##### Table of Contents

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U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON DC 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------



For the quarterly period ended October 2, 2004



| ̈ | TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | -----------------------------------------------------------------------------------



For the transition period from  to
 .



Commission File No. 0-28452



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VELOCITY EXPRESS CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                                      |  |                                  
|--------------------------------------------------------------------- |  | ---------------------------------
|Delaware                                                              |  | 87-0355929                       
|(State or other jurisdiction of incorporation)                        |  | (IRS Employer Identification No.)
|                                                                      | 
|One Morningside Drive North, Bldg. B Suite 300, Westport, Connecticut |  | 06880                            
|(Address of Principal Executive Offices)                              |  | (Zip Code)                       



(203) 349-4160

(Registrants telephone number, including area code)



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Check whether
the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.    YES ̈NO  x



Check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    YES ̈NO  x



As of January 6, 2005 there were 13,405,373 shares of common stock of the registrant issued and outstanding.



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##### Table of Contents

VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



INDEX TO FORM 10-Q



October 2, 2004



|           |  |                                                                                            |  |     
|---------- |  | ------------------------------------------------------------------------------------------ |  | ----
|           |  |                                                                                            |  | Page
|PART I.    |  | FINANCIAL INFORMATION                                                                      |  | 3   
|           |  |                                                                                           
|ITEM 1.    |  | Consolidated Financial Statements (Unaudited)                                              |  |     
|           |  | Balance Sheets as of October 2, 2004 and July 3, 2004                                      |  | 3   
|           |  | Statements of Operations for the Three Months Ended October 2, 2004 and September 27, 2003 |  | 4   
|           |  | Statement of Shareholders Equity for the Three Months Ended October 2, 2004               |  | 5   
|           |  | Statements of Cash Flows for the Three Months Ended October 2, 2004 and September 27, 2003 |  | 6   
|           |  | Notes to Consolidated Financial Statements                                                 |  | 7   
|           |  |                                                                                           
|ITEM 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations      |  | 15  
|ITEM 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                 |  | 22  
|ITEM 4.    |  | Controls and Procedures                                                                    |  | 22  
|           |  |                                                                                           
|PART II.   |  | OTHER INFORMATION                                                                          |  | 23  
|ITEM 1.    |  | Legal Proceedings                                                                          |  | 23  
|ITEM 2.    |  | Changes in Securities and Use of Proceeds                                                  |  | 23  
|ITEM 3.    |  | Defaults Upon Senior Securities                                                            |  | 25  
|ITEM 4.    |  | Submission of Matters to a Vote of Security Holders                                        |  | 25  
|ITEM 5.    |  | Other Information                                                                          |  | 26  
|ITEM 6.    |  | Exhibits and Reports on Form 8-K                                                           |  | 26  
|           | 
|SIGNATURES |  | 26                                                                                        



2



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##### Table of Contents

PART I.

VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except par value)



|                                                                                                                                                              |  |                |          |   |              |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | -------- | - | ------------ | - | -------- | -
|                                                                                                                                                              |  | October 2,2004 |          |   | July 3, 2004 |  
|                                                                                                                                                              |  | (unaudited)    |          |   |              |  
|ASSETS                                                                                                                                                        |  |                |          |   |              |   |          |  
|                                                                                                                                                              |  |               
|Current assets:                                                                                                                                               |  |                |          |   |              |   |          |  
|Cash                                                                                                                                                          |  | $              | 1,950    |   |              | $ | 1,220    |  
|Accounts receivable, net of allowance of $4,600 and $4,743 at October 2, 2004 and July 2, 2004, respectively                                                  |  |                | 29,329   |   |              |   | 27,419   |  
|Accounts receivable - other                                                                                                                                   |  |                | 996      |   |              |   | 592      |  
|Prepaid workers compensation and auto liability insurance                                                                                                    |  |                | 7,660    |   |              |   | 6,289    |  
|Other prepaid expenses                                                                                                                                        |  |                | 1,833    |   |              |   | 2,185    |  
|Other current assets                                                                                                                                          |  |                | 224      |   |              |   | 317      |  
|                                                                                                                                                              |  |                |          |   |              |   |          |  
|Total current assets                                                                                                                                          |  |                | 41,992   |   |              |   | 38,022   |  
|                                                                                                                                                              |  |               
|Property and equipment, net                                                                                                                                   |  |                | 12,092   |   |              |   | 11,362   |  
|                                                                                                                                                              |  |               
|Goodwill                                                                                                                                                      |  |                | 42,830   |   |              |   | 42,830   |  
|Deferred financing costs, net                                                                                                                                 |  |                | 346      |   |              |   | 235      |  
|Other assets                                                                                                                                                  |  |                | 1,311    |   |              |   | 1,227    |  
|                                                                                                                                                              |  |                |          |   |              |   |          |  
|Total assets                                                                                                                                                  |  | $              | 98,571   |   |              | $ | 93,676   |  
|                                                                                                                                                              |  |                |          |   |              |   |          |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                          |  |                |          |   |              |   |          |  
|                                                                                                                                                              |  |               
|Current liabilities:                                                                                                                                          |  |                |          |   |              |   |          |  
|Trade accounts payable                                                                                                                                        |  | $              | 25,166   |   |              | $ | 26,481   |  
|Accrued insurance and claims                                                                                                                                  |  |                | 2,748    |   |              |   | 3,697    |  
|Accrued wages and benefits                                                                                                                                    |  |                | 2,833    |   |              |   | 3,738    |  
|Accrued legal and claims                                                                                                                                      |  |                | 2,886    |   |              |   | 2,926    |  
|Due to Related Parties                                                                                                                                        |  |                | 6,627    |   |              |   | 3,625    |  
|Other accrued liabilities                                                                                                                                     |  |                | 1,517    |   |              |   | 2,090    |  
|Current portion of long-term debt                                                                                                                             |  |                | 31,741   |   |              |   | 31,008   |  
|                                                                                                                                                              |  |                |          |   |              |   |          |  
|Total current liabilities                                                                                                                                     |  |                | 73,518   |   |              |   | 73,565   |  
|                                                                                                                                                              |  |               
|Long-term debt less current portion                                                                                                                           |  |                | 5,330    |   |              |   | 5,235    |  
|Accrued insurance and claims                                                                                                                                  |  |                | 7,879    |   |              |   | 8,400    |  
|                                                                                                                                                              |  |               
|Shareholders equity:                                                                                                                                         |  |                |          |   |              |   |          |  
|Preferred stock, $0.004 par value, 53,510 shares authorized 45,046 and 32,919 shares issued and outstanding at October 2, 2004 and July 3,
2004, respectively |  |                | 108,879  |   |              |   | 91,051   |  
|Preferred warrants, 1,042 outstanding at October 2, 2004 and July 3, 2004                                                                                     |  |                | 7,600    |   |              |   | 7,600    |  
|                                                                                                                                                              |  |               
|Common stock, $0.004 par value, 150,000 shares authorized 12,266 and 10,415 shares issued and outstanding at October 2, 2004 and July 2, 2004,
respectively   |  |                | 49       |   |              |   | 42       |  
|Subscriptions receivable                                                                                                                                      |  |                | (7,550   | ) |              |   | (100     | )
|Additional paid-in-capital                                                                                                                                    |  |                | 120,670  |   |              |   | 101,120  |  
|Accumulated deficit                                                                                                                                           |  |                | (217,658 | ) |              |   | (193,058 | )
|Foreign currency translation                                                                                                                                  |  |                | (146     | ) |              |   | (179     | )
|                                                                                                                                                              |  |                |          |   |              |   |          |  
|Total shareholders equity                                                                                                                                    |  |                | 11,844   |   |              |   | 6,476    |  
|                                                                                                                                                              |  |                |          |   |              |   |          |  
|Total liabilities and shareholders equity                                                                                                                    |  | $              | 98,571   |   |              | $ | 93,676   |  
|                                                                                                                                                              |  |                |          |   |              |   |          |  



See notes to
consolidated financial statements.



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##### Table of Contents

VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in thousands, except per
share data)



|                                                  |  |                    |         |   |                   |   |        |  
|------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------ | -
|                                                  |  | Three Months Ended |        
|                                                  |  | October 2,2004     |         |   | September 27,2003 |  
|Revenue                                           |  | $                  | 67,913  |   |                   | $ | 76,639 |  
|Cost of services                                  |  |                    | 55,052  |   |                   |   | 61,052 |  
|                                                  |  |                    |         |   |                   |   |        |  
|Gross profit                                      |  |                    | 12,861  |   |                   |   | 15,587 |  
|                                                  |  |                   
|Operating expenses:                               |  |                    |         |   |                   |   |        |  
|Occupancy                                         |  |                    | 3,442   |   |                   |   | 3,207  |  
|Selling, general and administrative               |  |                    | 15,034  |   |                   |   | 13,112 |  
|                                                  |  |                    |         |   |                   |   |        |  
|Total operating expenses                          |  |                    | 18,476  |   |                   |   | 16,319 |  
|                                                  |  |                    |         |   |                   |   |        |  
|Loss from operations                              |  |                    | (5,615  | ) |                   |   | (732   | )
|                                                  |  |                   
|Other expense:                                    |  |                    |         |   |                   |   |        |  
|Interest expense                                  |  |                    | (762    | ) |                   |   | (1,041 | )
|Other                                             |  |                    | 45      |   |                   |   |       |  
|                                                  |  |                    |         |   |                   |   |        |  
|Net loss                                          |  | $                  | (6,332  | ) |                   | $ | (1,773 | )
|                                                  |  |                    |         |   |                   |   |        |  
|Net loss applicable to common shareholders        |  | $                  | (24,600 | ) |                   | $ | (1,773 | )
|                                                  |  |                    |         |   |                   |   |        |  
|Loss per share applicable to common shareholders: |  |                    |         |   |                   |   |        |  
|Basic                                             |  | $                  | (2.18   | ) |                   | $ | (0.33  | )
|                                                  |  |                    |         |   |                   |   |        |  
|Diluted                                           |  | $                  | (2.18   | ) |                   | $ | (0.33  | )
|                                                  |  |                    |         |   |                   |   |        |  
|Weighted average shares outstanding:              |  |                    |         |   |                   |   |        |  
|Basic                                             |  |                    | 11,265  |   |                   |   | 5,426  |  
|                                                  |  |                    |         |   |                   |   |        |  
|Diluted                                           |  |                    | 11,265  |   |                   |   | 5,426  |  
|                                                  |  |                    |         |   |                   |   |        |  



See notes to
consolidated financial statements.



