of $0.3 million were being amortized by the straight-line method over
twenty years. Accumulated amortization of intangible assets at December 31, 2002 and 2003 was $1.8 million.In accordance with Statement of Financial Accounting Standards No. 142, which the Company adopted as of January 1, 2002, the Company no longer recognizes
amortization of its goodwill and slots for 2002 and future years but, instead, evaluates these assets, at least annually, for potential impairment based upon
fair value. Based upon analyses performed by the Company, there were no impairment losses to these assets as of December 31, 2003.(k)
    
    MaintenanceThe Company has executed long term agreements with the engine manufacturers and other service providers covering repair and overhaul of certain of its engines,
airframe and avionics components, and landing gear. These agreements call for an escalating rate per hour flown over the life of the agreement. The Companys
maintenance accounting policy for items covered by such agreements is to expense amounts based on the current rate as the aircraft are flown. Prior to the
execution of these long-term maintenance agreements, the Companys maintenance policy was a combination of expensing certain events as incurred and accruing
for certain maintenance events at rates it estimated would be sufficient to cover maintenance cost for the aircraft.


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

In 2000, the Company executed a seven-year engine services agreement with GE Engine Services, Inc. (GE) covering the scheduled and unscheduled repair of
ACAs CRJ jet engines, operated on the 43 CRJs already delivered or on order at that time for the United Express operation. This agreement was amended in July
2000 to cover 23 additional CRJ aircraft, bringing the total number of CRJ aircraft covered under the agreement to 66. Under the terms of the agreement, the
Company pays a set dollar amount per engine hour flown on a monthly basis to GE and GE assumes the responsibility to repair the engines when required at no
additional expense to the Company, subject to certain exclusions. The Companys future maintenance expense on CRJ engines covered under the agreement will
escalate based on contractual rate increases, intended to match the timing of actual maintenance events that are due pursuant to the terms. The Company
expenses aircraft maintenance based upon the amount charged by GE under the agreement, as engine hours are flown. To date, the time between scheduled repair
work has been longer and therefore the costs of maintaining these engines by GE has been lower than anticipated at the time the original contract and rates
were agreed. The Company has been in negotiations with GE to reduce the base rate in the agreement to reflect the actual operating performance of the engines,
to add the remaining aircraft to the agreement, and to extend the term. The Company has disputed the appropriateness of certain contract rate adjustments and
in the fourth quarter of 2001 sought other rate concessions from GE in the context of negotiating with GE for an adjustment in rates and for an extension of
the contract to cover a longer term and to cover the remaining CRJ aircraft on order. Consistent with its understanding at the time, the Company reduced the
amounts it paid GE under the agreement and correspondingly reduced the amounts it expensed for engine maintenance. The Company continues to negotiate with GE
and other vendors in order to reach an acceptable maintenance agreement. Accordingly, the Company currently is not adding engines beyond the 66 covered
aircraft and anticipates that the adjustments described above will continue to be disputed. In addition, the Company believes that, if it so elects, it has
the right to remove any or all engines from this agreement at any time. GE does not agree with the Companys interpretation of the agreement. On October 14,
2003, the Company commenced arbitration proceedings against 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


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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.Effective September 2001, the Company entered a sixteen year maintenance agreement with Air Canada covering maintenance, repair and overhaul services for
airframe components on its CRJ aircraft. Under the terms of this agreement, the Company pays a varying amount per flight hour each month, based on the age of
the aircraft. The Company expenses the amount paid to Air Canada based on the rates stipulated in the agreement and the hours flown each month. In February
2002, the Company entered into a five-year agreement with Air Canada covering the scheduled airframe C-check overhaul of its CRJ aircraft. The Company
expenses this cost as the overhaul is completed.Effective January 2001, the Company entered into an agreement with BAE Systems Holdings, Inc. covering repair and overhaul of airframe rotable parts on the
Companys J-41 aircraft through the remaining service life of the J-41 fleet. Under the terms of this agreement, the Company pays a fixed amount per flight
hour each month. The Company expenses the amount paid to BAE Systems Holdings, Inc. based on the rates stipulated in the agreement and the hours flown each
month.(l)
    
    Deferred CreditsThe Company accounts for incentives provided by the aircraft manufacturers as deferred credits for leased aircraft. These credits are amortized on a
straight-line basis as a reduction to lease expense over the respective lease term. The incentives are credits that may be used to purchase spare parts, pay
for training expenses, or be applied against future rental payments.(m)
    
    Income TaxesThe Company accounts for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between the financial statement carrying amounts for existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in future years in
which those temporary differences are expected to be recovered or settled.


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

(n)
    
    Stock-Based CompensationThe Company accounts for its stock-based compensation plans using the intrinsic value method prescribed under Accounting Principles Board (APB) No. 25. As
such, the Company records compensation expense for stock options and awards only if the exercise price is less than the fair market value of the stock on the
measurement date.For purposes of the pro forma disclosures of compensation expense under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, the Company uses the Black-Scholes option model to estimate the fair value of options. A risk-free interest rate of 4.5%, 3.1% and 3.6% for
2001, 2002 and 2003, respectively, a volatility rate of 73.4%, 70.6% and 77.5% for 2001, 2002 and 2003, respectively, with an expected life of 4.0 years for
2001, 6.3 years for 2002 and 7.4 years for 2003 were assumed in estimating the fair value. No dividend rate was assumed for any of the years.The following summarizes the pro forma effects assuming compensation for such awards had been recorded based upon the estimated fair value. The pro forma
information disclosed below does not include the impact of awards made prior to January 1, 1995 (in thousands, except per share data):


2001
    
    2002
    
    2003Net income, as reported
    
    $
    34,322
    
    
    $
    39,286
    
    
    $
    82,798Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects
    
    
    976
    
    
    
    847
    
    
    
    14Less: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects
    
    
    (6,260
    )
    
    
    (7,367
    )
    
    
    (5,990
    )Pro forma net income
    
    $
    29,038
    
    
    $
    32,766
    
    
    $
    76,822Earnings per share:Basic  as reported
    
    $
    .79
    
    
    $
    .87
    
    
    $
    1.83Basic  pro forma
    
    $
    .67
    
    
    $
    .73
    
    
    $
    1.70Diluted  as reported
    
    $
    .76
    
    
    $
    .85
    
    
    $
    1.82Diluted  pro forma
    
    $
    .64
    
    
    $
    .71
    
    
    $
    1.69


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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

(o)
    
    Income Per ShareBasic income per share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted income per share is computed by
dividing net income by the weighted average number of common shares outstanding and common stock equivalents, which consist of shares subject to stock options
computed using the treasury stock method.A reconciliation of the numerator and denominator used in computing income per share is as follows (in thousands, except per share amounts):


2001
    
    2002
    
    2003Basic
    
    Diluted
    
    Basic
    
    Diluted
    
    Basic
    
    DilutedShare calculation:Average number of common shares
outstanding
    
    
    43,434
    
    
    
    43,434
    
    
    
    45,047
    
    
    
    45,047
    
    
    
    45,285
    
    
    
    45,285Incremental shares due to assumed exercise of options
    
    
    
    
    
    
    1,776
    
    
    
    
    
    
    
    972
    
    
    
    
    
    
    
    113Weighted average common shares
outstanding
    
    
    43,434
    
    
    
    45,210
    
    
    
    45,047
    
    
    
    46,019
    
    
    
    45,285
    
    
    
    45,398Net Income
    
    $
    34,322
    
    
    $
    34,322
    
    
    $
    39,286
    
    
    $
    39,286
    
    
    $
    82,798
    
    
    $
    82,798Net Income per share
    
    $
    .79
    
    
    $
    .76
    
    
    $
    .87
    
    
    $
    .85
    
    
    $
    1.83
    
    
    $
    1.82


(p)
    
    ReclassificationsCertain prior years amounts as previously reported have been reclassified to conform to the current year presentation.(q)
    
    Interest Rate HedgesThe Company has periodically used swaps to hedge the effects of fluctuations in interest rates associated with aircraft financings. These transactions meet the
requirements for current hedge accounting. The effective portions of hedging gains and losses resulting from the interest rate swap contracts are deferred
until the contracts are settled and then amortized over the aircraft lease term or capitalized as part of acquisition cost, if purchased, and depreciated over
the life of the aircraft. The ineffective portions of hedging gains and losses are recorded as incurred.


75



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

(r)
    
    Segment InformationThe Company has adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. The statement requires disclosures related to
components of a company for which separate financial information is available that is evaluated regularly by a companys chief operating decision maker in
deciding the allocation of resources and assessing performance. The Company is engaged in one line of business, the scheduled and chartered transportation of
passengers, which constitutes nearly all of its operating revenues.(s)
    
    Aircraft DepositsAs part of the Companys purchase agreements for certain aircraft, the manufacturers require deposits to be placed and/or progress payments to be made in
advance of the aircrafts delivery to the Company. These aircraft deposits are considered long term in nature due to the fact that they are scheduled to be
returned in years extending beyond 2004.


