OST-99-5670 / Southern Air Transport / Transfer of Route Authority / Answer of Kitty Hawk / June 7, 1999

Joint Application of

for approval of a transfer of route authority under 49 U.S.C. 41105

Kitty Hawk, Inc., the parent of Kitty Hawk Aircargo, Inc. and Kitty Hawk International, Inc., both of which conduct extensive domestic and international all-cargo air transportation, hereby answer in opposition to the joint application of Southern Air, Inc. ("SAI") and Southern Air Transport, Inc. ("SAT") . Kitty Hawk's objections to the joint request are both procedural and substantive.

First, according to the joint application, SAI has acquired the route authority of the dormant SAT, which currently is liquidating under the auspices of the Bankruptcy Court. SAI is requesting the Department to transfer to it all of SAT's now dormant route authority. While conclusively stating in its application that SAI is fit to engage in air transportation, and therefore eligible to receive the authority previously held by SAT, the DOT has yet to make any such determination. Indeed, the joint application, while styled as a route transfer request under 49 U.S.C. § 41105, should more properly have been fashioned as an application for an initial certificate. SAI has put the cart before the horse by seeking the wholesale transfer of SAT's route authority even before the DOT has rendered a decision on SAI's statutory fitness. For this reason Kitty Hawk requests the DOT to dismiss the route transfer application until such time that SAI _s found to be a U.S. citizen as defined in 49 U.S.C. § 40102(a)(15) that possesses the financial, managerial and requisite compliance disposition to be issued a certificate. 49 U.S.C. § 41102 (b) (1) . Until such a DOT decision is rendered it is premature to consider the merits of the route transfer request.

Second, Kitty Hawk opposes the request to transfer SAT's route authority to SAI (assuming SAI had followed the appropriate procedure for seeking such authority) because SAI has no expressed intention to utilize any of SAT's authority in the near future. Many of the countries to which SAT had obtained authority are not open to new entry, either by virtue of the terms of a restricted air transport agreement or by virtue of foreign government policies that thwart free entry despite the literal terms of the applicable bilateral agreements. It would be inconsistent with the sound DOT policy to ensure the full utilization of often difficult to obtain route rights were the Department to permit SAI to bank valuable route authority in the hope that its business plan develops to the point that it will seek to make use of SAT's route rights. These route rights are inherently too valuable to be allowed to go unutilized. Therefore, Kitty Hawk urges the Department to announce its intention to make available to interested air carriers the unused foreign route opportunities of SAT. For this reason, Kitty Hawk opposes the SAI request on the merits. In further support of these positions, Kitty Hawk states as follows.

SAI and SAT have filed one of the most unusual applications ever in -the annals of DOT practice. Labeled as a route transfer application, SAI is seeking the Department to approve the transfer of all of SAT's now dormant route authority, both permanent and exemption authority, to the prospective new entrant air carrier, SAI. As surely SAI understands, the DOT will ultimately have to rule on whether SAI satisfies the requirements of the federal transportation statute and the DOT's policies and precedents in order to qualify as a holder of a certificate of public convenience and necessity. What SAI does not seem to comprehend however, is that this mandatory DOT determination must be made prior to any decision being rendered on the route transfer request. To this extent SAI's application is in reverse order. SAI properly should have submitted a stand alone application for a certificate in order for the DOT to properly, and in an appropriate sequence, assess its fitness to possess a certificate. The statute requires such an application be submitted before a carrier may be considered a transferee of route authority. /1 Specifically, 49 U.S.C. § 41102 (b)(1) mandates the DOT first find an applicant fit, willing and

1/ SAI's application suffers from the additional defect in that its subject matter is overly broad. Section 201.4(c) of the DOT's Regulations prohibits an applicant for certificate authority to include requests for interstate and foreign authority and scheduled and charter service in the same application. SAI has failed to adhere to this long-standing DOT procedure.

able to provide air transportation and to comply with the Department's rules "before issuing a certificate under subsection(a) of this section...." Emphasis supplied.

Kitty Hawk can find no significant DOT route transfer case in which the transferee of the subject route authority was not an operating air carrier which had previously been found fit to engage in air transportation. American-Eastern and Delta-Eastern Route Transfers, Order 91-8-1, Order 91-10-35; American-Delta Route Transfer, Order 95-3-53; Northwest-Delta Route Transfer, Order 95-4-41; Federal Express-Evergreen, Order 95-8-9.

SAI, on the other hand, is the purchaser of one spare JT9D engine, some furnishings, computer programs and airline-related manuals that the FAA may or may not accept for use by SAI in its operations, once they are certificated. /2 Joint Application, Exhibit 1, p. 2. From this bare bones asset purchase, SAI has fashioned itself as a legitimate applicant for DOT route authority. Whether this is the case or not will have to he decided by the Department in the exercise of its stewardship of the fitness of the nation's air carriers. However, this determination must be made solely in the context of a certificate application and not through the entirely different prism of a route transfer case in which entirely different decisional criteria apply as further discussed in point 2 below.