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##### Table of Contents

VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY

(Unaudited)

(Amounts in
thousands)



|                                                  |  |                          |  |                          |        |                          |       |                          |   |        |                          |        |  |                          |       |  |                          |   |  |        |       |   |        |       |   |        |   |       |        |  |     |        |  |        |       |   |  |        |  |   |       
|------------------------------------------------- |  | ------------------------ |  | ------------------------ | ------ | ------------------------ | ----- | ------------------------ | - | ------ | ------------------------ | ------ |  | ------------------------ | ----- |  | ------------------------ | - |  | ------ | ----- | - | ------ | ----- | - | ------ | - | ----- | ------ |  | --- | ------ |  | ------ | ----- | - |  | ------ |  | - | ------
|                                                  |  | Series B Preferred Stock |  | Series C Preferred Stock |        | Series D Preferred Stock |       | Series F Preferred Stock |   |        | Series G Preferred Stock |        |  | Series H Preferred Stock |       |  | Series I Preferred Stock
|                                                  |  | Shares                   |  | Amount                   |        | Shares                   |       | Amount                   |   | Shares |                          | Amount |  | Shares                   |       |  | Amount                   |   |  | Shares |       |   | Amount |       |   | Shares |   |       | Amount |  |     | Shares |  | Amount
|Balance at July 3, 2004                           |  | 2,807                    |  | $                        | 24,304 |                          | 2,000 |                          | $ | 13,600 |                          | 1,517  |  | $                        | 8,308 |  | 740                      |   |  | $      | 7,802 |   |        | 5,478 |   |        | $ | 4,087 |        |  | 478 |        |  | $      | 3,761 |   |  | 16,810 |  | $ | 24,558
|                                                  |  |                          |  |                          |        |                          |       |                          |   |        |                          |        |  |                         
|Stock options                                     |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Issuance of restricted stock                      |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Warrants issued to contractors for services       |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Warrant exercises                                 |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Non-cash interest expense/bank charges            |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Conversion of Series F to Common Stock            |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  | (15                      | ) |  |        | (172  | ) |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Conversion of Series G to Common Stock            |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        | (10   | ) |        |   | (8    | )      |  |    |        |  |        |      |   |  |       |  |   |      
|Conversion of Series H to Common Stock            |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  | (26 | )      |  |        | (259  | ) |  |       |  |   |      
|Payments against stock subscription receivable    |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Additional subscription receivable                |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Issuance of Series J Preferred Stock              |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Issuance of Series K Preferred Stock              |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Beneficial conversion of Series J Preferred Stock |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Beneficial conversion of Series K Preferred Stock |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Net loss                                          |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Foreign currency translation                      |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|Comprehensive loss                                |  |                         |  |                          |       |                          |      |                          |   |       |                          |       |  |                          |      |  |                         |   |  |        |      |   |        |      |   |        |   |      |        |  |    |        |  |        |      |   |  |       |  |   |      
|                                                  |  |                          |  |                          |        |                          |       |                          |   |        |                          |        |  |                          |       |  |                          |   |  |        |       |   |        |       |   |        |   |       |        |  |     |        |  |        |       |   |  |        |  |   |       
|Balance at October 2, 2004                        |  | 2,807                    |  | $                        | 24,304 |                          | 2,000 |                          | $ | 13,600 |                          | 1,517  |  | $                        | 8,308 |  | 725                      |   |  | $      | 7,630 |   |        | 5,468 |   |        | $ | 4,079 |        |  | 452 |        |  | $      | 3,502 |   |  | 16,810 |  | $ | 24,558
|                                                  |  |                          |  |                          |        |                          |       |                          |   |        |                          |        |  |                          |       |  |                          |   |  |        |       |   |        |       |   |        |   |       |        |  |     |        |  |        |       |   |  |        |  |   |       



|                                                  |  |                          |  |                          |        |                          |       |              |   |                             |  |        |                            |        |                     |        |        |                             |   |    |       |   |        |   |  |   |         |  |   |          |   |  |   |      |   |  |   |        |  
|------------------------------------------------- |  | ------------------------ |  | ------------------------ | ------ | ------------------------ | ----- | ------------ | - | --------------------------- |  | ------ | -------------------------- | ------ | ------------------- | ------ | ------ | --------------------------- | - | -- | ----- | - | ------ | - |  | - | ------- |  | - | -------- | - |  | - | ---- | - |  | - | ------ | -
|                                                  |  | Series J Preferred Stock |  | Series K Preferred Stock |        | Preferred Stock Warrants |       | Common Stock |   | StockSubscriptionReceivable |  |        | Additional Paid-in Capital |        | Accumulated Deficit |        |        | ForeignCurrency Translation |   |    | Total |  
|                                                  |  | Shares                   |  | Amount                   |        | Shares                   |       | Amount       |   | Shares                      |  | Amount |                            | Shares |                     | Amount |        |                             |   |    |      
|Balance at July 3, 2004                           |  | 3,088                    |  | $                        | 4,631  |                          |      |              |   |                            |  | 1,042  |                            | $      | 7,600               |        | 10,415 |                             | $ | 42 |       | $ | (100   | ) |  | $ | 101,120 |  | $ | (193,058 | ) |  | $ | (179 | ) |  | $ | 6,476  |  
|                                                  |  |                          |  |                          |        |                          |       |              |   |                             |  |        |                           
|Stock options                                     |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   | 60      |  |   |         |   |  |   |     |   |  |   | 60     |  
|Issuance of restricted stock                      |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   |        |  |   |         |   |  |   |     |   |  |   |       |  
|Warrants issued to contractors for services       |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   | 786     |  |   |         |   |  |   |     |   |  |   | 786    |  
|Warrant exercises                                 |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        | 313    |                             |   | 1  |       |   |       |   |  |   | 2       |  |   |         |   |  |   |     |   |  |   | 3      |  
|Non-cash interest expense/bank charges            |  |                         |  |                          |       |                          |      |              |   |                             |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   |        |  |   |         |   |  |   |     |   |  |   |       |  
|Conversion of Series F to Common Stock            |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        | 395    |                             |   | 2  |       |   |       |   |  |   | 171     |  |   |         |   |  |   |     |   |  |   |       |  
|Conversion of Series G to Common Stock            |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        | 11     |                             |   |   |       |   |       |   |  |   | 8       |  |   |         |   |  |   |     |   |  |   |       |  
|Conversion of Series H to Common Stock            |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        | 1,132  |                             |   | 5  |       |   |       |   |  |   | 254     |  |   |         |   |  |   |     |   |  |   |       |  
|Payments against stock subscription receivable    |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   | 50     |   |  |   |        |  |   |         |   |  |   |     |   |  |   | 50     |  
|Subscription receivableRelated Party             |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   | (7,500 | ) |  |   |        |  |   |         |   |  |   |     |   |  |   | (7,500 | )
|Issuance of Series J Preferred Stock              |  | 4,912                    |  |                          | 7,368  |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   |        |  |   |         |   |  |   |     |   |  |   | 7,368  |  
|Issuance of Series K Preferred Stock              |  |                         |  |                          |       |                          | 7,267 |              |   | 10,900                      |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   |        |  |   |         |   |  |   |     |   |  |   | 10,900 |  
|Beneficial conversion of Series J Preferred Stock |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   | 7,368   |  |   | (7,368   | ) |  |   |     |   |  |   |       |  
|Beneficial conversion of Series K Preferred Stock |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   | 10,900  |  |   | (10,900  | ) |  |   |     |   |  |   |       |  
|Net loss                                          |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   |        |  |   | (6,332   | ) |  |   |      |   |  |   | (6,332 | )
|Foreign currency translation                      |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   |        |  |   |         |   |  |   | 33   |   |  |   | 33     |  
|                                                  |  |                          |  |                          |        |                          |       |              |   |                             |  |        |                            |        |                     |        |        |                             |   |    |       |   |        |   |  |   |         |  |   |          |   |  |   |      |   |  |   |        |  
|Comprehensive loss                                |  |                         |  |                          |       |                          |      |              |   |                            |  |       |                            |        |                    |        |       |                             |   |   |       |   |       |   |  |   |        |  |   |         |   |  |   |     |   |  | $ | (6,299 | )
|                                                  |  |                          |  |                          |        |                          |       |              |   |                             |  |        |                            |        |                     |        |        |                             |   |    |       |   |        |   |  |   |         |  |   |          |   |  |   |      |   |  |   |        |  
|Balance at October 2, 2004                        |  | 8,000                    |  | $                        | 11,999 |                          | 7,267 |              | $ | 10,900                      |  | 1,042  |                            | $      | 7,600               |        | 12,266 |                             | $ | 49 |       | $ | (7,550 | ) |  | $ | 120,669 |  | $ | (217,658 | ) |  | $ | (146 | ) |  | $ | 11,844 |  
|                                                  |  |                          |  |                          |        |                          |       |              |   |                             |  |        |                            |        |                     |        |        |                             |   |    |       |   |        |   |  |   |         |  |   |          |   |  |   |      |   |  |   |        |  



Summary of Preferred
Stock Outstanding         45,046



See notes to consolidated financial statements.



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in thousands)