2.
    
    Property and
Equipment
    
    Property and equipment consist of the following:


(In thousands)December 31,
    
    2002
    
    2003Owned aircraft and improvements
    
    $
    103,833
    
    
    $
    241,979Improvements to leased aircraft
    
    
    7,023
    
    
    
    6,545Flight equipment, primarily rotable spare parts
    
    
    105,907
    
    
    
    107,017Maintenance and ground equipment
    
    
    13,849
    
    
    
    15,825Computer hardware and software
    
    
    19,730
    
    
    
    21,951Furniture and fixtures
    
    
    2,998
    
    
    
    4,251Leasehold improvements
    
    
    8,870
    
    
    
    9,709262,210
    
    
    
    407,277Less: Accumulated depreciation and amortization
    
    
    66,797
    
    
    
    92,477$
    195,413
    
    
    $
    314,800


76



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

In 1999, the Company commenced a replacement project of its computer software systems. The majority of these costs are being capitalized and amortized over seven years. In 2001 and 2002,
the Company capitalized an additional $2.8 million and $3.5 million of costs incurred, respectively, bringing the total capitalized costs to $13.8 million for the project.On May 29, 2003, the Company purchased and took delivery of six CRJ aircraft from Bombardier. The Company financed a portion of the purchase price of four of the aircraft with debt financing.
The promissory notes on each of the four aircraft are 16.5 years in length beginning May 29, 2003; carry a fixed interest rate of 5.112% per annum; and require thirty-three equal semi-annual
payments of principal and interest beginning November 29, 2003.In October 2003, the Company purchased and took delivery of two CRJ aircraft from Bombardier. The Company financed a portion of the purchase price of the aircraft with debt financing. The
promissory notes on each of the aircraft require monthly payments from November 1, 2003 through October 2005, with the remaining principal balance to be paid in October 2005. The variable
interest rate for the promissory notes is reset monthly based on the 1-month LIBOR rate plus 2.25%


77



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

3.
    
    Accrued
    
    Accrued liabilities consist of the following:Liabilities


(In thousands)December 31,
    
    2002
    
    2003Payroll and employee benefits
    
    $
    29,973
    
    
    $
    27,634Air traffic liability
    
    
    2,398
    
    
    
    2,569Landing fees
    
    
    2,994
    
    
    
    3,295Property taxes
    
    
    2,907
    
    
    
    4,594Corporate income taxes
    
    
    (130
    )
    
    
    4,594Aircraft rents
    
    
    3,712
    
    
    
    2,526Passenger related expenses
    
    
    5,179
    
    
    
    5,314Maintenance costs
    
    
    8,933
    
    
    
    11,378Fuel
    
    
    11,455
    
    
    
    12,137Other
    
    
    16,956
    
    
    
    16,894$
    84,377
    
    
    $
    90,935


4.
    
    Debt
    
    On September 28, 2001, the Company entered into an asset-based lending agreement with Wachovia Bank, N.A.
(Wachovia) that initially provided the Company with a line of credit for up to $25.0 million. Under the
terms of the line of credit, it was necessary for the Company to request a covenant waiver as a result of the
Chapter 11 bankruptcy filing by United Airlines. In order to obtain this waiver, the Company agreed to reduce
the size of the line of credit to $17.5 million and to revise certain covenants. On July 31, 2003, the
Company entered into a new agreement with Wachovia which replaced the line of credit. This new agreement,
which has no expiration date, provides for the issuance of letters of credit, and is collateralized by
certificates of deposit. Under this agreement, the Company has $14.8 million on deposit with Wachovia as
collateral for letters of credit issued on behalf of the Company. The amounts on deposit with Wachovia are
shown as restricted cash on the Companys balance sheet as of December 31, 2003.In September 1997, approximately $112 million of pass through certificates were issued in a private placement
by separate pass through trusts, which purchased with the proceeds, equipment notes (the Equipment Notes)
issued in connection with (i) leveraged lease transactions relating to four J-41s and six CRJs, all of which
were leased to the Company (the Leased Aircraft), and (ii) the financing of four J-41s owned by the Company
(the Owned Aircraft). The Equipment Notes issued with respect to the Owned Aircraft are direct obligations
of ACA, guaranteed by ACAI and are included as debt obligations in the accompanying consolidated financial
statements. The Equipment Notes issued with respect to the Leased Aircraft are not obligations of ACA or
guaranteed by ACAI.


78



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

On May 29, 2003 the Company purchased and took delivery of six CRJ aircraft from Bombardier. The Company
financed a portion of the purchase price of four of the aircraft with debt financing. The promissory notes on
each of the four aircraft are 16.5 years in length beginning May 29, 2003; carry a fixed interest rate of
5.112% per annum; and require thirty-three equal semi-annual payments of principal and interest beginning
November 29, 2003.In October 2003, the Company purchased and took delivery of two CRJ aircraft from Bombardier. The Company
financed a portion of the purchase price of the aircraft with debt financing. The promissory notes on each of
the aircraft require monthly payments from November 1, 2003 through October 2005, with the remaining principal
balance to be paid in October 2005. The variable interest rate for the promissory notes is reset monthly
based on the 1-month LIBOR rate plus 2.25%Long-term debt consists of the following:


(In thousands)December 31,
    
    2002
    
    2003Equipment Notes associated with Pass Through Trust Certificates, due
January 1, 2008 and January 1, 2010, principal payable annually through January 1, 2006 and
semi-annually thereafter through maturity, interest payable semi-annually at 7.49% throughout term of
notes, collateralized by four J-41 aircraft.
    
    $
    11,147
    
    
    $
    10,008Notes payable to institutional lenders, due between October 23, 2010 and May 15, 2015, principal
payable semiannually with interest ranging from 5.65% to 7.63% through maturity, collateralized by
four CRJ aircraft.
    
    
    45,047
    
    
    
    41,794Note payable to institutional lender, due October 2, 2006, principal payable semiannually with
interest at 6.56%, collateralized by one J-41 aircraft.
    
    
    2,246
    
    
    
    1,738Notes payable to institutional lender, due November 2019, principal payable semiannually with interest
at 5.11%, collateralized by four CRJ aircraft.
    
    
    
    
    
    
    58,897Notes payable, due October 2005, principal payable monthly with variable rate based on 1-month LIBOR
rate plus 2.25% through maturity, collateralized by two CRJ aircraft.
    
    
    
    
    
    
    30,461Total
    
    
    58,440
    
    
    
    142,898Less: Current Portion
    
    
    4,900
    
    
    
    8,927$53,540
    
    
    
    $133,971


79



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

As of December 31, 2003, maturities of long-term debt are as follows:


(in thousands)Year Ending December 31,2004
    
    $
    8,9272005
    
    
    37,7422006
    
    
    8,6502007
    
    
    8,3972008
    
    
    10,542Thereafter
    
    
    68,640$
    142,898


The Company has various financial covenant requirements associated with its debt and the UA Agreement. These
covenants require the Company to meet certain financial ratio tests, including tangible net worth, net earnings,
current ratio and debt service levels. The Company was in compliance with such covenants at December 31, 2003.5.
    
    Obligations
Under Capital
Leases
    
    The Company leases certain equipment for noncancelable terms of more than one year. These lease agreements expire on
various dates through 2008. The net book value of the equipment under capital leases at December 31, 2002 and 2003 was
$2.2 million and $499,000, respectively. The leases were capitalized at the present value of the lease payments. The
weighted average interest rate for these leases is approximately 5.0%.At December 31, 2003, the future minimum payments, by year and in the aggregate, together with the present value of the
net minimum lease payments, are as follows:


(in thousands)Year Ending December 31,2004
    
    $
    1802005
    
    
    1862006
    
    
    1012007
    
    
    882008
    
    
    7Total future minimum lease payments
    
    
    562Amount representing interest
    
    
    47Present value of minimum lease payments
    
    
    515Less: Current maturities
    
    
    159$
    356


80



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

6.
    
    OperatingLeases
    
    Future minimum lease payments under noncancelable operating leases at December 31, 2003 are as follows:


(in thousands)Year ending December 31,
    
    Aircraft
    
    Other
    
    Total2004
    
    $
    147,292
    
    $
    8,904
    
    $
    156,1962005
    
    
    147,597
    
    
    8,641
    
    
    156,2382006
    
    
    145,315
    
    
    8,640
    
    
    153,9552007
    
    
    138,598
    
    
    8,364
    
    
    146,9622008
    
    
    128,478
    
    
    7,417
    
    
    135,895Thereafter
    
    
    1,008,168
    
    
    44,890
    
    
    1,053,058Total minimum
lease payments
    
    $
    1,715,448
    
    $
    86,856
    
    $
    1,802,304


Certain of the Companys leases require aircraft to be in a specified maintenance condition at lease
termination or upon return of the aircraft.The Companys lease agreements generally provide that the Company pays taxes, maintenance, insurance and
other operating expenses applicable to leased assets. Operating lease expense was $107.4 million, $133.6
million and $154.1 million for the years ended December 31, 2001, 2002 and 2003, respectively.7.
    
