##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One)þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended March 31, 2004 or o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from _______ to ________ Commission file number: 0-25202 KITTY HAWK, INC.  Delaware
    
    75-2564006(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 1515 West 20th StreetP.O. Box 612787Dallas/Fort Worth International Airport, Texas
    
    75261(Address of principal executive offices)
    
    (Zip Code)
 (972) 456-2200
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes o No þ Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes þ No o The number of shares of common stock, par value $0.000001 per share,
outstanding at May 11, 2004 was 43,744,806.




---



##### Table of Contents



KITTY HAWK, INC. INDEX PAGE NUMBERPART I. FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets March 31, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations Three months ended March 31, 2004 and 2003
    
    
    4Condensed Consolidated Statement of Stockholders Equity Three months ended March 31, 2004
    
    
    5Condensed Consolidated Statements of Cash Flows Three months ended March 31, 2004 and 2003
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    21Item 4. Controls and Procedures
    
    
    21PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    21Item 2. Changes in Securities and Use of Proceeds
    
    
    22Item 3. Defaults upon Senior Securities
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22Item 5. Other Information
    
    
    22Item 6. Exhibits and Reports on Form 8-K
    
    
    22Certification of Principal Executive OfficerCertification of Principal Financial OfficerCertification Pursuant to Section 906
 2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS KITTY HAWK, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data) March 31,
    
    December 31,2004







    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    11,307
    
    
    $
    15,729Restricted cash and short-term investments
    
    
    1,314
    
    
    
    579Trade accounts receivable, net of allowance for doubtful accounts of $0.6
million and $0.5 million, respectively
    
    
    13,040
    
    
    
    11,539Assets held for sale
    
    
    105
    
    
    
    114Inventory and aircraft supplies
    
    
    5,710
    
    
    
    5,441Deposits and prepaid expenses
    
    
    1,440
    
    
    
    1,135Prepaid fuel
    
    
    1,766
    
    
    
    1,122Settlement receivable
    
    
    1,265
    
    
    
    1,765Other current assets, net
    
    
    99
    
    
    
    143Total current assets
    
    
    36,046
    
    
    
    37,567Property and equipment, net
    
    
    8,312
    
    
    
    9,058Other assets, net
    
    
    400
    
    
    
    485Total assets
    
    $
    44,758
    
    
    $
    47,110LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Current liabilities:Accounts payable  trade
    
    $
    2,112
    
    
    $
    2,880Accrued wages
    
    
    800
    
    
    
    761Other accrued expenses
    
    
    6,396
    
    
    
    5,519Other taxes payable
    
    
    2,036
    
    
    
    2,270Current portion of accrued maintenance reserves
    
    
    1,814
    
    
    
    2,617Current portion of lease return provisions
    
    
    3,216
    
    
    
    2,459Current maturities of long-term debt
    
    
    1,887
    
    
    
    2,348Total current liabilities
    
    
    18,261
    
    
    
    18,854Long-term debt
    
    
    
    
    
    
    34Accrued maintenance reserves
    
    
    3,486
    
    
    
    3,311Other long-term liabilities
    
    
    1,185
    
    
    
    1,307Total liabilities
    
    
    22,932
    
    
    
    23,506Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Preferred stock, $0.01 par value: Authorized shares  3,000,000; none issued
    
    
    
    
    
    
    Common stock, $0.000001 par value: Authorized shares  62,000,000; issued
and outstanding  43,612,306 and 40,760,084 at March 31, 2004 and December
31, 2003, respectively
    
    
    
    
    
    
    Additional capital
    
    
    18,321
    
    
    
    18,311Retained earnings
    
    
    3,505
    
    
    
    5,293Total stockholders equity
    
    
    21,826
    
    
    
    23,604Total liabilities and stockholders equity
    
    $
    44,758
    
    
    $
    47,110
 The accompanying notes are an integral part of these financial statements. 3




---



##### Table of Contents



KITTY HAWK, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited) Three months ended March 31,2004
    
    2003Revenue:Scheduled freight
    
    $
    33,224
    
    
    $
    28,429ACMI
    
    
    
    
    
    
    2,025Miscellaneous
    
    
    518
    
    
    
    530Total revenue
    
    
    33,742
    
    
    
    30,984Cost of revenue:Flight expense
    
    
    7,189
    
    
    
    6,262Transportation expense
    
    
    2,825
    
    
    
    6,039Fuel expense
    
    
    9,203
    
    
    
    7,921Maintenance expense
    
    
    3,380
    
    
    
    3,360Freight handling expense
    
    
    6,488
    
    
    
    5,730Depreciation and amortization
    
    
    812
    
    
    
    905Operating overhead expense
    
    
    2,655
    
    
    
    2,434Total cost of revenue
    
    
    32,552
    
    
    
    32,651Gross profit (loss)
    
    
    1,190
    
    
    
    (1,667
    )General and administrative expense
    
    
    2,916
    
    
    
    2,685Operating loss
    
    
    (1,726
    )
    
    
    (4,352
    )Other (income) expense:Interest expense
    
    
    96
    
    
    