|                                                                                                       |  |                    |        |   |                   |   |        |  
|------------------------------------------------------------------------------------------------------ |  | ------------------ | ------ | - | ----------------- | - | ------ | -
|                                                                                                       |  | Three Months Ended |       
|                                                                                                       |  | October 2,2004     |        |   | September 27,2003 |  
|OPERATING ACTIVITIES                                                                                   |  |                    |        |   |                   |   |        |  
|Net loss                                                                                               |  | $                  | (6,332 | ) |                   | $ | (1,773 | )
|Adjustments to reconcile net income loss to net cash flows (used in) provided by operating activities: |  |                    |        |   |                   |   |        |  
|Depreciation                                                                                           |  |                    | 1,044  |   |                   |   | 974    |  
|Amortization                                                                                           |  |                    | 53     |   |                   |   | 246    |  
|Equity instruments issued in lieu of payment for services received                                     |  |                    | 75     |   |                   |   | 5      |  
|Stock option expense                                                                                   |  |                    | 60     |   |                   |   | 60     |  
|Non-cash interest expense/bank charges                                                                 |  |                    | 29     |   |                   |   | 207    |  
|Bad debt                                                                                               |  |                    | 428    |   |                   |   | 264    |  
|Change in operating assets and liabilities:                                                            |  |                    |        |   |                   |   |        |  
|Accounts receivable                                                                                    |  |                    | (2,338 | ) |                   |   | (1,322 | )
|Other current assets                                                                                   |  |                    | (1,439 | ) |                   |   | (422   | )
|Other assets                                                                                           |  |                    | (84    | ) |                   |   | (28    | )
|Accounts payable                                                                                       |  |                    | (1,315 | ) |                   |   | 5,773  |  
|Accrued liabilities                                                                                    |  |                    | 481    |   |                   |   | (2,825 | )
|                                                                                                       |  |                    |        |   |                   |   |        |  
|Cash (used in) provided by operating activities                                                        |  |                    | (9,338 | ) |                   |   | 1,159  |  
|                                                                                                       |  |                    |        |   |                   |   |        |  
|INVESTING ACTIVITIES                                                                                   |  |                    |        |   |                   |   |        |  
|Capital expenditures                                                                                   |  |                    | (1,774 | ) |                   |   | (480   | )
|Other                                                                                                  |  |                    | 33     |   |                   |   | (53    | )
|                                                                                                       |  |                    |        |   |                   |   |        |  
|Cash (used in) investing activities                                                                    |  |                    | (1,741 | ) |                   |   | (533   | )
|                                                                                                       |  |                    |        |   |                   |   |        |  
|FINANCING ACTIVITIES                                                                                   |  |                    |        |   |                   |   |        |  
|Borrowings (repayments) under revolving credit agreement, net                                          |  |                    | 1,072  |   |                   |   | (1,540 | )
|Proceeds from notes payable and long-term debt                                                         |  |                    |       |   |                   |   | 1,000  |  
|Proceeds from issuance of preferred stock, net                                                         |  |                    | 10,739 |   |                   |   |       |  
|Proceeds from issuance of common stock, net                                                            |  |                    | 3      |   |                   |   |       |  
|Stock subscription receivable, net activity                                                            |  |                    | 50     |   |                   |   |       |  
|Issuance costs related to preferred stock                                                              |  |                    |       |   |                   |   | (64    | )
|Debt financing costs                                                                                   |  |                    | (55    | ) |                   |   | (53    | )
|                                                                                                       |  |                    |        |   |                   |   |        |  
|Cash provided by (used in) financing activities                                                        |  |                    | 11,809 |   |                   |   | (657   | )
|                                                                                                       |  |                    |        |   |                   |   |        |  
|Net increase (decrease) in cash and cash equivalents                                                   |  |                    | 730    |   |                   |   | (31    | )
|                                                                                                       |  |                   
|Cash and cash equivalents, beginning of period                                                         |  |                    | 1,220  |   |                   |   | 1,589  |  
|                                                                                                       |  |                    |        |   |                   |   |        |  
|Cash and cash equivalents, end of period                                                               |  | $                  | 1,950  |   |                   | $ | 1,558  |  
|                                                                                                       |  |                    |        |   |                   |   |        |  



See notes to
consolidated financial statements.



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|1. | DESCRIPTION OF BUSINESS
|-- | -----------------------



Velocity Express Corporation and its subsidiaries (collectively, the Company) are engaged in the business of providing same-day transportation
and distribution/logistics services to individual consumers and businesses. The Company operates primarily in the United States with limited operations in Canada. The Company currently operates in a single-business segment and thus additional
disclosures under Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures About Segments of an Enterprise and Related Information, are not required.



|2. | SIGNIFICANT ACCOUNTING POLICIES
|-- | -------------------------------



Basis of Presentation The consolidated financial statements included herein have been prepared by Velocity Express Corporation which,
together with its wholly-owned subsidiaries, shall be referred to herein as the Company, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company, all adjustments consisting only of
normal recurring adjustments, necessary to present fairly the financial position of the Company as of October 2, 2004, and the results of its operations for the three months ended October 2, 2004 and September 27, 2003, and its cash flows for the
three months ended October 2, 2004 and September 27, 2003 have been included, with the exception of fiscal 2004 adjustments, if any, which while posted could not be assigned to any specific quarter as identified in the Companys fiscal 2004
Form 10-K filed December 23, 2004 as detailed below. The results of operations for the three months ended October 2, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending July 2, 2005. Certain information
in footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles has been condensed or omitted pursuant to such rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading.



These consolidated financial statements should be read in conjunction with the financial statements for the year ended July 3, 2004 (filed December 23, 2004), and the footnotes thereto, included in the Companys
Report on Form 10-K, filed with the Securities and Exchange Commission. In connection with the preparation of such consolidated financial statements for the year ended July 3, 2004 certain significant internal control deficiencies became evident to
management that, in the aggregate, represent material weaknesses, including, inadequate staffing and supervision leading to the untimely identification and resolution of certain accounting matters; failure to perform timely cutoff and reviews,
substantiation and evaluation of certain general ledger account balances; inadequate procurement procedures; lack of procedures or expertise needed to prepare all required disclosures; and evidence that employees lack the experience and training to
fulfill their assigned functions. A material weakness is a significant deficiency in one or more of the internal control components that alone or in the aggregate precludes the Companys internal controls from reducing to an appropriately low
level the risk that material misstatements in its financial statements will not be prevented or detected on a timely basis. If the Company is unable to correct these weaknesses in a timely manner it will represent a risk.



As part of the Companys fiscal year-end 2004 closing, expenses were
identified that may have had a material impact on the reported results of prior fiscal quarters. Managements attempts to accurately quantify the extent of the required inter-quarter reclassification(s), and then to access the need to restate
prior quarters reported results, have been precluded from definitive completion by the very weaknesses identified herein. As such, attempts to completely quantify and accurately allocate quarter-specific amounts were not possible; and
therefore all fiscal 2004 year-end adjustments were recorded as part of the Companys fourth quarter results. Corrections of the underlying weaknesses have been identified, and annual fiscal 2004 results were fairly stated. Therefore, the
Company can not definitively ascertain that these adjustments would not have materially impacted the first quarter of fiscal 2004 results, which are reported herein.



Principles of Consolidation The consolidated financial statements include the accounts of Velocity
Express Corporation and its wholly-owned subsidiaries. All inter-company balances and transactions have been eliminated in the consolidation. The consolidated financial statements also include Peritas as the result of FASB Interpretation No. 46,
Consolidation of Variable Interest Entities[FIN No. 46].



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



(Unaudited)



Reclassifications Certain reclassifications have been
made to the prior period consolidated financial statements to conform to the current period presentation.



Comprehensive loss Comprehensive loss was $(6.3) million and $(1.8) million for the three months ended October 2, 2004 and September
27, 2003, respectively. The difference between net loss and total comprehensive loss in the respective periods related to foreign currency translation adjustments.



New accounting pronouncements  In December 2004, the Financial Accounting Standards Board issued SFAS
No. 123 (revised 2004), Shared-Based Payment replacing SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized
in the financial statements based on their fair values (i.e. proforma disclosure is no longer an alternative to financial statement recognition). The provisions in SFAS No. 123(R) are effective for all stock options or other equity-based awards to
employees or directors that vest or become exercisable in the Companys first quarter of fiscal 2006.



Earnings per Share Basic earnings per share is computed based on the weighted average number of common shares outstanding by dividing
net income or loss applicable to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other obligations to issue
common stock such as options, warrants or convertible preferred stock, were exercised or converted into common stock that then shared in the earnings of the Company.



The following table sets forth a reconciliation of the numerators and denominators of basic and diluted net (loss) per
common share:



|                                                     |  |                                               |         |   |                   |   |        |  
|---------------------------------------------------- |  | --------------------------------------------- | ------- | - | ----------------- | - | ------ | -
|                                                     |  | Three Months Ended                            |        
|                                                     |  | October2, 2004                                |         |   | September 27,2003 |  
|                                                     |  | (Amounts in thousands, except per share data) |        
|Numerator:                                           |  |                                               |         |   |                   |   |        |  
|Net loss                                             |  | $                                             | (6,332  | ) |                   | $ | (1,773 | )
|Beneficial conversion feature for Series J Preferred |  |                                               | (7,368  | ) |                   |   |       |  
|Beneficial conversion feature for Series K Preferred |  |                                               | (10,900 | ) |                   |   |       |  
|                                                     |  |                                               |         |   |                   |   |        |  
|Net loss applicable to common shareholders           |  | $                                             | (24,600 | ) |                   | $ | (1,773 | )
|                                                     |  |                                               |         |   |                   |   |        |  
|Denominator:                                         |  |                                               |         |   |                   |   |        |  
|Weighted average shares                              |  |                                               | 11,265  |   |                   |   | 5,426  |  
|                                                     |  |                                               |         |   |                   |   |        |  
|Total common equivalents outstanding                 |  |                                               | 11,265  |   |                   |   | 5,426  |  
|                                                     |  |                                               |         |   |                   |   |        |  
|Net loss per share:                                  |  |                                               |         |   |                   |   |        |  
|Basic                                                |  | $                                             | (2.18   | ) |                   | $ | (0.33  | )
|                                                     |  |                                               |         |   |                   |   |        |  
|Diluted                                              |  | $                                             | (2.18   | ) |                   | $ | (0.33  | )
|                                                     |  |                                               |         |   |                   |   |        |  



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



(Unaudited)



The following table presents securities that could be converted into common
shares and potentially dilute basic earnings per share in the future. In the quarter ended October 2, 2004, the potentially dilutive securities were not included in the computation of diluted earnings per share because to do so would have been
antidilutive:



|                               |  |                        |  |                  
|------------------------------ |  | ---------------------- |  | -----------------
|                               |  | Three Months Ended    
|                               |  | October 2,2004         |  | September 27,2003
|                               |  | (Amounts in thousands)
|Stock options                  |  |                       |  |                 
|Common warrants                |  | 10,519                 |  | 6,189            
|Preferred warrants:            |  |                        |  |                  
|Series C Convertible Preferred |  | 4,497                  |  | 903              
|Series D Convertible Preferred |  | 2,887                  |  | 564              
|Convertible preferred stock:   |  |                        |  |                  
|Series B Convertible Preferred |  | 22,060                 |  | 4,580            
|Series C Convertible Preferred |  | 10,934                 |  | 2,214            
|Series D Convertible Preferred |  | 20,433                 |  | 4,143            
|Series F Convertible Preferred |  | 19,880                 |  | 5,901            
|Series G Convertible Preferred |  | 6,162                  |  | 1,428            
|Series H Convertible Preferred |  | 21,599                 |  | 5,000            
|Series I Convertible Preferred |  | 228,190                |  |                 
|Series J Convertible Preferred |  | 77,372                 |  |                 
|Series K Convertible Preferred |  | 32,740                 |  |                 
|                               |  |                        |  |                  
|                               |  | 457,273                |  | 30,922           
|                               |  |                        |  |                  



Stock Plans and
Awards The Company follows Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for its employee stock options.