    Stockholders
Equity
    
    Stock Option PlansThe Companys 1992 Stock Option Plan had 3.0 million shares of which all have been granted. The Companys
1995 Stock Incentive Plan has 5.0 million shares of which the majority had been granted by year-end 1999.
In 2000, the Companys shareholders approved a new 2000 Stock Incentive Plan for 4.0 million shares. The
shareholder approved plans provide for the issuance of incentive stock and non qualified stock options to
purchase common stock of the Company and restricted stock awards to certain employees and directors of the
Company. During 2000, the Companys Board of Directors approved stock option programs for an additional
2.4 million shares. The Board approved programs provide for the issuance of non-qualified stock options to
purchase common stock of the Company and restricted stock awards to certain employees. Executive officers
and directors of the Company are not eligible to participate in the Board authorized stock option
programs. Under the plans and programs, options are granted by the Chief Executive Officer of the Company
with approval from the Compensation Committee of the Board of Directors and vest over a period ranging
from three to five years.


81



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

A summary of the status of the Companys stock option plan awards, including restricted stock awards as of December 31, 2001, 2002, and 2003 and changes during the periods ending on those dates is presented below:


2001
    
    2002
    
    2003Weighted-average
    
    
    
    
    
    Weighted-average
    
    
    
    
    
    Weighted-averageShares
    
    exercise price
    
    Shares
    
    exercise price
    
    Shares
    
    exercise priceOptions outstanding at beginning of year
    
    
    4,576,994
    
    
    $
    8.57
    
    
    
    5,194,638
    
    
    $
    12.07
    
    
    
    4,710,831
    
    
    $
    13.12Granted
    
    
    2,202,826
    
    
    $
    14.74
    
    
    
    645,500
    
    
    $
    12.19
    
    
    
    2,003,500
    
    
    $
    9.30Exercised
    
    
    1,524,482
    
    
    $
    5.35
    
    
    
    1,025,982
    
    
    $
    6.87
    
    
    
    149,103
    
    
    $
    6.81Canceled
    
    
    60,700
    
    
    $
    14.90
    
    
    
    103,325
    
    
    $
    16.34
    
    
    
    589,758
    
    
    $
    13.07Options outstanding at end of year
    
    
    5,194,638
    
    
    $
    12.07
    
    
    
    4,710,831
    
    
    $
    13.12
    
    
    
    5,975,470
    
    
    $
    11.99Options exercisable at year end
    
    
    1,408,608
    
    
    $
    7.88
    
    
    
    1,694,566
    
    
    $
    12.49
    
    
    
    2,762,241
    
    
    $
    13.10Options available for grant at year end
    
    
    3,048,758
    
    
    
    
    
    
    
    2,520,320
    
    
    
    
    
    
    
    1,117,479Weighted-average fair value of options granted
during the year
    
    $
    8.77
    
    
    
    
    
    
    $
    8.05
    
    
    
    
    
    
    $
    6.93


The Company awarded a total of 55,900 shares of restricted stock to certain employees during 2001. These shares vest over four
years and have a provision for accelerated vesting tied to a 25% increase in any 2002 quarters operating results over the prior
years quarter. In the first quarter of 2002, the Companys operating results met the threshold for accelerated vesting and as a
result, these restricted shares vested 100% in April 2002. The Company recognized $1.1 million in compensation expense in 2002,
due to these restricted stock awards and as a result of the accelerated vesting schedule. In 1998, the Company awarded a total of
200,000 shares of restricted stock to certain employees. These shares vest over three to five years. The Company recognized
$298,000, $289,000 and $23,000 in compensation expense for the year ended 2001, 2002 and 2003, respectively, associated with the
1998 restricted stock awards and with certain stock option awards.In December 2003, the Company modified all outstanding stock options to allow the option holders a longer period of time to
exercise an option after a change in control event has occurred. As a result of this modification, these options will be subject
to variable plan accounting treatment if a triggering event were to occur.


82



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##### 



The following table summarizes information about stock options outstanding at December 31, 2003:


Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

Options Outstanding
    
    
    
    
    
    Options ExercisableWeighted-averageremainingNumber outstanding
    
    contractual life
    
    Weighted-average
    
    Number exercisable
    
    Weighted-averageRange of exercise price
    
    at 12/31/03
    
    (years)
    
    exercise price
    
    12/31/03
    
    exercise price$0.00 - $2.79
    
    
    2,800
    
    
    
    1.6
    
    
    $
    1.97
    
    
    
    2,800
    
    
    $
    1.97$2.80 - $5.59
    
    
    89,660
    
    
    
    3.1
    
    
    $
    3.59
    
    
    
    89,660
    
    
    $
    3.59$5.60 - $8.39
    
    
    325,868
    
    
    
    8.7
    
    
    $
    7.03
    
    
    
    42,868
    
    
    $
    6.29$8.40 - $11.19
    
    
    2,347,941
    
    
    
    8.6
    
    
    $
    9.50
    
    
    
    538,816
    
    
    $
    9.70$11.20 - $13.99
    
    
    2,639,015
    
    
    
    7.0
    
    
    $
    13.43
    
    
    
    1,658,986
    
    
    $
    13.33$14.00 - $16.79
    
    
    255,786
    
    
    
    6.1
    
    
    $
    15.87
    
    
    
    211,536
    
    
    $
    15.79$16.80 - $19.59
    
    
    13,000
    
    
    
    7.0
    
    
    $
    17.70
    
    
    
    8,500
    
    
    $
    17.57$19.60 - $22.39
    
    
    131,750
    
    
    
    7.0
    
    
    $
    20.81
    
    
    
    100,250
    
    
    $
    20.73$22.40 - $25.19
    
    
    89,500
    
    
    
    7.9
    
    
    $
    23.38
    
    
    
    71,500
    
    
    $
    23.33$25.20 - $27.99
    
    
    80,150
    
    
    
    7.6
    
    
    $
    26.88
    
    
    
    37,325
    
    
    $
    26.895,975,470
    
    
    
    7.6
    
    
    $
    11.99
    
    
    
    2,762,241
    
    
    $
    13.10


Preferred StockThe Board of Directors of the Company is authorized to provide for the issuance by the Company of preferred stock in one or more series
and to fix the rights, preferences, privileges, qualifications, limitations and restrictions thereof, including, without limitation,
dividend rights, dividend rates, conversion rights, voting rights, terms of redemption or repurchase, redemption or repurchase prices,
limitations or restrictions thereon, liquidation preferences and the number of shares constituting any series or the designation of such
series, without any further vote or action by the stockholders.8.
    
    Employee Benefit
Plans
    
    Employee Stock Ownership PlanThe Company established an Employee Stock Ownership Plan (the ESOP) covering substantially all employees. For each of the years 1992
through 1995, the Company made contributions to the ESOP that were used in part to make loan and interest payments. Shares of common
stock acquired by the ESOP were allocated to each employee based on the employees annual compensation.Effective June 1, 1998, the Board of Directors of the Company voted to terminate the Plan. On March 15, 1999, the Internal Revenue
Service issued a determination letter notifying the Company that the termination of the Plan does not adversely affect the Plans
qualification for federal tax purposes. Upon termination of the Plan, a participant becomes 100% vested in his or her account. In
preparing for the final distribution of ESOP shares to participants, it was determined that a misallocation of shares had occurred in
years 1993 through 1997 resulting in certain eligible participants not receiving some of their


83



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

entitled shares. The Company contributed
the required number of additional shares to the ESOP during the second and third quarters of 1999 when the final calculation was
determined and recognized approximately $250,000 in expense. The Company filed a request for a compliance statement under the IRSs
Voluntary Compliance Resolution Program to obtain Service approval of the Companys response to the share misallocation issue. In
September 1999, the ESOP trustee began distribution of the ESOP assets per participants direction. In 2000 and 2001, additional ESOP
shares were distributed, as participants were located. The ESOP will continue until all participants are located and any remaining
assets are properly distributed. The number of shares remaining in the Plan as of December 31, 2002 and 2003 were 11,789 and 11,304,
respectively.401K PlanEffective January 1, 1992, the Company adopted a 401(k) Plan (the Plan). The Plan covers all employees who meet the Plans eligibility
requirements. Employees may elect a salary reduction contribution of up to 15% of their annual compensation not to exceed the maximum
amount allowed by the Internal Revenue Service.The Plan allows the Company to make discretionary matching contributions for non-union employees, mechanics, and certain flight
attendants, equal to 25% of salary contributions up to 4% of total compensation. Effective with the ratification of the pilots new
union agreement on February 9, 2001, the Companys match for pilots is variable depending upon the pilots length of service and the
Companys operational performance. The Companys matching percentage for a pilot can range from two to six percent of eligible
compensation. The Companys matching contribution for all qualified employees, if any, vests ratably over five years. Contribution
expense was approximately $3.9 million, $1.6 million, and $1.1 million for 2001, 2002 and 2003, respectively. The Companys
contribution expense in 2001 includes estimated costs of $2.9 million for additional contributions to correct operational defects found
in the Companys 401(k) plan in addition to $1 million in discretionary matching contributions. The Companys contribution expense for
2003 includes a reversal of $1.2 million of the $2.9 million in estimated costs recorded in 2001 for operational defects in the Companys
401(k) plan based upon the current expected resolution of these matters with government regulatory agencies.Profit Sharing ProgramsThe Company has profit sharing programs that result in periodic payments to all eligible employees. Profit sharing compensation, which
is based on attainment of certain performance and financial goals, was approximately $6.3 million, $10.3 million, and $1.1 million in
2001, 2002 and 2003, respectively. In 2003, the Company suspended or reduced the payouts due under the profit sharing programs.