    116Other, net
    
    
    (34
    )
    
    
    (481
    )Net loss
    
    $
    (1,788
    )
    
    $
    (3,987
    )Basic net loss per share
    
    $
    (0.04
    )
    
    $
    (0.08
    )Weighted average common shares outstanding
    
    
    50,574,970
    
    
    
    49,999,970Diluted net loss per share
    
    $
    (0.04
    )
    
    $
    (0.08
    )Weighted average diluted common shares outstanding
    
    
    50,574,970
    
    
    
    49,999,970
 The accompanying notes are an integral part of these financial statements. 4




---



##### Table of Contents



KITTY HAWK, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
(in thousands, except share data)
(unaudited) Common StockNumber of
    
    Number ofUnrestricted
    
    Restricted
    
    
    
    
    
    Additional
    
    RetainedShares
    
    Shares
    
    Amount
    
    Capital
    
    Earnings
    
    TotalBalance at December 31, 2003
    
    
    40,622,584
    
    
    
    137,500
    
    
    $
    
    
    
    $
    18,311
    
    
    $
    5,293
    
    
    $
    23,604Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,788
    )
    
    
    (1,788
    )Compensation expense associated with stock option grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    10Issue common stock related to exercise of warrants to acquire stock
    
    
    2,852,222
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Vesting of restricted shares
    
    
    18,750
    
    
    
    (18,750
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at March 31, 2004
    
    
    43,493,556
    
    
    
    118,750
    
    
    $
    
    
    
    $
    18,321
    
    
    $
    3,505
    
    
    $
    21,826
 The accompanying notes are an integral part of these financial statements. 5




---



##### Table of Contents



KITTY HAWK, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited) Three months ended March 31,2004
    
    2003Operating activities:Net loss
    
    $
    (1,788
    )
    
    $
    (3,987
    )Adjustments to reconcile loss to net cash provided
by operating activities:Depreciation and amortization expense
    
    
    951
    
    
    
    989(Gain) loss on disposal of property and equipment
    
    
    5
    
    
    
    (262
    )Compensation expense related to stock options
    
    
    10
    
    
    
    Provision for doubtful accounts
    
    
    118
    
    
    
    142Changes in operating assets and liabilities:Trade accounts receivable
    
    
    (1,618
    )
    
    
    (737
    )Settlement receivable
    
    
    500
    
    
    
    Inventory and aircraft supplies
    
    
    (230
    )
    
    
    63Prepaid expenses and other
    
    
    (770
    )
    
    
    (866
    )Accounts payable and accrued expenses
    
    
    (139
    )
    
    
    (331
    )Accrued maintenance reserves
    
    
    128
    
    
    
    441Net cash used in operating activities
    
    
    (2,833
    )
    
    
    (4,548
    )Investing activities:Proceeds from sale of assets
    
    
    42
    
    
    
    350Change in restricted cash
    
    
    (735
    )
    
    
    238Capital expenditures
    
    
    (282
    )
    
    
    (104
    )Net cash provided by (used in) investing activities
    
    
    (975
    )
    
    
    484Financing activities:Borrowings of long-term debt
    
    
    1,886
    
    
    
    Loan origination cost
    
    
    (118
    )
    
    
    Repayments of long-term debt
    
    
    (2,382
    )
    
    
    (928
    )Net cash used in financing activities
    
    
    (614
    )
    
    
    (928
    )Net decrease in cash and cash equivalents
    
    
    (4,422
    )
    
    
    (4,992
    )Cash and cash equivalents at beginning of period
    
    
    15,729
    
    
    
    10,353Cash and cash equivalents at end of period
    
    $
    11,307
    
    
    $
    5,361
 The accompanying notes are an integral part of these financial statements. 6




---



##### Table of Contents



KITTY HAWK, INC. AND SUBSIDIARIES 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements, which should
be read in conjunction with the consolidated financial statements and footnotes
included in the Companys Annual Report on Form 10-K filed with the Securities
and Exchange Commission for the year ended December 31, 2003, are unaudited
(except for the December 31, 2003 condensed consolidated balance sheet, which
was derived from the Companys audited consolidated balance sheet included in
the aforementioned Form 10-K), but have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. In the
opinion of management, all adjustments (consisting only of normal recurring
adjustments) considered necessary for a fair presentation have been included. The preparation of the consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. On an
ongoing basis, management evaluates its estimates and judgments and
incorporates any changes in such estimates and judgments into the accounting
records underlying the Companys consolidated financial statements. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates. 2. LEGAL PROCEEDINGS General Motors and Delphi Automotive were sued in Wayne County, Michigan
by a number of air charter carriers in connection with air transportation
services the Company arranged with them on behalf of General Motors and Delphi
Automotive and for which the air charter carriers were not paid as a result of
the Companys bankruptcy. The air charter carriers are seeking to recover
approximately $4.6 million from General Motors and Delphi Automotive. General
Motors has named the Company as a third party defendant in the litigation and
is seeking indemnification of up to $4.6 million against the Company. The
parties have agreed that the indemnification claim will be heard in bankruptcy
court in Fort Worth, Texas (the Bankruptcy Court). In May, 2004, the Company
was dismissed from the litigation in Wayne County, Michigan. The Company
believes this claim should have been discharged when its Plan of Reorganization
was confirmed by the Bankruptcy Court. No amounts have been accrued for this
contingency. In the normal course of business, the Company is a party to various legal
proceedings and other claims. While the outcome of these other proceedings and
other claims cannot be predicted with certainty, management does not believe
these matters will have a material adverse affect on the Companys financial
condition or results of operations. 3. STOCK OPTIONS In September 2003, the Companys stockholders approved the Kitty Hawk 2003
Long Term Equity Incentive Plan (the Plan). Options granted under the Plan
are accounted for under the provisions of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The Company is required to disclose the pro forma effect of accounting for
stock options using the fair value recognition provisions of SFAS Statement No.
123, Accounting for Stock-Based Compensation and SFAS Statement No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure. The
Company uses the Black-Scholes option pricing model to calculate the fair value
of options. The following weighted average assumptions have been used in
determining the fair value of the options granted: 7