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure.SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for
stock-based employee compensation and to require expanded and more prominent disclosure about the method of accounting for stock-based employee compensation and the effect of the method on reported results. The Company has not adopted a method of
transition to the fair value-based method of accounting for stock-based employee compensation provided under SFAS No. 123 but rather, follows APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in
accounting for its stock option plans. As disclosed under New Accounting Pronouncements, the Company will be required under SFAS No. 123(R) to adopt the fair value-based method in the first quarter of fiscal 2006. The following table
illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of SFAS No. 123:



|                                                                                                               |  |                                          |         |   |                   |   |        |  
|-------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ----------------- | - | ------ | -
|                                                                                                               |  | Three Months Ended                       |        
|                                                                                                               |  | October 2,2004                           |         |   | September 27,2003 |  
|                                                                                                               |  | (In thousands, except per share amounts) |        
|Net loss applicable to common shareholders, as reported                                                        |  | $                                        | (24,600 | ) |                   | $ | (1,773 | )
|Add: Stock-based employee compensation expense included in reported net loss applicable to common shareholders |  |                                          | 32      |   |                   |   | 32     |  
|Deduct: Stock-based compensation expense determined under fair value method for all awards                     |  |                                          | 12      |   |                   |   | (275   | )
|                                                                                                               |  |                                          |         |   |                   |   |        |  
|Pro forma                                                                                                      |  | $                                        | (24,556 | ) |                   | $ | (2,016 | )
|                                                                                                               |  |                                          |         |   |                   |   |        |  
|Basic and diluted loss per common share:                                                                       |  |                                          |         |   |                   |   |        |  
|As reported                                                                                                    |  | $                                        | (2.18   | ) |                   | $ | (0.33  | )
|                                                                                                               |  |                                          |         |   |                   |   |        |  
|Pro forma                                                                                                      |  | $                                        | (2.18   | ) |                   | $ | (0.37  | )
|                                                                                                               |  |                                          |         |   |                   |   |        |  



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



(Unaudited)



|3. | RESTRUCTURING
|-- | -------------



During fiscal 2004 the Company relocated its headquarters and financial functions to Connecticut from Minnesota. The costs of relocation, employee
acquisition, training and severance were recognized as period costs. Approximately $123,000 of severance pay liability remains accrued at October 2, 2004.



|4. | CONSOLIDATED FINANCIAL INTEREST ENTITY
|-- | --------------------------------------



During May 2004 the Company entered into a business venture designed to provide both the manpower and the vehicle fleet to service, first - a major
customer and, subsequently - a growing market demand. This major customers desire to outsource its delivery operation and related vehicle fleet provided the genesis for this new business venture, named Peritas. It was formed by MCG Global, one
of the Companys largest investors with a strategic objective to acquire a fleet of vehicles and to lease such vehicles to Independent Contractors (ICs) to service outsourced customer business endeavors. When in full operation, the
Peritas / Velocity arrangement will be one where Velocity provides administrative services to Peritas for a fee and Peritas provides vehicle leases to ICs interested in providing outsource services to some customers on behalf of Velocity.



For the fiscal 2005 quarter ended October 2, 2004 the
operations of Peritas have been consolidated. Such operations provided a minimal net income to Velocity of $127,000 on net sales of $344,000.



During the second quarter of fiscal 2005 TH Lee Putnam Ventures, a major investor in and related party to Velocity purchased 100% of Peritas from MCG
Global [See footnote 8 SUBSEQUENT EVENTS].



|5. | LONG-TERM DEBT
|-- | --------------



Long-term debt consisted of the following:



|                         |  |                        |         |   |             |   |         |  
|------------------------ |  | ---------------------- | ------- | - | ----------- | - | ------- | -
|                         |  | October 2,2004         |         |   | July 3,2004 |  
|                         |  | (Amounts in thousands) |        
|Revolving note           |  | $                      | 29,764  |   |             | $ | 29,531  |  
|Senior subordinated note |  |                        | 5,507   |   |             |   | 5,468   |  
|Other                    |  |                        | 1,800   |   |             |   | 1,244   |  
|                         |  |                        |         |   |             |   |         |  
|                         |  |                        | 37,071  |   |             |   | 36,243  |  
|Less current maturities  |  |                        | (31,741 | ) |             |   | (31,008 | )
|                         |  |                        |         |   |             |   |         |  
|Total                    |  | $                      | 5,330   |   |             | $ | 5,235   |  
|                         |  |                        |         |   |             |   |         |  



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



(Unaudited)



The Company maintains a revolving credit facility with Fleet Capital
Corporation that allows for borrowings up to the lesser of $42.5 million or an amount based on a defined portion of receivables. Interest is payable monthly at a rate of prime plus 1.25% (5.5% at October 2, 2004), or, at the Companys election,
at LIBOR plus 3.25%. As of October 2, 2004, the Company has 84% of the facility usage under LIBOR contracts at an interest rate of 4.5%.In addition, the Company is required to pay a commitment fee of 0.375% on unused amounts of the total
commitment, as defined in the agreement. The facility terminates on December 31, 2006. The Companys accounts receivable have been pledged to secure borrowings under the revolving note. The Company is subject to certain restrictive covenants,
the more significant of which include limitations on dividends, acquisitions, new indebtedness and changes in capital structure. The Company is also required to maintain financial covenants related to capital expenditures and maintaining of minimum
availability levels. The Company also maintains a $6.0 million senior subordinated note with interest payable quarterly at 15% per annum (to be reduced to 12% upon the occurrence of certain events), with a quarterly principal repayment schedule
commencing January 2005 terminating with a final payment at October 31, 2007.



Substantially all of the Companys assets have been pledged to secure borrowings under the revolving credit facility and senior subordinated note. The Company is subject to certain restrictive covenants under the
agreements, the more significant of which include limitations on capital asset expenditures, dividends, acquisitions, new indebtedness in excess of $0.5 million and changes in capital structure. The Company has been required to maintain the
following financial covenants:



| |  | Capital expenditures may not exceed $2.75 million and $3.0 million, respectively for the fiscal years ending July 3, 2004 and July 2, 2005.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | EBITDA must exceed $0.75 million, $2.0 million, $2.5 million, and $3.3 million, respectively for the three month period ending January 1, 2005, the six month period ending April 2,
2005, and the six month period ending July 2, 2005, and each six month period thereafter.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Interest Coverage ratios must exceed 1.2 to 1, 1.5 to 1, and 2.2 to 1, respectively for the three month period ending January 1, 2005; the six month period ending April 2, 2005; and
the nine month period ending July 2, 2005.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On March 31, 2004 and
July 1, 2004, the Company entered into the third and fourth amendments, respectively, to the amended and restated revolving credit facility with Fleet. The purpose of these amendments was to reset certain of the financial covenants provided for in
the agreement discussed above.



As of July 3, 2004, the Company
had in place waivers of its financial debt covenants related to its revolving credit and its senior subordinated debt facilities. Pursuant to the Companys receipt of $21.0 million of investment capital, on December 21, 2004 the Company
obtained waivers and consents from its lenders. The lenders waived all existing defaults and delayed the start date for the financial covenants for both minimum EBITDA and interest coverage ratio until the earlier of January 1, 2007 and the date
upon which the



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



(Unaudited)



(a) Companys EBITDA for each of two consecutive months equals or exceeds the
Companys fixed charges (interest expense and scheduled principal payments due with respect to Money Borrowed) for the applicable month and (b) Availability under the credit facility for each day of the immediately preceding thirty days is
greater than or equal to $1,000,000.



|6. | SHAREHOLDERS EQUITY
|-- | --------------------



Series J Convertible Preferred Stock In February 2004, the Companys Board of Directors authorized the sale of up to $12.0
million of Series J Convertible Preferred Stock (Series J Preferred) through a private placement. Pursuant to Stock Purchase Agreements entered into during March, April and July 2004, the Company contracted to issue, upon shareholder
approval, 7,999,993 shares of Series J Preferred to investors for $1.50 per share. As part of the Boards action it approved the option of funding the investment in the Series J Preferred by TH Lee Putnam Ventures in the form of a letter of
credit that would later be replaced by a cash investment in a like amount. This transaction was completed between the Company and TH Lee Putnam Ventures, and it affiliates, on July 26, 2004. Since the Company has not received cash as of October 2,
2004, $7.5 million has been reflected in stockholder equity as a Subscription ReceivableRelated Party. The issuance of the Series J Preferred is subject to shareholder approval and is non-voting unless it is converted into common stock. TH Lee
Putnam Ventures & MCG Global, who control a majority of the shares, have agreed to vote for such approvals. Additionally, shareholder approval is required to increase the number of authorized shares of the Companys stock by an amount
sufficient to provide for the issuance of all the preferred shares. The initial conversion price of the Series J Preferred is $0.15 per common share, and, at the time the stock purchase agreements were entered into, assuming that the Series J
Preferred were issued and convertible then, each share of Series J Preferred was convertible into ten shares of the Companys common stock. Both the conversion price and the number of common shares into which the Series J Preferred is
convertible are subject to adjustment in order to prevent dilution. The Series J Preferred was deemed to have contained a beneficial conversion amounting to $12.0 million, $4.6 million of which was recognized in the fourth quarter of fiscal 2004,
and $7.4 million of which was recognized in the first quarter of fiscal 2005, as charges against net income (loss) available to common shareholders in the respective fiscal quarters.



Series K Convertible Preferred Stock On June 30, 2004, the Companys Board of Directors authorized
the sale of up to $25.0 million of Series K Convertible Preferred Stock (Series K Preferred) through a private placement. Pursuant to a Stock Purchase Agreement entered into on August 23, 2004, the Company sold, pending shareholder
approval, 7,266,666 shares of Series K Preferred to investors for $1.50 per share and received net proceeds of approximately $10.9 million. The issuance of the Series K Preferred is subject to shareholder approval and is non-voting unless it is
converted into common stock. Additionally, shareholder approval is required to increase the number of authorized shares of the Companys common stock by an amount sufficient to provide for the issuance of all the preferred shares. TH Lee Putnam
Ventures and MCG Global, who control a majority of the shares, have agreed to vote for such approvals. The initial conversion price of the Series K Preferred is $0.15 per common share, and, at the time the stock purchase agreements were executed,
assuming that the Series K Preferred were issued and convertible then, each share of Series K Preferred was convertible into ten shares of the Companys common stock. Both the conversion price and the number of common shares into which the
Series K Preferred is convertible are subject to adjustment in order to prevent dilution. This sale of Series K Preferred was deemed to have contained a beneficial conversion amounting to $10.9 million which was recognized as a deemed dividend to
preferred shareholders at the time of the sale. The Company began selling its Series K Preferred on August 23, 2004. Subsequent to the end of the first quarter, on December 21, 2004, the Company sold 2,584,800 additional shares of Series K Preferred
for net proceeds of approximately $3.9 million to complete its sales of Series K Preferred. Upon completion of the sale of the Series K Preferred in the second fiscal quarter of 2005, the Company will be required to recognize a charge against net
income (loss) available to common shareholders of approximately $3.9 million to reflect the beneficial conversion in the Series K Preferred.