84



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

9.
    
    Income Taxes
    
    The provision (benefit) for income taxes includes the following components:


(in thousands)Year Ended December 31,
    
    2001
    
    2002
    
    2003Federal:Current
    
    $
    15,392
    
    
    $
    25,124
    
    
    $
    26,152Deferred
    
    
    4,437
    
    
    
    (2,850
    )
    
    
    18,435Total federal provision
    
    
    19,829
    
    
    
    22,274
    
    
    
    44,587State:Current
    
    
    2,207
    
    
    
    4,388
    
    
    
    4,895Deferred
    
    
    477
    
    
    
    (1,523
    )
    
    
    2,970Total state provision
    
    
    2,684
    
    
    
    2,865
    
    
    
    7,865Total provision
    
    $
    22,513
    
    
    $
    25,139
    
    
    $
    52,452


A reconciliation of income tax expense at the applicable federal statutory income tax rate of 35% to the tax provision
recorded is as follows:


(in thousands)Year ended December 31,
    
    2001
    
    2002
    
    2003Income tax expense at statutory rate
    
    $
    19,892
    
    
    $
    22,549
    
    
    $
    47,337Increase (decrease) in tax expense due to:Permanent differences and other
    
    
    877
    
    
    
    711
    
    
    
    2State income taxes, net of federal benefit
    
    
    1,744
    
    
    
    1,879
    
    
    
    5,113Income tax expense
    
    $
    22,513
    
    
    $
    25,139
    
    
    $
    52,452


Deferred income taxes result from temporary differences which are the result of provisions of the tax laws that either
require or permit certain items of income or expense to be reported for tax purposes in different periods than for financial
reporting purposes.


85



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

The following is a summary of the Companys deferred income taxes as of December
31, 2002 and 2003:


(in thousands)December 31,
    
    2002
    
    2003Deferred tax assets:Engine maintenance accrual
    
    $
    3,212
    
    
    $
    3,576Intangible assets
    
    
    333
    
    
    
    97Air traffic liability
    
    
    432
    
    
    
    445Allowance for bad debts
    
    
    1,248
    
    
    
    4,180Deferred aircraft rent
    
    
    2,824
    
    
    
    797Deferred credits
    
    
    2,431
    
    
    
    17,165Accrued compensation
    
    
    1,964
    
    
    
    2,328Accrued aircraft early retirement charge
    
    
    18,587
    
    
    
    7,192Start up and organizational costs
    
    
    1,227
    
    
    
    752Other
    
    
    5,787
    
    
    
    7,626Total deferred tax assets
    
    
    38,045
    
    
    
    44,158Deferred tax liabilities:Depreciation and amortization
    
    
    (43,277
    )
    
    
    (71,118
    )Accrued expenses and other
    
    
    (1,038
    )
    
    
    (715
    )Total deferred tax liabilities
    
    
    (44,315
    )
    
    
    (71,833
    )Net deferred income tax liabilities
    
    $
    (6,270
    )
    
    $
    (27,675
    )


No valuation allowance was established in either 2002 or 2003, as the
Company believes it is more likely than not that the deferred tax
assets will be realized.


86



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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

10.
    
    Commitments
and Contingencies
    
    AircraftAs of December 31, 2003, the Company had a total of 34 Bombardier CRJ200s
(CRJs) on order from Bombardier, Inc., and held options for 80 additional
CRJs. Of the 34 firm aircraft deliveries, 6 are scheduled for 2004 and an
additional 28 are scheduled for 2005. The Company is obligated to purchase
and finance (including leveraged leases) the firm ordered aircraft at an
approximate capital cost of $0.7 billion. The 34 firm ordered aircraft are
subject to United assuming the current United Express Agreements in bankruptcy
court, and certain other 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 Company has signed Memoranda of Understanding for the lease of 10 and
purchase of 15 Airbus narrowbody aircraft. The commitment to lease or
purchase these aircraft is subject to negotiating definitive lease and
purchase agreements which were not completed as of December 31, 2003.Deferred Compensation ArrangementsThe Company has committed to provide its senior executive officers a deferred
compensation plan which utilizes split dollar life insurance policies, and for
a certain officer, a make-whole provision for taxes, post retirement salary
based on ending salary, and post retirement benefits based on benefits similar
to those currently provided to the executive while actively employed. The
Company has estimated the cost of the deferred compensation and tax gross up
feature, future salary and future benefits and is accruing this cost over the
remaining required service time of the executive officer. The Company
expensed $1.8 million and $2.5 million for these benefits for the year ending
December 31, 2002 and 2003, respectively. The Company expects to recognize
similar costs annually over the remaining service life of the senior
executives.TrainingThe 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.


87



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

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.At December 31, 2003, the Companys minimum payment obligations under the
PAIFA agreements for the CRJ simulator is as follows:


(in thousands)Year ended December 31,2004
    
    $
    1,3912005
    
    
    1,1782006
    
    
    1,1952007
    
    
    1,2132008
    
    
    1,230Thereafter
    
    
    2,518Total
    
    $
    8,725


Derivative Financial InstrumentsThe Company has periodically entered into a series of put and call contracts
as an interest rate hedge designed to limit its exposure to interest rate
changes on the anticipated issuance of permanent financing relating to the
delivery of the CRJ aircraft. During 2001, the Company settled one hedge
transaction paying the counterparty $722,000. The Company had no interest
rate hedge transactions in 2002 and 2003.11.
    
    Aircraft Early
Retirement Charge
    
    The Company has long-term lease commitments for 25 British Aerospace Turboprop
J-41 (J-41) aircraft and owns five J-41 aircraft. During 2001 and 2002, the
Company recorded aircraft early retirement operating charges totaling $23.0
million and $24.3 million ($13.8 million and $14.6 million net of income tax),
respectively, for the non-discounted value of future lease payments and other
costs associated with the planned retirement of its J-41 aircraft. After
retiring three J-41s, the Company delayed the retirement schedule of its
remaining J-41 turboprop aircraft as a result of uncertainty over the
Companys contractual relationship with United,. As such, in the second
quarter 2003, the Company reversed $34.6 million in pretax early aircraft
retirement charges that had been recorded in prior periods. Under FASB
Statement No. 146, which the Company adopted effective January 1, 2003, the
Company will now recognize an early aircraft retirement charge as each of the
remaining 20 leased J-41 aircraft is retired from its fleet. The


88



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Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements



---

Company retired two leased J-41s in the fourth quarter of 2003 and recorded a charge
of $6.9 million pretax and currently anticipates that the remaining J-41s will
be early retired by the end of 2004. The Company does not plan to operate the
J-41s as part of its independent airline operation. The Company estimates
that it will expense approximately $50 million (pre-tax) relating to the
remaining 20 leased J-41s as the aircraft are retired. During fourth quarter
2003, the Company also retired one owned aircraft. The Company recognized an
impairment loss of approximately $738,000 ($452,000 net of income tax) for the
retired owned aircraft included in depreciation expense for the year ended
December 31, 2003. The remaining four owned J-41s and all of the Companys
associated spare parts inventories are being depreciated over their estimated
remaining service in the United Express program. The Company estimates that
the fair market value of the remaining four owned J-41 aircraft will be below
book value when the aircraft are retired from the fleet. As a result, the
Company recognized $1.0 million and $3.2 million in additional depreciation
charges related to owned aircraft for the year ended December 31, 2002 and
2003, respectively.The Company plans to actively remarket the J-41s through leasing, subleasing
or outright sale of the aircraft. Any sales arrangements involving leased
aircraft may require the Company to make payments to the leasor to cover
shortfalls between sale prices and lease stipulated loss values. In
calculating the amount of charge recorded for the 2003 retirements, the
sublease income was estimated to be zero.As of December 31, 2003, the Company had liabilities of $18.0 million accrued
for the four leased J-41 aircraft that have been early retired and not yet
disposed of.Changes in the aircraft early retirement charge liability for the years ending
December 31, 2002 and 2003 are as follows:


(in thousands)
    
    2002
    
    2003Beginning balance as of January 1,
    
    $
    23,887
    
    
    $
    46,468Estimated charge for aircraft early retirement
    
    
    24,531
    
    
    
    6,932Reversal of estimated charge for aircraft early retirement
    
    
    (200
    )
    
    
    (34,586
    )Cash payments
    
    
    (1,750
    )
    
    
    (835
    )Balance as of December 31,
    
    $
    46,468
    
    
    $
    17,979


89



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

12.
    