In the case of an initial certification case the DOT focuses on three areas of concern. First, does carrier management possess

2/ One turbojet engine does not an air carrier make.

the experience and technical skills to exercise the privileges of a certificate holder. Second, has the applicant carrier raised or obtained access to sufficient capital to support its proposed operations so-as not to place passenger or shipper funds at undue risk. Third, are those individuals who are in a control position disposed to comply with all applicable DOT and FAA regulations. National Airlines, Inc., Order 99-1-13. Only if each of these three questions can be answered in the affirmative will the D07 bestow a certificate upon an applicant.

While SAI has provided 17 exhibits to its route transfer application, it is not clear that the material, a, good deal of which was filed pursuant to Rule 39 and therefore not available to Kitty Hawk, supports the necessary three part finding. For example, SAI indicates in Exhibit 13 that in the first year of operation it will employ approximately 1.5 aircraft. Based on its experience, Kitty Hawk questions whether a fleet of such small size can support long-term and often long haul ACMI operations for other air carriers and forwarders as SAI says it intends to do. A fleet of such relatively small size lacks the necessary flexibility to ensure maximum utilization in revenue operations. Consequently, Kitty Hawk questions SAI's assumption of a first year net profit of over $5.8 million. As the Department knows from its experience, small new entrant air carriers are rarely, if ever, profitable in the first year of operation and few applicants forecast such will be the case. Second, with high fixed costs, airlines with small fleets do not enjoy the economies of scale that are characteristic of the industry, but which will be working against SAI as it pursues its business plan in the initial years of operation.

In the absence of an operating profit, it is doubtful that SAT will have sufficient financial resources to support its initial operation. Moreover, even if SAI were to be profitable, it did not properly calculate the amount of funds to which it must have access in order to meet the DOT's financial means test. SAI used its operating expenses projected for its first quarter of operation of $4.81 million as the measure of the DOT mandated capital requirement. In fact, the DOT requires applicants to use an annualized expense estimate which is then divided by four to calculate the required amount of capital that must be on hand prior to the start up of service. National Airlines, Inc., Order 99-1-13, p. 6, fn.8. This is significant for SAI since only in the second half of its first year of operation will it be operating two B-747 aircraft. Therefore, only acknowledging its first quarter's expense substantially understates the required cash or other liquid resources the DOT must find will be available to SAI before it may be issued (or transferred, assuming transfer is appropriate) a certificate. One quarter of SAI's first year annualized expense including pre-operating expense of $1,315,000 is $6,291,855. Based on SAI's pro-forma balance sheet it will have cash and loan proceeds available to it of only $2,346,000, far less than required by DOT policy and precedent. Although SAI has also taken credit for $2,246,000 in current assets, what these assets represent and the extent of their liquidity is not possible to determine from SAI's application exhibits. However, even if the DOT were to give SAI full credit for these current assets, the applicant would only have $4,592,000 of arguably available cash and cash equivalents- -still almost $1.7 million short of the required amount to satisfy the DOT's test of minimum pre-certification financial resources.

The Department should also note in reviewing SAI's financial statements that it has not provided for any repayment of the loans from shareholders. /3 This expense must properly be included in the applicant's financial projections when the DOT calculates whether it possesses or will possess the necessary financial resources to be found fit to engage in air transportation.

Whether SAI will ever be able to establish its fitness to the satisfaction of the Department is yet to be determined. However, the issues highlighted above are illustrative of the significant issues that must be addressed by the Department before it can consider the route transfer aspect of the joint application. By having failed to properly seek an initial certificate, the joint applicants are asking the Department to not only address the critical certification issues, but as well the merits of the applicant's joint request for route transfer authority. Such a procedure is inconsistent with DOT procedure and wasteful of the Department's resources. Therefore, Kitty Hawk urges the Department to either issue a procedural order dismissing, without prejudice, the route transfer application and convert this proceeding into one

3/ Exhibit 12 (page 1) states that SAI's shareholders will make a loan of $3.4 million to the applicant. However, the unnumbered page of Exhibit 13 which consists of the pro forma balance sheet reflects the amount of the shareholder loan as $2,246,000. The DOT must reconcile these inconsistent SAI statements on the critical subject of its capital structure.

that will only consider the initial certification issue. Alternatively, the DOT should issue an appropriate order deferring consideration of the route transfer application. The need for dispositive action on SAI's request for a fitness finding is a prerequisite to Department action on the applicant's route transfer request.