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



(Unaudited)



|7. | LIQUIDITY
|-- | ---------



The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of business. The Company reported a loss from operations of approximately $5.6 million for the first fiscal quarter of 2004; and, had negative working capital of
approximately $34.7 million at October 2, 2004.



At July 3,
2004, the Company had in place waivers of its financial debt covenants related to its revolving credit facility and its senior subordinated debt facility. These waivers were to be in effect through January 1, 2005; and pursuant to the Companys
receipt of $21.0 million of investment capital [See footnote 8, SUBSEQUENT EVENTS], on December 21, 2004 the Company obtained additional waivers and consents from its lenders. The lenders waived all existing defaults and delayed the start date for
the financial covenants for both minimum EBITDA and interest coverage ratio until the earlier of January 1, 2007 and the date upon which the (a) Companys EBITDA for each of two consecutive months equals or exceeds the Companys fixed
charges (interest expense and scheduled principal payments due with respect to Money Borrowed) for the applicable month and (b) availability under the credit facility for each day of the immediate preceding thirty days is greater than or equal to
$1,000,000.



|8. | SUBSEQUENT EVENTS
|-- | -----------------



| |  | New Equity Investments
| | - | ----------------------



Series M Convertible Preferred Stock On December 21, 2004, the Company signed a purchase agreement to raise approximately $21.0
million of new equity capital investment. The investment is initially in the form of a convertible note that will automatically convert into Series M Convertible Preferred Stock (Series M Preferred) upon approval of the transaction by
the Companys shareholders. The proceeds will be used for general working capital needs consistent with financial budgets approved from time to time by the Companys Board of Directors. The Series M Preferred will accrue cumulative PIK
dividends equal to 6% per annum. In the event the Companys shareholders do not approve the transaction, the interest rate will increase to 19% per annum. As part of the transaction, the investors required that the Companys charter be
amended in a number of respects, including a requirement that, upon shareholder approval for the transaction, all preferred shareholders automatically convert their shares of preferred stock to common stock. In the event of any liquidation or
winding up of the Company, the holders of the Series M Preferred will be entitled to a preference on liquidation equal to one times (1x) the original purchase price of the Series M Preferred plus accrued and unpaid dividends. A consolidation or
merger of the Company or a sale of substantially all of its assets shall be treated as a liquidation for these purposes. The Series M Preferred is deemed to contain a beneficial conversion amounting to $21 million which will be recognized at the
time of the sale as a charge against net income (loss) available to common shareholders.



Management believes the investment will provide the Company with sufficient working capital resources to provide for the anticipated liquidity needs for the fiscal year and to position the Company to accept definitive
and available business with existing and new customers by settling their respective concerns about the Companys ability to service their respective business needs on a continuing basis.



Warrant to Purchase Common Stock As part of the Series M
Preferred private placement, THLPV agreed to extend for a two-year period the July 1, 2004 capital contribution agreement previously entered into between THLPV and the Companys lenders in support of the Companys revolving credit
facility. Under the terms of the capital contribution agreement, in the event that THLPV elects to not provide further financial support for the Company, THLPV is required to notify the Companys lenders of such decision and provide specific
levels of financial support for a thirty-day period following the notification. In exchange for entering into the capital contribution agreement, the lenders agreed to waive certain financial covenants under the Companys credit facilities. At
the time, THLPV did not receive any compensation in exchange for entering into the capital contribution agreement. As part of the extension of the capital contribution agreement, the Company agreed to issue to THLPV, subject to shareholder approval,
a warrant to purchase 9,677,553 shares of common stock. The term of the warrant will be five years, and the warrant will have an exercise price of $0.0001 per share. Due to the pricing of the warrant, the Company will be required to record a charge.



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VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



(Unaudited)



Series L Convertible Preferred Stock The Company entered
into a Stock Purchase Agreement on December 21, 2004, pursuant to which the Company sold, pending shareholder approval, 7,000,000 shares of Series L Preferred to investors for $1.00 per share for net proceeds of approximately $7.0 million. The
issuance of the Series L Preferred is subject to shareholder approval and is non-voting unless it is converted into common stock. Additionally, shareholder approval is required to increase the number of authorized shares of the Companys common
stock by an amount sufficient to provide for the issuance of all of the preferred shares. TH Lee Putnam Ventures and MCG Global, who control a majority of the shares, have agreed to vote for such approvals. The conversion price of the Series L
Preferred is $0.10 per common share, and, at the time the stock purchase agreements are executed, assuming that the Series L Preferred were issued and convertible then, each share of Series L Preferred will be convertible into ten shares of the
Companys common stock. Based on the pricing of the Series L Preferred, the sale of Series L Preferred is expected to contain a beneficial conversion amounting to $7.0 million which will be recognized as a deemed dividend to preferred
shareholders at the time of the sale and a charge against net income (loss) available to common shareholders.



| |  | Peritas LLC
| | - | -----------



During November 2004, the Companys Consolidated Financial Interest Entity was purchased by THLee Putnam Ventures from a third party. The Company
will continue, on a forward basis, to enjoy a strategic relationship with Peritas pursuant to customer service and business development. As TH Lee Putnam Ventures is a significant investor in the Company, the business relationship and extent of
interactivity will hereafter be disclosed along with related party transactions. The future need to consolidate Peritas as part of the Companys financial statements will be determined based upon the requirements as set forth in FIN No. 46.



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##### Table of Contents

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



VELOCITY EXPRESS CORPORATION AND SUBSIDIARIES



In accordance with the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, the Company notes that certain
statements in this Form 10-Q and elsewhere which are forward-looking and which provide other than historical information, involve risks and uncertainties that may impact the Companys results of operations. These forward-looking statements
include, among others, statements concerning the Companys general business strategies, financing decisions, and expectations for funding capital expenditures and operations in the future. When used herein, the words believe,
plan, continue, hope, estimate, project, intend, expect, and similar expressions are intended to identify such forward-looking statements. Although the Company
believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, no statements contained in this Form 10-Q should be relied upon as predictions of future events. Such statements are necessarily
dependent on assumptions, data or methods that may be incorrect or imprecise and may be incapable of being realized. The risks and uncertainties inherent in these forward-looking statements could cause results to differ materially from those
expressed in or implied by these statements.



Readers
are cautioned not to place undue reliance on the forward-looking statements contained herein, which speak only as of the date hereof. The information contained in this Form 10-Q is believed by the Company to be accurate as of the date hereof.
Changes may occur after that date, and the Company will not update that information except as required by law in the normal course of its public disclosure practices.



Overview



The Company is engaged in the business of providing same-day time-critical logistics solutions to individual consumers and businesses, primarily in the
United States with limited operations in Canada.



The Company
has one of the largest nationwide networks of time-critical logistics solutions in the United States and is a leading provider of scheduled, distribution and expedited logistics services. The Companys service offerings are divided into the
following categories:



| |  | Scheduled logistics consisting of the daily pickup and delivery of parcels with narrowly defined time schedules predetermined by the customer, for example, financial institutions
that need a wide variety of services including the pickup and delivery of non-negotiable instruments, primarily canceled checks and ATM receipts, the delivery of office supplies, and the transfer of inter-office mail and correspondence.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Distribution logistics consisting of the receipt of customer bulk shipments that are divided and sorted at major metropolitan locations and delivered into multiple routes with
defined endpoints and more broadly defined time schedules. Customers utilizing distribution logistics normally include pharmaceutical wholesalers, retailers, manufacturers or other companies who must distribute merchandise every day from a single
point of origin to many locations within a clearly defined geographic region.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Expedited logistics consisting of unique and expedited point-to-point service for customers with extremely time sensitive delivery requirements. Most expedited logistics services
occur within a major metropolitan area or radius of 40 miles, and the Company usually offers one-hour, two- to four-hour and over four-hour delivery services depending on the customers time requirements. These services are typically available
24 hours a day, seven days a week. Expedited logistics services also include critical parts management and delivery for companies.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

The Companys customers represent a variety of industries and utilize the Companys services
across multiple service offerings. Revenue categories and percentages of total revenue for the quarters ended October 2, 2004 and September 27, 2003 are as follows:



|                             |  |      |   |  |      |  
|---------------------------- |  | ---- | - |  | ---- | -
|                             |  | 2004 |   |  | 2003 |  
|Commercial & office products |  | 38.7 | % |  | 39.1 | %
|Financial services           |  | 28.6 | % |  | 26.4 | %
|Healthcare                   |  | 19.1 | % |  | 21.8 | %
|Transportation & logistics   |  | 7.7  | % |  | 4.7  | %
|Energy                       |  | 4.5  | % |  | 4.4  | %
|Technology                   |  | 1.4  | % |  | 3.6  | %



With the enactment of
the Federal Law known as Check 21, on October 28, 2004, the Company anticipates continued derogation of financial services revenue as financial institutions will now electronically scan and process checks, without the required need to move the
physical documents to the clearing institution. More than off-setting this derogation of revenue in the Financial Services industry, the Company believes it will continue to benefit from the growth in Healthcare and Healthcare related services
industries within the United States, and be able to effectively leverage their broad coverage footprint to capitalize on this national growth industry.



During fiscal 2005, the Company plans to continue to invest in automated technologies that will increase their competitive advantage in the market by
providing more economical delivery routing, enhance and automated package tracking, and increased productivity from both a frontline delivery and back office perspective. During fiscal 2004, the Company spent over $3 million, in the development and
implementation of route management software solutions that are anticipated to have a significant impact on reducing overall delivery cost, and increasing the Companys ability to better manage their variable operating cost. These initiatives
will be fine tuned over the next 12 to 24 months, and are anticipated to be applied across all services offering categories, allowing the Company to become more profitable and price competitive, through optimized route management and delivery
density.



Historical Results of Operations



In connection with the preparation of the Companys consolidated
financial statements for the year ended July 3, 2004 certain significant internal control deficiencies became evident to management that, in the aggregate, represent material weaknesses, including, inadequate staffing and supervision leading to the
untimely identification and resolution of certain accounting matters; failure to perform timely cutoff and reviews, substantiation and evaluation of certain general ledger account balances; inadequate procurement procedures; lack of procedures or
expertise needed to prepare all required disclosures; and evidence that employees lack the experience and training to fulfill their assigned functions. A material weakness is a significant deficiency in one or more of the internal control components
that alone or in the aggregate precludes the Companys internal controls from reducing to an appropriately low level the risk that material misstatements in its financial statements will not be prevented or detected on a timely basis. If the
Company is unable to correct these weaknesses in a timely manner it will represent a risk.