    Air Transportation Safety and System Stabilization
Act/Aviation and Transportation Security Act
    
    On September 22, 2001, President Bush signed into law the Air
Transportation Safety and System Stabilization Act (the
Stabilization Act). The Stabilization Act provided 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 has complied with the requirements of the Stabilization Act
and submitted its final claim. The Company and the Airline
Stabilization Review Team have reached agreement on $10.7 million as
the total amount the Company was eligible to receive as direct
compensation under the Stabilization Act. The Company has recorded
and received payment of $9.7 million and $0.9 million as government
compensation for the years 2001 and 2002, respectively. All amounts
received as government compensation are subject to additional audit
by the federal government for the next five years.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 be
adopted as well as enhanced airport security procedures. The
Security Act created the Transportation Security Administration
(TSA) that has taken over from the air carriers the reasonability
for conducting the screening of passengers and their baggage. The
TSA assumed both of the Companys passenger screening contracts on
February 17, 2002. Air carriers continue to have responsibility for
aircraft security, employee background checks, the security of air
carrier airport facilities and other security related functions.The activities of the TSA are to be 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 is required
to deploy federal air marshals on an increased number of passenger
flights. 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


90



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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.On April 16, 2003, Congress passed the Emergency Wartime Supplemental
Appropriations Act (the Act). The Act makes available
approximately $2.3 billion to United States flag air carriers, a
portion of which is based on each carriers proportional share of the
amounts remitted in passenger and carrier security fees by eligible
air carriers to the TSA under the Stabilization Act which was earlier enacted
by Congress. In the second quarter of 2003, the Company received and
recorded $1.5 million in compensation under the Act. In addition to
refunding previously remitted security fees, the Act waived the
collection and payment by carriers of any passenger or carrier
security fees imposed by the Stabilization Act for the period June 1,
2003 through September 30. 2003. The Act also extended by 24 months
the governments war risk insurance program which otherwise would
have expired on December 31, 2002. The FAA provides war risk
insurance to carriers pursuant to the Act through short-term
policies, which it extends from time to time. The Company
anticipates renewing the insurance through the FAA as long as it is
available.13.
    
    Subsequent
Event
    
    In January 2004 the Company executed the lease agreements for the first four Airbus A319 aircraft with a third
party leasing company. The aircraft will be delivered one a month beginning in September 2004 and will have an
initial term of five years. The leases require the Company to put up a security deposit and to make monthly rent
and maintenance reserve payments. Annual cash rent for the four aircraft is estimated to be approximately $12.7
million.14.
    
    Litigation
    
    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 that was delivered to secure 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. The Company has fully reserved for
this receivable.


91



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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.


92



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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


93



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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, 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


94



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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. The Company incurred approximately
$9.6 million in expenses related to its defense of Mesas hostile takeover offer.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.


95



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

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.15.
    
    Financial
Instruments
    
    Statement of Financial Accounting Standards No. 107, Disclosure of Fair Value of Financial Instruments requires
the disclosure of the fair value of financial instruments. Some of the information used to determine fair value
is subjective and judgmental in nature; therefore, fair value estimates, especially for less marketable
securities, may vary. The amounts actually realized or paid upon settlement or maturity could be significantly
different.Unless quoted market price indicates otherwise, the fair values of cash and cash equivalents, short-term
investments, accounts receivable and accounts payable generally approximate market because of the short maturity
of these instruments. The Company has estimated the fair value of long term debt based on quoted market prices,
when available, or by discounted expected future cash flows using current rates offered to the Company for debt
with similar maturities.


96



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

The estimated fair values of the Companys financial instruments, none of which are
held for trading purposes, are summarized as follows (brackets denote liability):


(in thousands)
    

December
31, 2002
    

December
31, 2003Carrying
    
    Estimated
    
    Carrying
    
    EstimatedAmount
    
    Fair Value
    
    Amount
    
    Fair ValueCash and cash equivalents
    
    $
    29,261
    
    
    $
    29,261
    
    
    $
    95,879
    
    
    $
    95,879Short-term investments
    
    
    213,360
    
    
    
    213,360
    
    
    
    202,055
    
    
    
    202,055Accounts receivable
    
    
    13,870
    
    
    
    13,870
    
    
    
    9,071
    
    
    
    9,071Accounts payable
    
    
    (22,475
    )
    
    
    (22,475
    )
    
    
    (24,842
    )
    
    
    (24,842
    )Long-term debt
    
    
    (58,440
    )
    
    
    (63,265
    )
    
    
    (142,898
    )
    
    
    (143,373
    )


16.
    
    Supplemental Cash Flow
    
    Supplemental disclosures of cash flow information:Information


Year ended December 31,(in thousands)2001
    
    2002
    
    2003Cash paid during the period for:- Interest
    
    $
    4,811
    
    
    $
    4,382
    
    
    $
    5,657- Income taxes
    
    
    7,837
    
    
    
    24,353
    
    
    
    26,158Non-cash transactions for:- Purchase of aircraft
    
    $
    
    
    
    $
    
    
    
    $
    83,258


The following non cash investing and financial activities took
place in 2001, 2002 and 2003:In 2001, the Company capitalized $2.6 million in interest related
to $44.8 million on deposit with aircraft manufacturers.In 2002, the Company capitalized $1.4 million (net of a reversal
$1.1 million of capitalized interest in connection with the
cancellation of future deliveries of 328Jets due to the Fairchild
Dornier insolvency) in interest related to $44.8 million on deposit
with aircraft manufacturers.In 2003, the Company capitalized $0.1 million (net of a reversal
$0.8 million of capitalized interest related to CRJ aircraft that
are scheduled to be delivered in 2004 and 2005) in interest related
to $38.8 million on deposit with Bombardier.In 2003, the Company obtained $30.7 million in seller financing for
two aircraft and agreed with the seller to apply the present value
of a portion of future manufacturers credits and payments toward
the purchase of goods and services, including aircraft on order.
This results in $43.5 million of deferred credits that are being
amortized over the life of the aircraft associated with the
original manufacturers credit.


97



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

17.
    
    Recent Accounting
Pronouncements
    
    In January 2003, the Financial
Accounting Standards Board issued
FASB Interpretation No. 46, (FIN
46) Consolidation of Variable
Interest Entities, (VIEs), an
interpretation of Accounting
Research Bulletin No. 51,
Consolidated Financial Statements.
This interpretation was revised by
the Financial Accounting Standards
Board in December 2003. This
interpretation requires an existing
unconsolidated variable interest
entity to be consolidated by its
primary beneficiary if the entity
has (1) an insufficient amount of
equity to absorb the entitys
expected losses, (2) equity owners
as a group are not able to make
decisions about the entitys
activities, or (3) equity that does
not absorb the entitys losses or
receive the entitys residual
returns. The primary beneficiary is
the party that absorbs a majority of
the entitys expected losses,
receives a majority of its expected
residual returns, or both, as a
result of holding variable
interests, which are the ownership,
contractual, or other pecuniary
interests in an entity. As a
result, variable interest entities
can arise from items such as lease
agreements, loan arrangements,
guarantees or service contracts.
Effective February 1, 2003, the
Company adopted the requirement of
FIN 46 for any interests in VIEs
acquired after January 31, 2003.
Effective December 2003, the Company
adopted all requirements of the
revised FIN 46.The Company has variable interests
in the following types of variable
interest entities:Aircraft Leases. The Company is the
lessee in a series of leveraged
operating lease transactions
relating to four J-41s and six CRJs
in conjunction with the issuances of
the Equipment Notes described in
Note 4. The lessors are trusts
established specifically to
purchase, finance and lease aircraft
to the Company. These leasing
entities meet the criteria for
variable interest entities. Based on
analysis by the Company, the terms
of the lease were consistent with
market terms at the inception of the
lease and do not contain a residual
value guarantee. However, the lease
agreements do contain a fixed price
purchase option on a specific date
during the lease term. The Company
has not consolidated the related
trusts upon application of FIN 46
because it believes that it is not
the primary beneficiary based on the
analysis performed that takes into
account the purchase options. The Companys
anticipated maximum exposure under
these leases is the remaining lease
payments, which are reflected in
future lease commitments in Note 6.Airport Hangar Lease.The Company is
the lessee of a hangar located at
Dulles International Airport under a
long-term operating lease and is
also the guarantor of approximately
$12.3 million of underlying debt and
interest, thereon, issued by the
Industrial Development Authority of