---



##### Table of Contents



Three MonthsEndedMarch 31,2004
    
    2003Risk free interest rate
    
    
    4.05
    %
    
    
    Expected life (years)
    
    
    10
    
    
    
    Volatility
    
    
    50
    %
    
    
    Dividend yield
    
    
    0
    %
    
    
    
 Some of these assumptions are judgmental and highly sensitive in the
determination of pro forma compensation expense. The following table
illustrates the effect on net income and earnings per share if the Company had
applied fair value accounting. Three MonthsEndedMarch 31,2004
    
    2003(In thousands,except per share data)Net loss, as reported
    
    $
    (1,788
    )
    
    $
    (3,987
    )Add: Total stock-based employee
compensation expense determined
under the intrinsic method for all
awards
    
    
    10
    
    
    
    Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards
    
    
    (78
    )
    
    
    Pro forma net loss
    
    $
    (1,856
    )
    
    $
    (3,987
    )Basic loss per share  as reported
    
    $
    (0.04
    )
    
    $
    (0.08
    )Basic loss per share  pro forma
    
    $
    (0.04
    )
    
    $
    (0.08
    )Diluted loss per share  as reported
    
    $
    (0.04
    )
    
    $
    (0.08
    )Diluted loss per share  pro forma
    
    $
    (0.04
    )
    
    $
    (0.08
    )
 The Plan provides for the issuance of up to 6,500,000 shares of common
stock. The options granted generally have an exercise price equal to the quoted
market price of the stock on the date of grant. The options granted vest over
periods of 36 to 48 months. The options expire ten years from the date of
grant, subject to earlier forfeiture provisions. The following table summarizes the stock option activity under the Plan
for the three months ended March 31, 2004: WeightedAvailable for
    
    Options
    
    AverageGrant
    
    Outstanding
    
    Exercise PriceOutstanding at December 31, 2003:
    
    
    1,465,000
    
    
    
    4,460,000
    
    
    $
    0.30Authorized for grant
    
    
    
    
    
    
    
    
    
    
    Granted (weighted average fair value of $1.24)
    
    
    (200,000
    )
    
    
    200,000
    
    
    $
    1.41Exercised
    
    
    
    
    
    
    
    
    
    
    Canceled
    
    
    131,250
    
    
    
    (131,250
    )
    
    $
    0.30Outstanding at March 31, 2004:
    
    
    1,396,250
    
    
    
    4,528,750
    
    
    $
    0.35
 The following table summarizes information about the stock options
outstanding at March 31, 2004: Weighted
    
    Weighted Average
    
    
    
    
    
    Weighted AverageNumber of
    
    Average
    
    Exercise Price
    
    Number of
    
    Exercise PriceOptions
    
    Remaining
    
    of Options
    
    Options
    
    of OptionsExercise Prices
    
    Outstanding
    
    Life (Years)
    
    Outstanding
    
    Exercisable
    
    Exercisable$0.30
    
    
    4,318,750
    
    
    
    9.33
    
    
    $
    0.30
    
    
    
    1,212,500
    
    
    $
    0.30$1.105
    
    
    10,000
    
    
    
    9.75
    
    
    $
    1.105
    
    
    
    833
    
    
    $
    1.105$1.41
    
    
    200,000
    
    
    
    9.83
    
    
    $
    1.41
    
    
    
    11,111
    
    
    $
    1.414,528,750
    
    
    
    9.57
    
    
    $
    0.35
    
    
    
    1,224,444
    
    
    $
    0.31
 8




---



##### Table of Contents



4. SEGMENT REPORTING The Companys operations are comprised of two segments  an expedited
scheduled freight network and a cargo airline. Each segments respective
financial performance is detailed below. Each segment is currently evaluated on
financial performance at the operating income line. The column labeled other consists of corporate activities. Business
assets are owned by or allocated to each of the business segments. Assets
included in the column labeled other include cash, allowance for doubtful
accounts and the corporate headquarters building. The accounting policies of
each segment are the same as those reported in Note 2 of the Annual Report on
Form 10-K for the year ended December 31, 2003. ScheduledFreight
    