As part of the Companys year-end closing, expenses were identified which may have a material impact on the reported results of prior fiscal quarters. Managements attempts to accurately quantify the extent
of the required inter-quarter reclassification(s), and then to access the need to restate prior quarters reported results, have been precluded from definitive completion by the very weaknesses identified herein. As such, attempts to completely
quantify and accurately allocate quarter-specific amounts were not possible; and therefore all fiscal year-end adjustments were recorded as part of the Companys fourth quarter results. Corrections of the underlying weaknesses have been
identified, and annual fiscal results are fairly stated.



Revenue for the quarter ended October 2, 2004 decreased $8.7 million or 11.4% to $67.9 million from $76.6 million for the quarter ended September 27, 2003. The decrease in revenue for the quarter ended October 2, 2004 compared to the same
period last year is related to lower volume experienced as a result of customer attrition, revenue loss associated with pricing pressure, and customer freight volume fluctuations of approximately $14.7 million. This decline was offset by revenue
growth during the quarter from new customer contracts and expansion within existing customers of approximately $6.0 million.



Cost of services for the quarter ended October 2, 2004 was $55.1 million, a decrease of $6.0 million or 9.8% from $61.1 million for the quarter ended
September 27, 2003. The reduction in cost is a result of decreased business volumes, which accounted for a reduction of $7.0 million, offset by cost increases of $1 million, which are primarily increased insurance premiums. As a result, gross margin
declined from 20.3% in the prior year quarter to 18.9% for the quarter ended October 2, 2004. The Company has renegotiated new insurance policies which are effective as of January 1, 2005 at significantly lower rates. The Company has also developed
systems to more accurately manage driver pay in response to revenue pricing changes allowing the Company to be more responsive to volume changes.



Selling, general and administrative (SG&A) expenses for the quarter ended October 2, 2004 were $15.0 million or 22.1% of revenue, an
increase of $1.9 million or 14.7% as compared with $13.1 million or 17.1% of revenue for the quarter ended September 27, 2003. The increase in SG&A for the quarter resulted primarily from the Companys moving its headquarters from
Minneapolis to Westport, Connecticut and the costs associated with duplicate financial staffs during the transition.



Occupancy charges for the quarter ended October 2, 2004 was $3.4 million, an increase of $0.2 million or 7.3% from $3.2 million for the quarter ended
September 27, 2003.



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Interest expense for the quarter ended October 2, 2004 decreased $0.2 million to $0.8 million from $1.0
million for the quarter ended September 27, 2003. Interest expense related to the Companys borrowings decreased over the same period in the prior year as a result of lower average borrowings.



As a result of the foregoing factors and a beneficial conversion feature of
$18.3 million (Series J Preferred$7.4 million; Series K Preferred$10.9 million), the net loss applicable to common shareholders, for the quarter ended October 2, 2004 was $24.6 million, compared with a net loss applicable to common
shareholders of $1.8 million for the same period in fiscal 2003, a decline of $22.8 million.



Liquidity and Capital Resources



Cash used in operations was $9.3 million for the first quarter of fiscal 2005. Of the $9.3 million of negative cash flow, approximately $4.6 million was as a result of operations and $4.7 used was as a result of working capital changes.
Cash used as a result of the increase in accounts receivable was approximately $2.3 million as a result of reduced collections for the period. Accounts payable used approximately $1.3 million as a result of changes in vendor demands for payments.
The remaining use of working capital of $1.1 million was due to funding of insurance, legal and other miscellaneous claims.



Cash used as a result of investing activities was $1.7 million for the first quarter of fiscal 2005 and consisted primarily of capital expenditures for
the Companys continued implementation of the customer-driven technology solutions initiative. The Companys customer-driven technology solutions initiative is comprised mainly of two elements: (i) smart package tracking technology which
will provide a single source of aggregated delivery information to national customers, and (ii) a customer-oriented web portal for online information access to provide package tracking, chain-of-custody updates, electronic signature capture, and
real-time proof of delivery retrieval.



Cash provided
as a result of financing activities amounted to $11.8 million during first quarter of fiscal 2005. The primary source of cash was from issuance of preferred stock, net of subscription receivables which provided $10.8 million. Net borrowings on the
revolving credit facility provided $1.1 million.



As of October
2, 2004, the Company had no outstanding purchase commitments for capital improvements.



The Company reported a loss from operations of approximately $5.6 million for the first quarter of fiscal 2005 and has negative working capital of approximately $31.5 million at October 2, 2004.



On June 30, 2004, the Companys Board of Directors authorized the sale
of up to $25 million of Series K Convertible Preferred Stock (Series K Preferred) through a private placement. Pursuant to a Stock Purchase Agreement entered into on August 23, 2004, the Company sold, pending shareholder approval,
7,266,666 shares of Series K Preferred to investors for $1.50 per share and received net proceeds of approximately $10.9 million. The issuance of the Series K Preferred is subject to shareholder approval and is non-voting unless it is converted into
common stock. Additionally, shareholder approval is required to increase the number of authorized shares of the Companys common stock by an amount sufficient to provide for the issuance of all the preferred shares. TH Lee Putnam Ventures and
MGC Global, who control a majority of the shares, have agreed to vote for such approvals. The initial conversion price of the Series K Preferred is $0.15 per common share, and, at the time the stock purchase agreements were executed, assuming that
the Series K Preferred were issued and convertible then, each share of Series K Preferred was convertible into ten shares of the Companys common stock. Both the conversion price and the number of common shares into which the Series K



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##### Table of Contents

Preferred is convertible are subject to adjustment in order to prevent dilution. This sale of Series K Preferred was
deemed to have contained a beneficial conversion amounting to $10.9 million which was recognized as a deemed dividend to preferred shareholders. The Company began selling its Series K Preferred on August 23, 2004 and has not completed the sale of
the total authorized Series K Preferred. Upon the sale of any additional shares of Series K Preferred, the Company may again be required to recognize a charge against net income (loss) available to common shareholders to reflect beneficial
conversion.



On December 21, 2004, the Company signed a
purchase agreement to raise approximately $21.million of new equity capital investment. The investment is initially in the form of a convertible note that will automatically convert into Series M Convertible Preferred Stock upon approval of the
transaction by the Companys shareholders. The proceeds will be used for general working capital needs consistent with financial budgets approved from time to time by the Companys Board of Directors. . The Preferred Series M Stock will
accrue cumulative PIK dividends equal to 6% per annum. In the event the Companys shareholders do not approve the transaction, the interest rate will increase to 19%. As part of the transaction, the investors required that the Companys
charter be amended in a number or respects, including a requirement that, upon shareholder approval for the transaction, all preferred shareholders automatically convert their shares of preferred stock to common stock. In the event of any
liquidation or winding up of the Company, the holders of the Preferred Series M will be entitled to a preference on liquidation equal to one times (1x) the original purchase price of the Preferred Series M Stock plus accrued and unpaid dividends. A
consolidation or merger of the Company or a sale of substantially all of its assets shall be treated as a liquidation for these purposes.



The investment will provide the Company with sufficient working capital resources to provide for the anticipated liquidity needs for the fiscal year; and
to position the Company to accept definitive and available business with existing and new customers by settling their respective concerns about the Companys ability to service their respective business needs on a continuing basis.



As part of the above-described Series M private placement, the new
investors required that TH Lee Putnam Ventures (THLPV) reach an agreement to extend, for a two-year period, the July 1, 2004 capital contribution agreement previously entered into between THLPV and the lenders. Under the terms of the
capital contribution agreement, in the event that THLPV elects to not provide further financial support for the Company, THLPV is required to notify the Companys lenders of such decision and provide specific levels of financial support for a
thirty (30) day period following the notification. In exchange for entering in to the capital contribution agreement, the lenders agreed to waive certain financial covenants under the Companys credit facilities. At the time, THLPV did not
receive any compensation in exchange for entering into the capital contribution agreement. As part of the extension of the capital contribution agreement the Company agreed to issue to THLPV, subject to shareholder approval, a warrant to purchase
shares of common stock equal to 1% of the fully diluted common stock of the Company on a fully converted basis. The term of the warrant will be five years and will have an exercise price of $0.0001. Due to the pricing of the warrant, the Company
expects to take a charge



On December 20, 2004, the
Companys Board of Directors authorized the sale of up to $7.0 million of Series L Convertible Preferred Stock (Series L Preferred) through a private placement. The purchaser will be TH Lee Putnam Ventures and its related
affiliates. The Company entered into a Stock Purchase Agreement on December 21, 2004, pursuant to which the Company will sell, pending shareholder approval, 7,000,000 shares of Series L Preferred to investors for $1.00 per share for net proceeds of
approximately $7.0 million. The consideration for the Series L will consist of cancellation of the Companys obligation to repay the investor the funds paid by the investor to the Companys senior lender to support the Companys
revolving credit facility. The issuance of the Series L Preferred is subject to shareholder approval and is non-voting unless it is converted into common stock. Additionally, shareholder approval is required to increase the number of authorized
shares of the Companys common stock by an amount sufficient to provide for the issuance of all the preferred shares. The conversion price of the Series L Preferred is $0.10 per common share, and, at the time the stock purchase agreements are
executed, assuming that the Series L Preferred were issued and convertible then, each share of Series L Preferred will be convertible into ten shares of the Companys common stock. Based on the pricing of the Series L Preferred, the sale of
Series L Preferred is expected to contain a beneficial conversion amounting to $7.0 million which will be recognized as a deemed dividend to preferred shareholders at the time of the sale and a charge against net income (loss) available to common
shareholders.



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During fiscal 2005, the Company intends to aggressively focus its efforts on positive cash flow and
continue improved operating performance. These activities include, but are not limited to, implementation of the Companys routing optimization software, maximization of the effectiveness of the variable cost model, implementation of
customer-driven technology solutions, and improved leveraging of the consolidated back office SG&A platform.



The Company maintains a revolving credit facility with Fleet Capital Corporation that allows for borrowings up to the lesser of $42.5 million or an amount
based on a defined portion of receivables. Interest is payable monthly at a rate of prime plus 1.25% (5.5% at October 2, 2004), or, at the Companys election, at LIBOR plus 3.25%. As of October 2, 2004, the Company has 84% of the facility usage
under LIBOR contracts at an interest rate of 4.5%.In addition, the Company is required to pay a commitment fee of 0.375% on unused amounts of the total commitment, as defined in the agreement. The facility terminates on December 31, 2006.
The Companys accounts receivable have been pledged to secure borrowings under the revolving note. The Company is subject to certain restrictive covenants, the more significant of which include limitations on dividends, acquisitions, new
indebtedness and changes in capital structure. The Company is also required to maintain financial covenants related to capital expenditures and maintaining of minimum availability levels. The Company also maintains a $6.0 million senior subordinated
note with interest payable quarterly at 15% per annum (to be reduced to 12% upon the occurrence of certain events), with a quarterly principal repayment schedule commencing January 2005 terminating with a final payment at October 31, 2007.