SAI and SAT have attempted to portray their joint request as one which falls squarely within, and should be approved under, the decisional standard of § 41105 and the DOT's route transfer policy. However, the joint applicants have misconstrued the DOT's decisions as they apply to route transfers.

Section 41105 provides that a proposed route transfer may 6nly be approved if it is found to be consistent with the "public interest." The DOT has ruled that the public interest standard contained in § 41105 embraces the statutory statements of policy contained in 4'9 U.S.C. § 40101 as well as other DOT international policy objectives. Federal Express-Flying Tigers, Order 89-5-10, pp. 6-18. In addition, § 41105 directs the Department to analyze the effects of a route transfer on the carriers involved, on competition in the airline industry and on the U.S. international trade position.

In recent route transfer cases the DOT has stressed the ability of the transferee carrier to provide improved and expanded service to the public, and to make maximum use of U.S. international route rights. Northwest -Delta, Order 95-4-41, pp. 3-4 citing Order 91-1-11; Northwest -Hawaiian, Order 91-4-3, p. 5; Federal Express -Evergreen, Order 95-8-9, p. 4. It is on this critical point that the joint application fails to satisfy this important DOT-standard for approval.

Over the decades of operating history, SAT had amassed a substantial aircraft fleet and operated over an extensive route network thereby providing service opportunities for cargo shippers around the world. While SAT exercised its route authority in the interest of the shipping public, SAI is not in a position to similarly use the route rights held by SAT with its small fleet of aircraft and limited financial resources. And this fact distinguishes the joint application from those previously decided by the DOT in which a more viable carrier purchased the certificates.-Of carriers that could not either aggressively or profitably exercise their route rights.

Apart from SAI'S inability to use SAT's route authority, SAI by its own admission, has stated that it has no present intention of exercising SAT's scheduled route rights. ("Although the Joint Applicants ask the Department to transfer all of SAT's authority, Southern's initial operations will consist entirely of all-cargo wetlease services and, if Southern has any excess aircraft capacity, all-cargo charter services." Joint Application, p. 2, fn 1.) Rather SAI seeks to amass the SAT authority without ever stating to what use it plans to make of the authority. Not only would the transfer not make "full use of our limited bilateral rights" (emphasis supplied) (Order 90-5-5, p. 8 cited with approval by the joint applicants) SAI will make no use of these valuable route rights. No route transfer case decided by the Department has permitted the transferee to simply "sit" on unused route rights and have no specific plan for their use. Such would be contrary to the Department's International Air Transportation Policy (April 1995) which seeks to foster an expanded international aviation market.

The fact that SAI has no plan to use SAT's authority is not an academic issue because some of the authority held by SAT is in entry limited markets. For example, authority to Hong Kong and Australia is subject to bilateral route limitations. The same is true for Chile, Argentina, Ecuador and Colombia. Polar Air has already objected to the transfer of SAT's Colombia rights to SAI, which will remain unused, while Polar pursues the right to serve Colombia. The DOT must not permit the wholesale transfer-of extensive international route authority in markets that . are restricted, de facto or de jure, if the transferee air carrier cannot even articulate a plan for their use.

In countries in which frequencies are closely controlled, the DOT has a steady policy of requiring carriers to return any unused rights. U.S.-Germany Third/Fourth/Fifth Freedom Frequency Allocation for the 1995 Summer Season, Order 95-2-26; U.S.-China Frequency- Allocation Proceeding, Order 95-2-30. By analogy, this same policy supports the position of Kitty Hawk that SAT should not be vested with route rights that it can not or will not utilize. It will hardly further U.S. international aviation policy were SAI to be able to bank route authority it has no plans to use.

Finally, before the DOT can grant SAI a certificate authorizing it to engage in foreign air transportation, it must find that the transportation is consistent with the public convenience and necessity. 49 U.S.C. 5 41102(b)(2). In this case the DOT the facts necessary to make this finding with respect to SAI. the classic r(5ut-e transfer case, the transferee carrier is better able to exercise the rights of the transferor carrier, and the DOT approves the transfer because the § 41102 (b) (2) standard can be and is amply established on the record. In this case, the transferee has not established its ability to use SAT's authority and for this additional reason, the route transfer aspect of the joint application cannot be approved under § 41102(b)(2).

Kitty Hawk does not oppose route transfers. Indeed, they are a legitimate market-based technique for allocating carrier resources that normally should he given deference by the DOT. However, in this case SAI cannot articulate a plan for the use of SAT's certificate and exemption authority, and in the absence of any such plan, the DOT is compelled by policy and precedent to deny the request. In addition, SAI should in the first instance be required to establish that it is fit to possess certificate authority before the DOT decides the route transfer request of the joint applicants.

Respectfully submitted,

BAGILEO, SILVERBERG & GOLDMAN, L.L.P.

Attorneys for KITTY HAWK, INC.

Robert P. Silverberg