    Air Freight
    
    
    
    
    
    
    
    
    
    ConsolidatedNetwork
    
    Carrier
    
    Other
    
    Eliminations
    
    Balance(in thousands)Three months ended March 31, 2004:Revenue from external customers
    
    $
    33,224
    
    
    $
    518
    
    
    $
    
    
    
    $
    
    
    
    $
    33,742Revenue from intersegment
operations
    
    
    
    
    
    
    11,495
    
    
    
    
    
    
    
    (11,495
    )
    
    
    Depreciation and amortization
    
    
    93
    
    
    
    719
    
    
    
    
    
    
    
    
    
    
    
    812Operating income (loss)
    
    
    (1,630
    )
    
    
    31
    
    
    
    (127
    )
    
    
    
    
    
    
    (1,726
    )Total assets
    
    
    10,975
    
    
    
    12,772
    
    
    
    21,011
    
    
    
    
    
    
    
    44,758Three months ended March 31, 2003:Revenue from external customers
    
    $
    28,429
    
    
    $
    2,555
    
    
    $
    
    
    
    $
    
    
    
    $
    30,984Revenue from intersegment
operations
    
    
    
    
    
    
    8,952
    
    
    
    
    
    
    
    (8,952
    )
    
    
    Depreciation and amortization
    
    
    91
    
    
    
    814
    
    
    
    
    
    
    
    
    
    
    
    905Operating income (loss)
    
    
    (4,483
    )
    
    
    355
    
    
    
    (224
    )
    
    
    
    
    
    
    (4,352
    )Total assets
    
    
    4,003
    
    
    
    19,364
    
    
    
    18,850
    
    
    
    
    
    
    
    42,217
 5. EARNINGS PER SHARE In
March 2003, the Company issued shares of common stock and warrants to
purchase 9,814,886 shares of common stock to its former creditors in accordance with its Plan of
Reorganization. Because the exercise price of the warrants is nominal, such
warrants are treated as outstanding common shares for purposes of calculating
loss per share. These shares are deemed to be outstanding for the entire period
presented. For
the period ended March 31, 2004, we did not include outstanding options
to purchase 4,528,750 shares of common stock in the diluted loss per share
calculation since their effect was antidilutive due to the reported loss. For
the period ended March 31, 2003, there were no options outstanding. 6. RELATED PARTY TRANSACTIONS The Company has various agreements and relationships with beneficial
owners of 5% or more of the Companys common stock. See Item 13. Certain
Relationships and Related Party Transactions of the Companys Annual Report of
Form 10-K/A for the year ended December 31, 2003 for information on these
agreements and relationships. In addition, see the Companys
Form 8-K dated May 8, 2004 regarding the Companys  new
registration rights agreement and voting agreement with Resurgence
Asset Management, L.L.C., Everest Capital Limited and Stockton, LLC. 7. SUBSEQUENT EVENTS Pegasus Aviation Aircraft Lease Return.In October 2002, the Company
entered into four operating leases for Boeing 727-200 cargo aircraft with
affiliates of Pegasus Aviation. These leases expired on May 8, 2004. 9




---



##### Table of Contents



Under these leases, in addition to rental payments, the Company was
required to pay maintenance reserves each month with the amount determined
based on flight hours or cycles of utilization during the previous month. In
addition, under the terms of these leases, each aircraft had to be returned to
the lessor with the same number of available flight hours or cycles on the
airframe, aircraft engines, landing gear and auxiliary power units until the
next scheduled maintenance event as were available at the time the Company
originally took delivery of each of the aircraft. Each of the aircraft had
just undergone a light or heavy C-Check when the Company originally took
delivery. Under the terms of these leases, instead of performing a light or
heavy C-check on each of the airframes prior to returning them, the Company was
required to pay the lessor $750,000 per airframe in lieu of the C-Check. Such
payment does not satisfy any return condition requirement applicable to the
aircraft components which the Company must return with the same amount of
aggregate hours, cycles and days remaining as when delivered. Each $750,000
payment was reduced by the amount of maintenance reserves paid to the lessor
under these leases. Because the Companys estimate of the costs to meet these aircraft lease
return obligations exceed the $2.4 million of lease return reserves the Company
had recorded as of December 31, 2003 for these aircraft, the Company took a
charge of $1.2 million in the first quarter of 2004. As of May 14, 2004, the
Company was in the process of returning these aircraft to the lessor and,
according to the lessor, the Company has not yet fully satisfied its lease
return obligations under the leases. While the Company believes its current
lease return reserve pertaining to the return of these aircraft is sufficient
to meet the lease return obligations, the final cost will not be known until
the aircraft are returned and the lease return obligations are satisfied in
accordance with the lease. As a result, if the actual cost of meeting the
lease return conditions increase, the Company may be required to take an
additional charge in the second quarter of 2004. In addition, until
the lease return conditions are satisfied, the Company may be subject
to continuing lease payments. 10