Substantially all of the Companys assets have been
pledged to secure borrowings under the revolving credit facility and senior subordinated note. The Company is subject to certain restrictive covenants under the agreements, the more significant of which include limitations on capital asset
expenditures, dividends, acquisitions, new indebtedness in excess of $0.5 million and changes in capital structure. The Company is also required to maintain the following financial covenants:



| |  | Capital expenditures may not exceed $2.75 million and $3.0 million, respectively for the fiscal years ending July 3, 2004 and July 2, 2005.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | EBITDA must exceed $0.75 million, $2.0 million, $2.5 million, and $3.3 million, respectively for the three month period ending January 1, 2005, the six month period ending April 2,
2005, and the six month period ending July 2, 2005, and each six month period thereafter.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Interest Coverage ratios must exceed 1.2 to 1, 1.5 to 1, and 2.2 to 1, respectively for the three month period ending January 1, 2005; the six month period ending April 2, 2005; and
the nine month period ending July 2, 2005.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



At
July 3, 2004, the Company had in place waivers of its financial debt covenants related to its revolving credit facility and its senior subordinated debt facility. These waivers are in effect through January 1, 2005; and pursuant to the
Companys December 2004 receipt of $21.0 million of investment capital, the Company has finalized the extensions of the waivers for an additional two years.



On March 31, 2004 and July 1, 2004, the Company entered into the third and fourth amendments, respectively, to the amended
and restated revolving credit facility with Fleet. The purpose of these amendments was to reset certain of the financial covenants provided for in the agreement discussed above.



In connection with amending and restating the revolving credit facility and obtaining the senior subordinated note, the
Company was required to obtain an additional $25.2 million of investment capital. As part of this equity raise, the Company borrowed $1.0 million during the first quarter of fiscal 2004 from an individual investor with an agreement to repay the
principal and interest within 90 days. During the second quarter, the indebtedness to the individual investor plus the interest thereon as well as $0.1 million of other borrowings were converted to Series I Convertible Preferred Stock



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The company is continuing to pursue operational efficiencies through conversion of employee drivers to
independent contractors, will reduce its back office workforce, and is pursuing savings in other areas.



Risk Factors



Customer Contractual
Commitments



The Companys contracts with its
commercial customers typically have a term of one to three years, but are terminable upon 30 or 60 days notice. Although the Company has no reason to believe that these contracts will be terminated prior to the expiration of their terms, early
termination of these contracts could have a material adverse effect on the Companys business, financial condition and results of operations.



Highly Competitive Industry



The market for same-day delivery and logistics services has been and is expected to remain highly competitive. Competition is often intense, particularly
for basic delivery services. High fragmentation and low barriers to entry characterize the industry. Other companies in the industry compete with the Company not only for provision of services but also for qualified drivers. Some of these companies
have longer operating histories and greater financial and other resources than the Company. Additionally, companies that do not currently operate delivery and logistics businesses may enter the industry in the future.



Claims Exposure



As of October 2, 2004, the Company utilized the services of approximately 4,000 drivers and messengers. From time to time
such persons are involved in accidents or other activities that may give rise to liability claims. The Company currently carries liability insurance with a per occurrence and an aggregate limit of $15 million. Owner-operators are required to
maintain liability insurance of at least the minimum amounts required by applicable state or provincial law. The Company also has insurance policies covering property and fiduciary trust liability, which coverage includes all drivers and messengers.
There can be no assurance that claims against the Company, whether under the liability insurance or the surety bonds, will not exceed the applicable amount of coverage, that the Companys insurer will be solvent at the time of settlement of an
insured claim, or that the Company will be able to obtain insurance at acceptable levels and costs in the future. If the Company were to experience a material increase in the frequency or severity of accidents, liability claims, workers
compensation claims or unfavorable resolutions of claims, the Companys business, financial condition and results of operations could be materially adversely affected. In addition, significant increases in insurance costs could reduce the
Companys profitability.



Certain Tax Matters Related to Drivers



A significant number of the Companys drivers are
currently independent contractors (meaning that they are not its employees). From time to time, federal and state taxing authorities have sought to assert that independent contractor drivers in the same-day transportation and transportation
industries are employees. The Company does not pay or withhold federal or state employment taxes with respect to drivers who are independent contractors. Although the Company believes that the independent contractors the Company utilizes are not
employees under existing interpretations of federal and state laws, the Company cannot guarantee that federal and state authorities will not challenge this position or that other laws or regulations, including tax laws and laws relating to
employment and workers compensation, will not change. If the IRS were to successfully assert that the Companys independent contractors are in fact its employees, the Company would be required to pay withholding taxes, extend additional
employee benefits to these persons and could be required to pay penalties or be subject to other liabilities as a result of incorrectly classifying employees. If drivers are deemed to be employees rather than independent contractors, the Company
could be required to increase their compensation since they may no longer be receiving commission-based compensation. Any of the foregoing possibilities could increase the Companys operating costs and have a material adverse effect on its
business, financial condition and results of operations.



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Local Delivery Industry; General Economic Conditions



The Companys sales and earnings are especially sensitive to events
that affect the delivery services industry including extreme weather conditions, economic factors affecting the Companys significant customers and shortages of or disputes with labor, any of which could result in the Companys inability
to service its clients effectively or the inability of the Company to profitably manage its operations. In addition, downturns in the level of general economic activity and employment in the U.S. or Canada may negatively impact demand for the
Companys services.



Permits and Licensing



Although certain aspects of the transportation industry have been
significantly deregulated, the Companys delivery operations are still subject to various federal (U.S. and Canadian), state, provincial and local laws, ordinances and regulations that in many instances require certificates, permits and
licenses. Failure by the Company to maintain required certificates, permits or licenses or to comply with applicable laws, ordinances or regulations could result in substantial fines or possible revocation of the Companys authority to conduct
certain of its operations.



Dependence on Key Personnel



The Companys success is largely dependent on the skills, experience
and performance of certain key members of its management. The loss of the services of any of these key employees could have a material adverse effect on the Companys business, financial condition and results of operations. The Companys
future success and plans for growth also depend on its ability to attract and retain skilled personnel in all areas of its business. There is strong competition for skilled personnel in the same-day delivery and logistics businesses.



Dependence on Availability of Qualified Delivery Personnel



The Company is dependent upon its ability to attract and retain, as
employees or through independent contractor or other arrangements, qualified delivery personnel who possess the skills and experience necessary to meet the needs of its operations. The Company competes in markets in which unemployment is generally
relatively low and the competition for owner-operators and other employees is intense. The Company must continually evaluate and upgrade its pool of available owner-operators to keep pace with demands for delivery services. There can be no assurance
that qualified delivery personnel will continue to be available in sufficient numbers and on terms acceptable to the Company. The inability to attract and retain qualified delivery personnel could have a material adverse impact on the Companys
business, financial condition and results of operations.



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Volatility of Stock Price



Prices for the Companys common stock will be determined in the marketplace and may be influenced by many factors,
including the depth and liquidity of the market for the common stock, investor perception of the Company and general economic and market conditions. Variations in the Companys operating results, general trends in the industry and other factors
could cause the market price of the common stock to fluctuate significantly. In addition, general trends and developments in the industry, government regulation and other factors could have a significant impact on the price of the common stock. The
stock market has, on occasion, experienced extreme price and volume fluctuations that have often particularly affected market prices for smaller companies and that often have been unrelated or disproportionate to the operating performance of the
affected companies, and the price of the common stock could be affected by such fluctuations.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.



The Companys operations are not currently subject to material market risks for interest rates, foreign currency rates, or other market price risks.
However, the Company has revolving debt of $29.8 million at October 2, 2004. If the entire revolving credit facility were subject to a one percentage point change in the borrowing rate, the corresponding annualized effect on interest expense would
be $298,000.



ITEM 4. CONTROLS AND PROCEDURES



(a) Evaluation
of Disclosure Controls and Procedures



As
of the end of the period covered by this report, under the supervision and with the participation of the Companys management, including the companys Chief Executive Officer (CEO) and Chief Financial Officer (CFO) (the Certifying
Officers), the Company carried out an evaluation of the effectiveness of its disclosure controls and procedures (as the term is defined in the Securities Exchange Act of 1934, as amended (the Act) Rules 13a-15(e) and
15d-15(e) to mean controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports it files or submits under the Act is recorded, processed, summarized and reported, within
the time periods specified in the Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Act is accumulated and communicated to the issuers management, including the Certifying Officers, to allow timely decisions regarding required disclosure).



As we reported in our Form 10-K for the fiscal year ended July 3, 2004 (filed
December 23, 2004), in connection with the audit of our financial statements for that year, we identified significant deficiencies which represented a material weakness, caused by the Companys relocation of its Finance function during the
4thfiscal quarter of that year; and related to inadequate staffing and supervision leading to the untimely
identification and resolution of certain accounting matters; failure to perform timely cutoff and reviews, substantiation and evaluation of certain general ledger account balances; inadequate procurement procedures; lack of procedures or expertise
needed to prepare all required disclosures; and evidence that employees lack the experience and training to fulfill their assigned functions, Based on this evaluation, the Certifying Officers concluded that the Companys disclosure controls and
procedures were not effective to ensure that material information was recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Companys disclosure obligations under the Securities
Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. As we reported this material weakness in our Form 10-K under ITEM 9A.Controls and Procedures filed December 23, 2004, such material weakness and
associated ineffectiveness also existed at October 2, 2004.



(b) Changes in
internal controls over financial reporting



As described in section (b) above, on December 23, 2004 we reported a material weakness as of July 3, 2004. The Company has taken steps to attempt to improve its internal controls and its control environment. The Company has appointed a new
Chief Financial Officer to provide oversight of the monthly financial



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closing, data analysis, account reconciliation and cutoff, and is restructuring its Finance organization to address the defined weaknesses and implement
appropriate accounting & documentation standards, staff training and mentoring, period cutoff and supervisory review, and timeliness of reporting. The Company believes that the corrective steps described herein will enable management to conclude
that the internal controls over its financial reporting are effective when they are fully implemented The Company will continue its efforts to identify, assess and correct any additional weaknesses in internal control.



PART II



ITEM 1. LEGAL PROCEEDINGS.



The
Company is a party to litigation and has claims asserted against it incidental to its business. Most of such claims are routine litigation that involve workers compensation claims, claims arising out of vehicle accidents and other claims
arising out of the performance of same-day transportation services. The Company carries workers compensation insurance and auto liability coverage for its employees.The Company and its subsidiaries are also named as defendants in
various employment-related lawsuits arising in the ordinary course of the business of the Company. The Company vigorously defends against all of the foregoing claims.