98



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

Loudon County, Virginia for the
construction of the facility. The
hangar is leased from the
Metropolitan Washington Airports
Authority, a government agency that
holds title to the property. The
Company has not consolidated the
entity under the requirements of FIN
46 because arrangements with
governmental entities and financing
entities established by governmental
agencies are not applicable to this
interpretation. The payments for
the underlying debt are included as
part of the operating lease
agreement. The Companys
anticipated maximum exposure under
this lease is the remaining lease
payments, which are reflected in
future lease commitments in Note 6.In November 2002, the Financial
Accounting Standards Board issued
FASB Interpretation No. 45,
Guarantors Accounting and
Disclosure Requirements for
Guarantees, Including Indirect
Guarantees of Indebtedness of
Others, an interpretation of FASB
Statements No. 5, 57 and 107 and
rescission of FASB Interpretation
No. 34. This interpretation outlines
disclosure requirements in a
guarantors financial statements
relating to any obligations under
guarantees for which it may have
potential risk or liability, as well
as clarifies a guarantors
requirement to recognize a liability
for the fair value, at the inception
of the guarantee, of an obligation
under that guarantee. The initial
recognition and measurement
provisions of this interpretation
are effective for guarantees issued
or modified after December 31, 2002
and the disclosure requirements are
effective for financial statements
of interim or annual periods ending
after December 15, 2002. As of
December 31, 2003, we have not
provided any guarantees that would
require recognition or disclosure as
liabilities under this
interpretation.Effective January 1, 2003, the
Company adopted Statement No. 146,
Accounting for Costs Associated
with Exit or Disposal Activities,
which requires that liabilities for
the costs associated with exit or
disposal activities be recognized
when the liabilities are incurred,
rather than when an entity commits
to an exit plan. Adoption of this
statement changes the timing of the
liability and expense recognition
related to exit or disposal
activities, but not the ultimate
amount of such expenses. See Note
11 of Notes to Condensed
Consolidated Financial Statements
for the impact of this statement on
the Companys plan to retire its
J-41 aircraft fleet.


99



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

18.
    
    Selected
Quarterly Financial
Data (Unaudited)


Quarter Ended(in
thousands, except per share amounts)March 31,
    
    June 30,
    
    September 30,
    
    December 31,2003
    
    2003
    
    2003
    
    2003Operating revenues
    
    $
    204,209
    
    
    $
    227,130
    
    
    $
    221,036
    
    
    $
    224,036Operating income
    
    
    3,851
    
    
    
    77,206
    1
    
    
    37,374
    
    
    
    19,472
    1Net income (loss)
    
    
    1,996
    
    
    
    45,735
    1,3
    
    
    21,332
    
    
    
    13,736
    1Net income (loss)
per shareBasic
    
    $
    0.04
    
    
    $
    1.01
    
    
    $
    0.47
    
    
    $
    0.30Diluted
    
    $
    0.04
    
    
    $
    1.01
    
    
    $
    0.47
    
    
    $
    0.30Weighted average
shares outstandingBasic
    
    
    45,225
    
    
    
    45,247
    
    
    
    45,333
    
    
    
    45,333Diluted
    
    
    45,328
    
    
    
    45,344
    
    
    
    45,425
    
    
    
    45,648


Quarter EndedMarch 31,
    
    June 30,
    
    September 30,
    
    December 31,2002
    
    2002
    
    2002
    
    2002Operating revenues
    
    $
    172,966
    
    
    $
    188,193
    
    
    $
    195,033
    
    
    $
    204,332Operating income
    
    
    23,698
    
    
    
    28,633
    2
    
    
    13,051
    2
    
    
    (2,749
    )2Net income (loss)
    
    
    14,319
    
    
    
    17,436
    2,4
    
    
    8,500
    2
    
    
    (969
    )2Net income (loss)
per shareBasic
    
    $
    0.32
    
    
    $
    0.39
    
    
    $
    0.19
    
    
    $
    (0.02
    )Diluted
    
    $
    0.31
    
    
    $
    0.38
    
    
    $
    0.19
    
    
    $
    (0.02
    )Weighted average
shares outstandingBasic
    
    
    44,677
    
    
    
    45,115
    
    
    
    45,194
    
    
    
    45,195Diluted
    
    
    46,367
    
    
    
    46,305
    
    
    
    45,484
    
    
    
    45,195


100



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##### 



Atlantic Coast Airlines Holdings, Inc.
Notes to Consolidated Financial Statements

1In the second and fourth quarters of 2003, the Company recorded aircraft early retirement charges. The amount of the charges were $(34.6) million
(pre-tax) credit in the second quarter to reverse amounts recorded in the years ended 2001 and 2002 and $6.9 million (pre-tax) in the fourth quarter.

2In the second, third and fourth quarters of 2002, the Company recorded aircraft early retirement charges. The amount of the charges were $(4.8) million
(pre-tax) credit in the second quarter to reverse amounts recorded in the fourth quarter of 2001, $7.6 million (pre-tax) in the third quarter, and $21.5
million in the fourth quarter.

3Includes government compensation of $1.5 million in the second quarter of 2003.

4Includes government compensation of $0.9 million in the second quarter of 2002.

Note: The sum of the four quarters may not equal the totals for the year due to rounding of quarterly results.

101



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##### 



Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None to report.

Item 9A. Controls and Procedures

As of December 31, 2003 the Company carried out an evaluation, under the
supervision and with the participation of the Companys management, including
the Companys principal executive officer and principal financial officer, of
the effectiveness of the design and operation of the Companys disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14 and 13a15.
Disclosure controls and procedures include controls and other procedures
designed to ensure that information required to be disclosed in the Companys
reports filed under the Exchange Act, such as this Form 10-K, is properly
recorded, processed, summarized and reported within the time periods required
by the Securities and Exchange Commissions rules and forms. Management
necessarily applied its judgment in assessing the costs and benefits of such
controls and procedures that, by their nature, can provide only reasonable
assurance regarding managements control objectives. Management does not expect
that its disclosure controls and procedures will prevent all errors and fraud.
A control system, irrespective of how well it is designed and operated, can
only provide reasonable assurance, and cannot guarantee, that it will succeed
in its stated objectives.

Based upon the foregoing evaluation, the principal executive officer and
principal financial officer concluded that the Companys disclosure controls
and procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to
be included in the Companys periodic SEC reports. In addition, during the
period covered by this annual report, there have been no changes to the
Companys internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting.

PART III

Item 10. Directors and Executive Officers of the Registrant

The information required by this Item is hereby incorporated by reference
from the Companys definitive proxy statement, which is expected to be filed
pursuant to Regulation 14A of the Securities Exchange Act of 1934 not later
than 120 days after the end of the fiscal year covered by this report.

Item 11. Executive Compensation

The information required by this Item is hereby incorporated by reference
from the Companys definitive proxy statement, which is expected to be filed
pursuant to Regulation 14A of the Securities Exchange Act of 1934 not later
than 120 days after the end of the fiscal year covered by this report.

102



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##### 



Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information as of December 31, 2003 regarding equity compensation plans
approved and not approved by shareholders is summarized in the following table:

Number of securitiesremainingNumber of
    
    
    
    
    
    available forsecurities to
    
    
    
    
    
    future issuancebe issued
    
    
    
    
    
    under equityupon
    
    
    
    
    
    compensationexercise of
    
    Weighted-average
    
    plansoutstanding
    
    exercise price of
    
    (excludingoptions,
    
    outstanding
    
    securitieswarrants and
    
    options, warrants
    
    reflected inPlan category
    
    rights
    
    and rights
    
    column (a))(a)
    
    (b)
    
    (c)Equity compensation plans approved by shareholders
    
    
    3,993,345
    
    
    $
    11.64
    
    
    
    825,852Equity compensation plans not approved by
shareholders
    
    
    1,982,125
    
    
    $
    12.68
    
    
    
    291,627Total
    
    
    5,975,470
    
    
    $
    11.99
    
    
    
    1,117,479


The Company has two equity compensation plans that were not approved by
shareholders, pursuant to which options, rights or warrants may be granted:
the Non-Executive Officer Stock Option Plan (the Non-Executive Officer Plan)
and the Non-Officer Option Grant Program (the Non-Officer Option Program).
The Companys Board of Directors approved these two plans in 2000.