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Executive Overview Kitty Hawk is a holding company and currently operates through its two
wholly-owned subsidiaries, Kitty Hawk Cargo and Kitty Hawk Aircargo Through Kitty Hawk Cargo, we operate a major independent city-to-city
expedited scheduled freight network in the continental U.S. and selected cities
in Canada providing next-morning and two-day freight service. In addition, we
have business alliances that allow us to provide freight services to Alaska and
Hawaii. As an independent freight network, we typically do not transport
freight from shippers to our cargo facilities or from our cargo facilities to
recipients. As a result, we primarily provide freight services to freight
forwarders and logistics companies who either transport the freight to and from
our cargo facilities in the origin and destination cities we serve or arrange
for others to provide these services. In November 2003, on a test basis, we
began offering an airport-to-door delivery option to a limited number of our
customers by contracting with local cartage agents in major metropolitan areas
of the continental U.S. We began offering this service to all of our customers
during March 2004. On occasion, for an additional fee, we arrange for the
initial pick up of freight from shippers as well as the final delivery to
recipients. For the three months ended March 31, 2004, we generated
approximately 98% of our revenue from our expedited scheduled freight network. Kitty Hawk Aircargo, our cargo airline, provides air freight
transportation services for Kitty Hawk Cargos expedited scheduled freight
network. In addition, Kitty Hawk Aircargo provides services which include the
aircraft, crew, maintenance and insurance, also known as ACMI, and ad-hoc
charters for a variety of customers when its aircraft are not being used in our
expedited scheduled freight network. On March 31, 2004, Kitty Hawk Aircargo had
22 owned and leased aircraft available for operation in revenue service. By
providing ACMI and ad-hoc charters, Kitty Hawk Aircargo is able to improve the
utilization of its aircraft and generate additional revenue when its aircraft
would otherwise be idle. Our expedited scheduled freight business relies on customers who need
time-definite delivery on an as-needed basis. Because the freight is shipped on
an as-needed basis, we do not have long-term contracts with our customers.
Without long-term customer contracts, the overall demand for our expedited
freight services is primarily influenced by the health of the U.S. economy,
which is cyclical in nature. In addition, we believe that most of the freight
transported in our network relates to the automotive, electronics, telecom and
related infrastructure equipment, apparel and other durable goods and equipment
industries. These industries tend to be seasonal in nature and, as a result,
our business is also seasonal with the third and fourth quarters being the
strongest revenue quarters. Because of the foregoing factors, the amount of
freight shipped in our expedited scheduled freight network can fluctuate
significantly. In addition, our expedited freight services network is
experiencing increased competition from integrated carriers and trucking
networks that provide lower cost second- and third-day alternatives to our
overnight freight services. Our expedited scheduled freight network and cargo airline also have large
fixed costs which cannot be easily reduced in the short term. Therefore, we
typically have seasonal working capital needs in the first and second quarters
of the year. Since our expedited freight business is both seasonal and tied to
the economic trends of the consumer and manufacturing sectors of the U.S.
economy, we may incur additional working capital needs during the 11




---



##### Table of Contents



third and fourth quarters of the year to the extent that our revenues do
not allow us to cover our relatively high fixed costs. During the three months ended March 31, 2004, we have continued to focus
on reducing both our fixed and variable costs. We have also focused on
maintaining the efficiency and reliability of our network resulting in an on
time performance to our customers of 99.6%. One of our most significant and variable costs is the cost of jet fuel.
Because our network bears the cost of increases in jet fuel costs, we seek to
recapture the increase in jet fuel costs through increasing our prices to our
customers and/or through temporary fuel surcharges. We record these fuel
surcharges in our scheduled freight revenue. Historically, we have been able to
largely offset the rising costs of jet fuel through these fuel surcharges
and/or by raising our prices to our customers. However, if due to competitive
pressures or other reasons, we are unable to raise our fuel surcharge and/or
our prices due to competitive pressures or other reasons, we may be forced to
absorb increases in jet fuel costs, which could negatively affect our results
of operations. During the three months ended March 31, 2004 and 2003, we purchased jet
fuel from various suppliers at then current market prices. We do not currently
have any short- or long-term contracts for jet fuel, nor do we currently have
any agreements to hedge against changes in the price of jet fuel. From time to
time, we review the price and availability of jet fuel. If we have the
opportunity and ability to enter into supply contracts for jet fuel or
arrangements to hedge against changes in jet fuel prices, we may enter into
such agreements or arrangements. During the three months ended March 31, 2004,
our jet fuel averaged $1.17 per gallon and we used between 2.4 million and 2.9
million gallons of jet fuel per month, depending on the mix of aircraft
employed in our network and the amount, origin and destination of freight
shipped. At current levels of operations in our expedited scheduled freight
business, each $.01 change in the price per gallon of jet fuel results in a
change in our annual fuel cost of approximately $301,000. At May 11, 2004, we had $11.2 million of cash on hand. To supplement our
liquidity, we entered into a $10.0 million revolving credit facility with Wells
Fargo Business Credit in March 2004, replacing our $5.0 million receivables
purchase facility. We believe that our cash flow from operations, availability
under our credit facility and cash on hand will be sufficient to meet our
anticipated cash requirements for the next 12 months. In addition to our normal
operating cash requirements, we believe our cash requirements for 2004 include,
but are not limited to, seasonal working capital requirements, projected
capital expenditures, heavy aircraft maintenance events, investments in
information technology, meeting our lease return conditions with Pegasus
Aviation, future investments in aircraft and integration of Boeing 737-300
cargo aircraft into our fleet. In addition, the TSA may adopt additional
regulations regarding stringent cargo security screening procedures which may
have a material impact on our costs and cash flow. Additionally, if these
regulations and procedures are not met, we may be subject to civil penalties
and fines assessed by the TSA. Recent Developments Boeing
737-300 Cargo Aircraft Lease.On May 4, 2004, Kitty Hawk Aircargo
entered into ten year operating leases, with two 30-month extension options,
with affiliates of General Electric Capital Aviation Services, or GECAS, for
seven Boeing 737-300 cargo aircraft. The obligations of Kitty Hawk Aircargo
under the operating leases are guaranteed by Kitty Hawk and Kitty Hawk Cargo.
The first Boeing 737-300 aircraft is scheduled for delivery to us in the fourth
quarter of 2004, with the remaining six aircraft to be delivered to us during
2005. The Boeing 737-300 cargo aircraft has higher lease costs and approximately
30% less cargo capacity than our current fleet of Boeing 727-200 cargo
aircraft. However, the Boeing 737-300 cargo aircraft generally has lower
operating costs than our Boeing 727-200 cargo aircraft as a result of
significantly lower jet fuel consumption rates, lower crew costs as it operates
with a two person crew instead of three, lower landing fees and reduced maintenance costs over the long-term. In addition, the Boeing 737-300 cargo aircraft has
improved performance capabilities and range over the Boeing 727-200 cargo
aircraft. As a result of the addition of the Boeing 737-300 cargo aircraft to
our fleet, we may be required to adjust our Boeing 727-200 cargo
aircraft parts
inventory levels and maintenance reserves. A review of parts inventory levels and
maintenance reserves may result in a charge to earnings. See Critical
Accounting Policies  Aircraft Parts Inventory Accounting in our Annual Report
on Form 10-K for the year ended December 31, 2003. 12