The Company has established reserves for litigation, which it believes are adequate. The Company reviews its litigation
matters on a regular basis to evaluate the demands and likelihood of settlements and litigation related expenses. Based on this review, the Company does not believe that the pending active lawsuits, if resolved or settled unfavorably to the Company,
would have a material adverse effect upon the Companys balance sheet or results of operations. The Company has managed to fund settlements and litigation expenses through cash flow and believes that it will be able to do so going forward.
Settlements and litigation expenses have not had a material impact on cash flow and the Company believes they will not have a material impact going forward.



Cautionary Statements Regarding Pending Litigation and Claims



The Companys statements above concerning pending litigation constitute forward-looking statements. Investors should
consider that there are many important factors that could adversely affect the Companys assumptions and the outcome of claims, and cause actual results to differ materially from those projected in the forward-looking statements. These factors
include:



| |  | The Company has made estimates of its exposure in connection with the lawsuits and claims that have been made. As a result of litigation or settlement of cases, the actual amount of
exposure in a given case could differ materially from that projected. In addition, in some instances, the Companys liability for claims may increase or decrease depending upon the ultimate development of those claims.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In estimating the Companys exposure to claims, the Company is relying upon its assessment of insurance coverages and the availability of insurance. In some instances insurers
could contest their obligation to indemnify the Company for certain claims, based upon insurance policy exclusions or limitations. In addition, from time to time, in connection with routine litigation incidental to the Companys business,
plaintiffs may bring claims against the Company that may include undetermined amounts of punitive damages. The Company is currently not aware of any such punitive damages claim or claims in the aggregate which would exceed 10% of its current assets.
Such punitive damages are not normally covered by insurance.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.



Series J Convertible Preferred Stock In February 2004, the Companys Board of Directors authorized the sale of up to $12.0 million of Series J Convertible Preferred Stock (Series J
Preferred) through a private placement. Pursuant to Stock Purchase Agreements entered into during March, April and July 2004, the



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Company contracted to issue, upon shareholder approval, 7,999,993 shares of Series J Preferred to investors for $1.50 per share for net proceeds of $12.0
million. As part of the Boards action it approved the option of funding the investment in the Series J Preferred by TH Lee Putnam Ventures in the form of a letter of credit that would later be replaced by a cash investment in a like amount.
This transaction was completed between the Company and TH Lee Putnam Ventures, and it affiliates, on July 26, 2004. The issuance of the Series J Preferred is subject to shareholder approval and is non-voting unless it is converted into common stock.
TH Lee Putnam Ventures & MCG Global, who control a majority of the shares, have agreed to vote for such approvals. Additionally, shareholder approval is required to increase the number of authorized shares of the Companys stock by an
amount sufficient to provide for the issuance of all the preferred shares. The initial conversion price of the Series J Preferred is $0.15 per common share, and, at the time the stock purchase agreements were entered into, assuming that the Series J
Preferred were issued and convertible then, each share of Series J Preferred was convertible into ten shares of the Companys common stock. Both the conversion price and the number of common shares into which the Series J Preferred is
convertible are subject to adjustment in order to prevent dilution. The Series J Preferred was deemed to have contained a beneficial conversion amounting to $12.0 million, $4.6 million of which was recognized in the fourth quarter of fiscal 2004,
and $7.4 million of which was recognized in the first quarter of fiscal 2005, as charges against net income (loss) available to common shareholders in the respective fiscal quarters.



Series K Convertible Preferred Stock On June 30, 2004, the Companys Board of Directors authorized
the sale of up to $25.0 million of Series K Convertible Preferred Stock (Series K Preferred) through a private placement. Pursuant to a Stock Purchase Agreement entered into on August 23, 2004, the Company sold, pending shareholder
approval, 7,266,666 shares of Series K Preferred to investors for $1.50 per share and received net proceeds of approximately $10.9 million. The issuance of the Series K Preferred is subject to shareholder approval and is non-voting unless it is
converted into common stock. Additionally, shareholder approval is required to increase the number of authorized shares of the Companys common stock by an amount sufficient to provide for the issuance of all the preferred shares. TH Lee Putnam
Ventures and MCG Global, who control a majority of the shares, have agreed to vote for such approvals. The initial conversion price of the Series K Preferred is $0.15 per common share, and, at the time the stock purchase agreements were executed,
assuming that the Series K Preferred were issued and convertible then, each share of Series K Preferred was convertible into ten shares of the Companys common stock. Both the conversion price and the number of common shares into which the
Series K Preferred is convertible are subject to adjustment in order to prevent dilution. This sale of Series K Preferred was deemed to have contained a beneficial conversion amounting to $10.9 million which was recognized as a deemed dividend to
preferred shareholders at the time of the sale. The Company began selling its Series K Preferred on August 23, 2004. Subsequent to the end of the first quarter, on December 21, 2004, the Company sold 2,584,800 additional shares of Series K Preferred
for net proceeds of approximately $3.9 million to complete its sales of Series K Preferred. Upon completion of the sale of the Series K Preferred in the second fiscal quarter of 2005, the Company will be required to recognize a charge against net
income (loss) available to common shareholders of approximately $3.9 million to reflect the beneficial conversion in the Series K Preferred.



Series L Convertible Preferred Stock On December 20, 2004, the Companys Board of Directors authorized the sale of up to $7.0
million of Series L Convertible Preferred Stock (Series L Preferred) through a private placement to TH Lee Putnam Ventures and its related affiliates. The Company entered into a Stock Purchase Agreement on December 21, 2004, pursuant to
which the Company will sell, pending shareholder approval, 7,000,000 shares of Series L Preferred to investors for $1.00 per share for net proceeds of approximately $7.0 million. The consideration for the Series L will consist of cancellation of the
Companys obligation to repay the investor the funds paid by the investor to the Companys senior lender to support the Companys revolving credit facility. The issuance of the Series L Preferred is subject to shareholder approval and
is non-voting unless it is converted into common stock. Additionally, shareholder approval is required to increase the number of authorized shares of the Companys common stock by an amount sufficient to provide for the issuance of all of the
preferred shares. TH Lee Putnam Ventures and MCG Global, who control a majority of the shares, have agreed to vote for such approvals. The conversion price of the Series L Preferred is $0.10 per common share, and, at the time the stock purchase
agreements are executed, assuming that the Series L Preferred were issued and convertible then, each share of Series L Preferred will be convertible into ten shares of the Companys common stock. Based on the pricing of the Series L Preferred,
the sale of Series L Preferred is expected to contain a beneficial conversion amounting to $7.0 million which will be recognized as a deemed dividend to preferred shareholders at the time of the sale and a charge against net income (loss) available
to common shareholders



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Series M Convertible Preferred Stock On December 21, 2004, the Company signed a
purchase agreement to raise approximately $21.0 million of new equity capital investment. The investment is initially in the form of a convertible note that will automatically convert into Series M Convertible Preferred Stock (Series M
Preferred) upon approval of the transaction by the Companys shareholders. The proceeds will be used for general working capital needs consistent with financial budgets approved from time to time by the Companys Board of Directors.
The Series M Preferred will accrue cumulative PIK dividends equal to 6% per annum. In the event the Companys shareholders do not approve the transaction, the interest rate will increase to 19% per annum. As part of the transaction, the
investors required that the Companys charter be amended in a number of respects, including a requirement that, upon shareholder approval for the transaction, all preferred shareholders automatically convert their shares of preferred stock to
common stock. In the event of any liquidation or winding up of the Company, the holders of the Series M Preferred will be entitled to a preference on liquidation equal to one times (1x) the original purchase price of the Series M Preferred plus
accrued and unpaid dividends. A consolidation or merger of the Company or a sale of substantially all of its assets shall be treated as a liquidation for these purposes.



The investment will provide the Company with sufficient working capital resources to provide for the anticipated liquidity
needs for the fiscal year and to position the Company to accept definitive and available business with existing and new customers by settling their respective concerns about the Companys ability to service their respective business needs on a
continuing basis.



Warrant to Purchase Common Stock
As part of the Series M Preferred private placement, THLPV agreed to extend for a two-year period the July 1, 2004 capital contribution agreement previously entered into between THLPV and the Companys lenders in support of the
Companys revolving credit facility. Under the terms of the capital contribution agreement, in the event that THLPV elects to not provide further financial support for the Company, THLPV is required to notify the Companys lenders of such
decision and provide specific levels of financial support for a thirty-day period following the notification. In exchange for entering into the capital contribution agreement, the lenders agreed to waive certain financial covenants under the
Companys credit facilities. At the time, THLPV did not receive any compensation in exchange for entering into the capital contribution agreement. As part of the extension of the capital contribution agreement, the Company agreed to issue to
THLPV, subject to shareholder approval, a warrant to purchase 9,677,553 shares of common stock. The term of the warrant will be five years, and the warrant will have an exercise price of $0.0001 per share. Due to the pricing of the warrant, the
Company will be required to record a charge.



ITEM 3. DEFAULTS UPON SENIOR SECURITIES.



As of
October 2, 2004, the Company was not in compliance with the minimum availability or interest coverage ratio covenants in the revolving credit facility and the interest coverage ratio covenant in the senior subordinated debt facility. However, the
Company had in place waivers of its financial debt covenants related to its revolving credit facility and its senior subordinated debt facility. These waivers are in effect through January 1, 2005; and pursuant to the Companys receipt of $21.0
million of investment capital [See footnote 8 SUBSEQUENT EVENTS], on December 21, 2004 the Company obtained waivers and consents from its lenders. The lenders waived all existing defaults and delayed the start date for the financial covenants for
both minimum EBITDA and interest coverage ratio until the earlier of January 1, 2007 and the date upon which the (a) Companys EBITDA for each of two consecutive months equals or exceeds the Companys fixed charges (interest expense and
scheduled principal payments due with respect to Money Borrowed) for the applicable month and (b) Availability under the credit facility for each day of the immediately preceding thirty days is greater than or equal to $1,000,000.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.



Not Applicable.



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ITEM 5. OTHER INFORMATION.



Not
Applicable.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.



| | a. | Exhibits required by Item 601 of Regulation S-K:
| | -- | ------------------------------------------------



|     |  |                                                                                                                                   
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Section 302 Certification of CEO                                                                                                  
|     | 
|31.2 |  | Section 302 Certification of CFO                                                                                                  
|     | 
|32.1 |  | Certification of Chief Executive Officer pursuant to 18 U.S.C as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|     | 
|32.2 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



| | b. | Reports on Form 8-K
| | -- | -------------------



None



SIGNATURES



In accordance with the
requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned; thereunto duly authorized, in the City of Westport, State of Connecticut on January 14, 2005.



VELOCITY EXPRESS CORPORATION.By

/s/ Vincent A. WasikVINCENT A. WASIKChief Executive OfficerBy

/s/ Daniel R. DeFazioDANIEL R. DEFAZIOChief Financial Officer




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