Non-Executive Officer Stock Option Plan

The Non-Executive Officer Plan is substantially identical to the Companys
2000 Stock Incentive Plan, which was approved by shareholders. The
Non-Executive Officer Plan allows the Company to grant equity compensation
under non-qualified stock options and restricted stock awards. Eligible
participants are employees, as defined under Securities and Exchange Commission
Form S-8, and prospective employees of the Company or any of its affiliates who
are not executives or directors of the Company. A maximum of 2 million shares
of common stock are authorized for issuance under the Non-Executive Officer
Stock Option Plan. The exercise price of options granted under the plan can
not be less than 100% of the fair market value of a share of the Companys
stock on the option grant date. Awards are granted by the Chief Executive
Officer of the Company with approval from the Compensation Committee of the
Board of Directors. The terms of awards granted under the Non-Executive
Officer Plan, including vesting, forfeiture, post-termination exercisability
and the effects (if any) of a change in control, are set by the plan
administrator subject to certain restrictions set forth in the Non-Executive
Officer Plan.

103



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##### 



Non-Officer Option Grant Program

There are 400,000 shares reserved for issuance under the Non-Officer
Option Program. Options granted under the Non-Officer Option Program are
subject to the same terms as non-qualified stock options granted under the
Companys 1995 Stock Incentive Plan or the Companys 2000 Stock Incentive Plan
(both of which were approved by shareholders), as specified in the terms of any
such grant. The exercise price of options granted under the plan can not be
less than 100% of the fair market value of a share of the Companys stock on
the option grant date. Options are granted by the Chief Executive Officer of
the Company with approval from the Compensation Committee of the Board of
Directors. Stock options granted under the Non-Officer Option Program
generally vest over a period ranging from three to five years and expire 10
years after the date of grant.

Other information required by this Item is hereby incorporated by
reference from the Companys definitive proxy statement, which is expected to
be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 not
later than 120 days after the end of the fiscal year covered by this report.

Item 13. Certain Relationships and Related Transactions

The information required by this Item is hereby incorporated by reference
from the Companys definitive proxy statement, which is expected to be filed
pursuant to Regulation 14A of the Securities Exchange Act of 1934 not later
than 120 days after the end of the fiscal year covered by this report.

Item 14. Principal Auditor Fees and Services

The information required by this Item is hereby incorporated by reference
from the Companys definitive proxy statement, which is expected to be filed
pursuant to Regulation 14A of the Securities Exchange Act of 1934 not later
than 120 days after the end of the fiscal year covered by this report.

PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)
    
    
    1.
    
    
    Financial StatementsThe Consolidated Financial Statements listed in the index in Part II, Item 8,
are filed as part of this report.2.
    
    
    Consolidated Financial Statement SchedulesReference is hereby made to the Consolidated Financial
Statements and the Notes thereto included in this filing in
Part II, Item 8.3.
    
    
    Exhibits


104



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##### 



ExhibitNumber
    
    Description of Exhibit3.1 (note 8)
    
    Restated Certificate of Incorporation of the Company.3.2 (note 1)
    
    Restated By-laws of the Company.4.1 (note 13)
    
    Specimen Common Stock Certificate.4.19 (note 14)
    
    Rights Agreement between Atlantic Coast Airlines Holdings, Inc.
and Continental Stock Transfer & Trust Company dated as of January 27,
1999.10.1 (notes 16 and 18)
    
    Atlantic Coast Airlines, Inc. 1992 Stock Option Plan.10.6 (notes 9 and 17)
    
    United Express Agreement, dated as of November 22, 2000,
as amended as of February 6, 2001, among United Airlines, Inc., Atlantic
Coast Airlines and the Company.10.6(a) (notes 5 and 17)
    
    Amendment dated June 4, 2002 to United Express
Agreement, dated as of November 22, 2000, among United Airlines, Inc.,
Atlantic Coast Airlines and the Company.10.8 (notes 12 and 17)
    
    Delta Connection Agreement, dated as of September 9,
1999 among Delta Air Lines, Inc., Atlantic Coast Airlines Holdings, Inc.
and Atlantic Coast Jet, Inc.10.8(a) (notes 2 and 17)
    
    Amendment No. 1, dated June 29, 2000, Amendment No. 2,
dated February 6, 2001, Amendment No. 3, dated January 29, 2002, and
Amendment No. 4, dated January 22, 2003, to the Delta Connection
Agreement, dated as of September 9, 1999 among Delta Air Lines, Inc.,
Atlantic Coast Airlines Holdings, Inc. and Atlantic Coast Airlines.10.12(a) (notes 7 and 18)
    
    Second Amended and Restated Severance Agreement,
dated as of July 25, 2001, between the Company and Kerry B. Skeen.10.12(b) (notes 6 and 18)
    
    Amended and Restated Severance Agreement, dated as of
December 28, 2001, between the Company and Thomas J. Moore.10.12(c) (notes 6 and 18)
    
    Form of Severance Agreement substantially similar to
the agreement with Richard J. Surratt, restated as of December 28, 2001.10.12(d) (notes 1 and 18)
    
    Letter Agreement Clarifying the Effect of Temporary
Compensation Reduction Measures and the Severance Agreement with Kerry B.
Skeen, dated as of December 16, 2003.10.12(e) (notes 1 and 18)
    
    Form of Agreement Clarifying the Effect of Temporary
Compensation Reduction Measures substantially similar to agreements with
Thomas J. Moore, Richard J. Kennedy and David W. Asai, all dated as of
December 16, 2003.10.12(f) (notes 1 and 18)
    
    Letter Agreement Clarifying the Severance Agreement
with Thomas J. Moore, dated as of December 16, 2003.10.13(a) (note 3)
    
    Form of Indemnity Agreement. The Company has entered into
substantially identical agreements with the individual members of its
Board of Directors.10.23 (note 1)
    
    Amended and Restated Loan and Security Agreement dated July 31,
2004 between Atlantic Coast Airlines and Wachovia Bank, National
Association10.24 (notes 13 and 18)
    
    Atlantic Coast Airlines, Inc. 1995 Stock Incentive
Plan, as amended as of May 5, 1998.10.245 (notes 10 and 18)
    
    2000 Stock Incentive Plan of Atlantic Coast Airlines Holding, Inc.10.246 (notes 3 and 18)
    
    Non-Executive Officer Stock Plan of Atlantic Coast Airlines Holdings, Inc.10.247 (notes 3 and 18)
    
    Non-Officer Option Grant Program of Atlantic Coast Airlines Holdings, Inc.


105



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##### 



ExhibitNumber
    
    Description of Exhibit10.25(a)(notes 2 and 18)
    
    Form of Incentive Stock Option Agreement. The Company
enters into this agreement with employees who have been granted incentive
stock options pursuant to the Stock Incentive Plans. The exercise price,
vesting schedule, and certain other terms vary among grants, as reflected
in the form of agreement.10.25(b) (notes 2 and 18)
    
    Form of Incentive Stock Option Agreement. The
Company enters into substantially this agreement, adjusted to reflect the
terms of any employment agreements, with corporate officers who have been
granted incentive stock options pursuant to the Stock Incentive Plans. The
exercise price, vesting schedule, and certain other terms vary among
grants, as reflected in the form of agreement.10.25(c) (notes 2 and 18)
    
    Form of Non-Qualified Stock Option Agreement. The
Company enters into this agreement with employees who have been granted
non-qualified stock options pursuant to the Stock Incentive Plans. The
exercise price, vesting schedule, and certain other terms vary among
grants, as reflected in the form of agreement.10.25(d) (notes 2 and 18)
    
    Form of Non-Qualified Stock Option Agreement. The
Company enters into substantially this agreement, adjusted to reflect the
terms of any employment agreements, with corporate officers who have been
granted non-qualified stock options pursuant to the Stock Incentive Plans.
The exercise price, vesting schedule, and certain other terms vary among
grants, as reflected in the form of agreement.10.25(e) (notes 13 & 18)
    
    Form of Restricted Stock Agreement. The Company
entered into this agreement with corporate officers who were granted
restricted stock pursuant to the Stock Incentive Plans.10.25(f) (notes 2 and 18)
    
    Form of Directors Stock Option Agreement. The
Company enters into this agreement with directors who have been granted
stock options pursuant to the Companys Stock Incentive Plans. The
exercise price, vesting schedule, and certain other terms vary among
grants, as reflected in the form of agreement.10.27 (notes 11 and 18)
    
    Form of Split Dollar Agreement and Agreement of
Assignment of Life Insurance Death Benefit as Collateral. The Company has
entered into substantially identical agreements with Kerry B. Skeen,
Thomas J. Moore and Richard J. Surratt.10.31 (notes 1 and 18)
    
    Summary of Senior Management Incentive Plan. The
Company has adopted a plan as described in this exhibit for 2003 and for
the four previous years.10.32 (notes 1 and 18)
    
    Summary of Management Incentive Plan and Share the
Success Program. The Company has adopted plans as described in this
exhibit for 2003 and for the four previous years.10.40A (notes 13 and 17)
    
    Purchase Agreement between Bombardier Inc. and
Atlantic Coast Airlines Relating to the Purchase of Canadair Regional Jet
Aircraft dated January 8, 1997, as amended through December 31, 1998.10.40A(1)(notes 12 & 17)
    
    Contract Change Orders No. 13, 14, and 15, dated April
28, 1999, July 29, 1999, and September 24, 1999, respectively, amending
the Purchase Agreement between Bombardier Inc. and Atlantic Coast Airlines
relating to the purchase of Canadair Regional Jet Aircraft dated January
8, 1997.10.41 (notes 12 & 17)
    
    Purchase Agreement between Bombardier Inc. and Atlantic
Coast Airlines relating to the Purchase of Canadair Regional Jet Aircraft
dated July 29, 1999, as amended through September 30, 1999.10.41(a) (notes 12 & 17)
    
    Purchase Agreement between Bombardier Inc. and
Atlantic Coast Airlines relating to the Purchase of Canadair Regional Jet
Aircraft dated July 29, 1999, as amended.