---



##### Table of Contents



We
intend to deploy the Boeing 737-300 cargo aircraft in our operations
in situations where we can take advantage of its improved operating cost and
performance characteristics and
where its cargo capacity is better suited. We expect that the higher lease costs of the Boeing 737-300 cargo aircraft will
be offset by its higher utilization in our operations and its lower operating
costs as compared to the Boeing 727-200 cargo aircraft. As a result of adding Boeing 737-300 cargo aircraft to our fleet, we will
incur significant, one-time aircraft induction costs for, among other things,
pilot training, maintenance training, purchases of additional tooling and spare
parts and costs to rewrite our operational manuals and maintenance program to
include Boeing 737-300 cargo aircraft. We anticipate that these costs and
additional lease deposits to GECAS could be up to $3.3 million in the aggregate
during 2004 and 2005. In addition, we must receive the approval of the Federal Aviation
Administration (the FAA) to place the Boeing 737-300 cargo aircraft in
revenue service. This approval is contingent upon our meeting certain
regulatory requirements relating to maintenance, operation, training and record
keeping. We anticipate obtaining the approval of the FAA to place
these 737-300 cargo aircraft in revenue service within 30 days of delivery of the first aircraft. However,
any delay by the FAA in granting us approval will require us to pay lease and
other costs associated with maintaining the aircraft without deriving any
revenue from the aircraft, which could have a material adverse effect on our
results of operations. Pegasus Aviation Aircraft Lease Return.In October 2002, we entered into
four operating leases for Boeing 727-200 cargo aircraft with affiliates of
Pegasus Aviation. These leases expired on May 8, 2004. Under these leases, in addition to rental payments, we were required to
pay maintenance reserves each month with the amount determined based on flight
hours or cycles of utilization during the previous month. In addition, under
the terms of these leases, each aircraft had to be returned to the lessor with
the same number of available flight hours or cycles on the airframe, aircraft
engines, landing gear and auxiliary power units until the next scheduled
maintenance event as were available at the time we originally took delivery of
each of the aircraft. Each of the aircraft had just undergone a light or heavy
C-Check when we originally took delivery. Under the terms of these leases,
instead of performing a light or heavy C-check on each of the airframes prior
to returning them, we were required to pay the lessor $750,000 per airframe in
lieu of the C-Check. Such payment does not satisfy any return condition
requirement applicable to the aircraft components which we must return with the
same amount of aggregate hours, cycles and days remaining as when delivered.
Each $750,000 payment was reduced by the amount of maintenance reserves paid to
the lessor under these leases. Because our estimate of the costs to meet these aircraft lease return
obligations exceed the $2.4 million of lease return reserves we had recorded as
of December 31, 2003 for these aircraft, we took a charge of $1.2
million in the first quarter of 2004. As of May 14, 2004, we were in the
process of returning these aircraft to the lessor and, according to the lessor,
we had not yet fully satisfied our lease return obligations under the leases.
While we believe our current lease return reserve pertaining to the return of
these aircraft is sufficient to meet the lease return obligations, the final
cost will not be known until the aircraft are returned and the lease return
obligations are satisfied in accordance with the lease. As a result, if the
actual cost of meeting the lease return conditions increase, we may be required
to take an additional charge in the second quarter of 2004. In
addition, until the lease return conditions are satisfied, we may be
subject to continuing lease payments. Results of Operations Revenue.Scheduled freight revenue is generated from freight
transportation services provided by our expedited scheduled freight network.
Other revenue includes:  
    