106



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##### 



ExhibitNumber
    
    Description of Exhibit10.41A(1) (notes 4 & 17)
    
    Contract Change Orders No. 1, 2, 3, 4, 5 and 6 dated
September 24, 1999, August 2, 2000, December 6, 2000, November 7, 2001,
December 20, 2001 and July 19, 2002, respectively, amending the Purchase
Agreement between Bombardier Inc. and Atlantic Coast Airlines relating to
the purchase of Canadair Regional Jet Aircraft dated July 29, 1999.10.50(a) (note 15)
    
    Form of Purchase Agreement, dated September 19, 1997, among
the Company, Atlantic Coast Airlines, Morgan Stanley & Co. Incorporated
and First National Bank of Maryland, as Trustee.10.50(b) (note 15)
    
    Form of Pass Through Trust Agreement, dated as of September
25, 1997, among the Company, Atlantic Coast Airlines, and First National
Bank of Maryland, as Trustee.10.50(c) (note 15)
    
    Form of Pass Through Trust Certificate.10.50(d) (note 15)
    
    Form of Participation Agreement, dated as of September 30,
1997, Atlantic Coast Airlines, as Lessee and Initial Owner Participant,
State Street Bank and Trust Company of Connecticut, National Association,
as Owner Trustee, the First National Bank of Maryland, as Indenture
Trustee, Pass-Through Trustee, and Subordination Agent, including, as
exhibits thereto, Form of Lease Agreement, Form of Trust Indenture and
Security Agreement, and Form of Trust Agreement.10.50(e) (note 15)
    
    Guarantee, dated as of September 30, 1997, from the Company.10.80 (note 15)
    
    Ground Lease Agreement Between The Metropolitan Washington
Airports Authority And Atlantic Coast Airlines dated as of June 23, 1997.10.85 (note 13)
    
    Lease Agreement Between The Metropolitan Washington Airports
Authority and Atlantic Coast Airlines, with amendments as of January 1,
1999.21.1 (note 1)
    
    Subsidiaries of the Company.23.1 (note 1)
    
    Consent of KPMG LLP.31.1 (note 1)
    
    Certification of CEO31.2 (note 1)
    
    Certification of CFO32.1 (note 1)
    
    Certification pursuant to 8 U.S.C. section 1350, as adopted
pursuant to section 906 of the Sarbanes-Oxley Act of 2002


Notes



|(1) |  | Filed as an Exhibit to this Annual Report on Form 10-K for the fiscal
year ended December 31, 2003.
|--- |  | ---------------------------------------------------------------------------------------------------



|(2) |  | Filed as an Exhibit to the Quarterly Report on Form 10-Q for the
three-month period ended March 31, 2003.
|--- |  | ---------------------------------------------------------------------------------------------------------



|(3) |  | Filed as an Exhibit to the Annual Report on Form 10-K for the fiscal year
ended December 31, 2002.
|--- |  | --------------------------------------------------------------------------------------------------



|(4) |  | Filed as an Exhibit to the Quarterly Report on Form 10-Q for the
three-month period ended September 30, 2002.
|--- |  | -------------------------------------------------------------------------------------------------------------



|(5) |  | Filed as an Exhibit to the Quarterly Report on Form 10-Q for the
three-month period ended June 30, 2002.
|--- |  | --------------------------------------------------------------------------------------------------------



|(6) |  | Filed as an Exhibit to the Annual Report on Form 10-K for the fiscal year
ended December 31, 2001.
|--- |  | --------------------------------------------------------------------------------------------------



|(7) |  | Filed as an Exhibit to the Quarterly Report on Form 10-Q for the
three-month period ended
September 30, 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------

107



---



##### 





|(8) |  | Filed as an Exhibit to the Quarterly Report on Form 10-Q for the
three-month period ended June 30, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------



|(9) |  | Filed by Exhibit to the Annual Report on Form 10-K for the fiscal year
ended December 31, 2000.
|--- |  | -----------------------------------------------------------------------------------------------



|(10) |  | Filed as an Exhibit to the Quarterly Report on Form 10-Q for the
three-month period ended June 30, 2000.
|---- |  | --------------------------------------------------------------------------------------------------------



|(11) |  | Filed as an Exhibit to the Amended Annual Report on Form 10-K/A for the
fiscal year ended December 31, 1999.
|---- |  | ------------------------------------------------------------------------------------------------------------



|(12) |  | Filed as Exhibit to the Quarterly Report on Form 10-Q for the three month
period ended September 30, 1999.
|---- |  | ----------------------------------------------------------------------------------------------------------



|(13) |  | Filed as an Exhibit to the Annual Report on Form 10-K for the fiscal year
ended December 31, 1998.
|---- |  | --------------------------------------------------------------------------------------------------



|(14) |  | Filed as Exhibit 99.1 to Form 8-A (File No. 000-21976).
|---- |  | -------------------------------------------------------



|(15) |  | Filed as an Amendment to the Annual Report on Form 10-K for the fiscal
year ended December 31, 1997.
|---- |  | ----------------------------------------------------------------------------------------------------



|(16) |  | Filed as an Exhibit to Form S-1, Registration No. 33-62206, effective
July 20, 1993.
|---- |  | ------------------------------------------------------------------------------------



|(17) |  | Portions of this document have been omitted pursuant to a request for
confidential treatment that has been granted or has been requested.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------



|(18) |  | This document is a management contract or compensatory plan or
arrangement.
|---- |  | ---------------------------------------------------------------------------

Reports on Form 8-K:

Feb. 10, 2004
    
    FD Disclosure of Deutsche Banc Securities Global Transportation Conference Presentation.Feb. 4, 2004
    
    FD Disclosure of Goldman Sachs Transportation Conference Presentation.Jan. 29, 2004
    
    Regulation FD Disclosure of news release concerning the Companys fourth quarter and
year end 2003 earnings.Jan. 29, 2004
    
    Regulation FD Disclosure of Raymond James & Associates Institutional Investors
Conference Presentation.Dec. 23, 2003
    
    Regulation FD Disclosure of news release concerning the Companys response to Mesa Air
Group, Inc.s announcement that it will not be moving forward with either its proposed
consent solicitation or exchange offer for ACA.Dec. 12, 2003
    
    Regulation FD Disclosure of news release announcing that Institutional Shareholder
Services (ISS) has awarded ACA a Corporate Governance Quotient that ranks the Company
seventh overall in the S&P SmallCap 600 Index in ISSs December 1, 2003 listings.Nov. 21, 2003
    
    Regulation FD Disclosure of news release revealing the name and brand identity of the
Companys low-fare airline, Independence Air.Nov. 19, 2003
    
    Other Events and Regulation FD Disclosure of news release announcing that ACA entered
into a binding memorandum of understanding with Airbus Industrie AVSA.Nov. 10, 2003
    
    Regulation FD Disclosure of news release announcing the ratification by ACAs pilots of a
revised conditional contract.Oct. 22, 2003
    
    Regulation FD Disclosure of news release concerning the Companys third quarter earnings.Oct. 6, 2003
    
    Regulation FD Disclosure of news release concerning the Companys response to
Unsolicited Offer by Mesa Air Group.


108



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##### 



SIGNATURES

Pursuant to the requirements of Section 13 of 15(d) 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 on February 17,
2003.

ATLANTIC COAST AIRLINES HOLDINGS, INC.By:
    
    /S/Kerry B. SkeenChairman of the Board


Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on February 17, 2003.

Name
    
    Title/S/
    
    Chairman of the Board of Directorsand Chief Executive OfficerKerry B. Skeen
    
    (Principal executive officer)/S/
    
    Director, President andChief Operating OfficerThomas J. Moore/S/
    
    Executive Vice President, Treasurer and
Chief Financial OfficerRichard J. Surratt
    
    (Principal financial officer)/S/
    
    Vice President, and Controller(Principal accounting officer)David W. Asai/S/C. Edward Acker
    
    Robert E. BuchananDirector
    
    Director/S/
    
    /S/Susan MacGregor Coughlin
    
    Caroline M. DevineDirector
    
    Director/S/
    
    /S/Daniel L. McGinnis
    
    James C. Miller IIIDirector
    
    DirectorWilliam Anthony RiceDirector


109