    ACMI revenue,which is generated from contracts with third parties by
our cargo airline under which we generally provide the aircraft, crew,
maintenance and insurance, known as ACMI, on short to medium-term
contacts; and
    
    Miscellaneous revenue,which is generated from ad-hoc charters
provided by our cargo airline, maintenance revenue and freight handling
services provided for third parties. Cost of Revenue.Included in our cost of revenue are the following major
categories:  
    
    Flight Expense,which consists of costs related to the flight operations of our cargo airline, including: 13




---



##### Table of Contents



°
    
    flight crew member wages, benefits, training and travel;°
    
    operating lease expense for leased aircraft operated and flown by Kitty Hawk Aircargo;°
    
    insurance costs related to aircraft operated and flown by Kitty Hawk Aircargo; and°
    
    flight operations and airline management costs, including associated wages and benefits.  
    
    Transportation Expense,which consists of costs related to the
physical movement of freight between our cargo facilities and which is
not otherwise classified as flight expense, including:  °
    
    third party aircraft charter expense;°
    
    aircraft ground operating costs, such as landing and parking fees
charged by airports and cost of deicing aircraft;°
    
    trucking expenses for cities in our expedited scheduled freight
network that are not served by our aircraft; and°
    
    pickup and/or final delivery expenses as directed by customers.  
    
    Fuel,which consists of the all-inclusive cost of all jet fuel
consumed in our expedited scheduled freight network and on ad-hoc
charters that include jet fuel in the charter service, and the cost of
all taxes, fees and surcharges necessary to deliver the jet fuel into
the aircraft.
    
    Maintenance Expense,which consists of costs to maintain airframes
and aircraft engines operated by our cargo airline, including:  °
    
    wages and benefits for maintenance, records and maintenance management personnel;°
    
    costs for contract mechanics at cargo facility outstations;°
    
    costs of aircraft parts and supplies; and°
    
    accruals for maintenance of airframes and engines.  
    
    Freight Handling Expense,which consists of costs to handle the
loading and unloading of freight on aircraft and trucks operating within
our expedited scheduled freight network, including:  °
    
    wages and benefits for our Fort Wayne, Indiana hub sort and ramp operations personnel;°
    
    contract services to warehouse, load and unload aircraft principally at cargo facility outstations; and°
    
    wages and benefits for our outstation cargo facility personnel and field operations managers.  
    
    Depreciation and Amortization,which consists of depreciation and
amortization expenses for our owned airframes and aircraft engines and
freight-handling equipment.
    
    Asset Impairment,which consists of recognizing the lost value of
assets in our on-going operations under Statement of Financial
Accounting Standards No. 144  Accounting for the Impairment or
Disposal of Long-Lived Assetswhich requires current period recognition
of the reduction in the value of an asset that can no longer reasonably
be expected to generate adequate net cash flows to recover its value or
are no longer of such utility as to be utilized over the originally
expected life.
    
    Operating Overhead,which consists of direct overhead costs related
to operating our expedited scheduled freight network and cargo airline,
including: 14




---



##### Table of Contents



°
    
    wages and benefits for operational managers and customer service personnel of Kitty Hawk Cargo;°
    
    expedited scheduled freight network sales and marketing expenses;°
    
    rent and utilities;°
    
    bad debt expense; and°
    
    general operational office expenses. General and Administrative Expenses.General and administrative expenses
consist of salaries, benefits and expenses for executive management (other than
operational management of Kitty Hawk Aircargo and Kitty Hawk Cargo),
information technology, human resources, accounting, finance, legal and
corporate communications personnel. In addition, costs for corporate
governance, strategic planning, financial planning and asset management are
included in general and administrative expenses. Also included are legal and
professional fees and consulting fees. Critical Accounting
Policies For a discussion of our critical accounting policies refer to Item 7.
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Critical Accounting Policies included in our Annual Report on
Form 10-K for the year ended December 31, 2003. There have been no material
changes, except as discussed above in Item 2. Managements Discussion and
Analysis of Financial Condition and Results of Operations  Recent Developments
 Pegasus Aviation Lease Return, to the critical accounting policies
discussed in our Annual Report on Form 10-K for the year ended December 31,
2003. QUARTER ENDED MARCH 31, 2004 COMPARED TO QUARTER ENDED MARCH 31, 2003 The following table presents, for the periods indicated, condensed
consolidated statement of operations data expressed as a percentage of total
revenue: Three months ended March 31,2004
    
    2003Revenue:Scheduled freight
    
    
    98.5
    %
    
    
    91.8
    %Other
    
    
    1.5
    
    
    
    8.2Total revenue
    
    
    100.0
    
    
    
    100.0Cost of revenue
    
    
    96.5
    
    
    
    105.4Gross profit (loss)
    
    
    3.5
    
    
    
    (5.4
    )General and administrative expenses
    
    
    8.6
    
    
    
    8.7Operating loss
    
    
    (5.1
    )
    
    
    (14.1
    )Other (income) expense:Interest expense
    
    
    0.3
    
    
    
    0.4Other (income) expense
    
    
    (0.1
    )
    
    
    (1.6
    )Total other (income) expense
    
    
    0.2
    
    
    
    (1.2
    )Net loss
    
    
    (5.3
    )%
    
    
    (12.9
    )%
 REVENUE General. The following table presents, for the periods indicated, the
components of our revenue in dollars and as a percentage of our total revenue
and the percentage change from period-to-period: 15




---



##### Table of Contents



Three months ended March 31,2004
    
    2003Percentage
    
    
    
    
    
    Percentage
    
    Percentage Changeof Total
    
    
    
    
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Scheduled freight
    
    $
    33,224
    
    
    
    98.5
    %
    
    $
    28,429
    
    
    
    91.8
    %
    
    
    16.9
    %Other:ACMI
    
    
    
    
    
    
    
    
    
    
    2,025
    
    
    
    6.5
    
    
    
    (100.0
    )Miscellaneous
    
    
    518
    
    
    
    1.5
    
    
    
    530
    
    
    
    1.7
    
    
    
    (2.3
    )Total revenue
    
    $
    33,742
    
    
    
    100.0
    %
    
    $
    30,984
    
    
    
    100.0
    %
    
    
    8.9
    %
 Scheduled Freight.For the three months ended March 31, 2004, the $4.8
million increase in our scheduled freight revenue was due to an increase of
2.8% in our average yield and a 13.5% increase in our chargeable weight from
the three months ended March 31, 2003. Our yield increase was primarily due to
a larger proportion of higher yielding next morning freight in our total
chargeable weight and more chargeable weight from geographic areas that had
higher rates and, to a lesser extent, an increase in the fuel surcharge to
mitigate the increases in our fuel expense resulting from higher fuel prices.
Our chargeable weight increase was primarily due to a strengthening economy
toward the end of 2003 which carried over to the first quarter 2004, the
addition of two more weekday versus Friday operating days during the three
months ended March 31, 2004 than in the three months ended March 31, 2003, and
the expansion of our network through the addition of several road feeder
markets and the conversion of several road feeder markets to air markets
subsequent to the three months ended March 31, 2003. ACMI.During the first three months of 2003, we generated $2.0 million of
revenue from a one-year ACMI contract we entered into in December 2002 to
provide BAX Global with three Boeing 727-200 cargo aircraft. This contract was
cancelled by mutual agreement effective May 31, 2003. During the three months
ended March 31, 2004, we generated no ACMI revenue. Miscellaneous.For the three months ended March 31, 2004, our
miscellaneous revenue resulted from flying ad-hoc charter services for several
customers which generated $0.5 million of revenue and from maintenance work on
an aircraft operated by us, but owned by a third party on which we were not obligated to perform maintenance. Our miscellaneous revenue for the three months ended
March 31, 2003 included generating $0.5 million from flying ad-hoc charter
services. COST OF REVENUE General.The following table presents, for the periods indicated, the
components of our cost of revenue in dollars and as a percentage of total
revenue and the percentage change from period-to-period: Three months ended March 31,2004
    
    2003Cost
    
    Percentage
    
    Cost
    
    Percentage
    
    Percent Changeof
    
    of Total
    
    of
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Flight expense
    
    $
    7,189
    
    
    
    21.3
    %
    
    $
    6,262
    
    
    
    20.2
    %
    
    
    14.8
    %Transportation expense
    
    
    2,825
    
    
    
    8.4
    
    
    
    6,039
    
    
    
    19.5
    
    
    
    (53.2
    )Fuel
    
    
    9,203
    
    
    
    27.3
    
    
    
    7,921
    
    
    
    25.6
    
    
    
    16.2Maintenance expense
    
    
    3,380
    
    
    
    10.0
    
    
    
    3,360
    
    
    
    10.8
    
    
    
    0.6Freight handling expense
    
    
    6,488
    
    
    
    19.2
    
    
    
    5,730
    
    
    
    18.5
    
    
    
    13.2Depreciation and amortization
    
    
    812
    
    
    
    2.4
    
    
    
    905
    
    
    
    2.9
    
    
    
    (10.3
    )Operating overhead
    
    
    2,655
    
    
    
    7.9
    
    
    
    2,434
    
    
    
    7.9
    
    
    
    9.1Total cost of revenue
    
    $
    32,552
    
    
    
    96.5
    %
    
    $
    32,651
    
    
    
    105.4
    %
    
    
    (0.3
    )%
 Flight Expense.For the three months ended March 31, 2004, flight expense
increased $0.9 million or 14.8% compared to the three months ended March 31,
2003. This increase was primarily a result of a 22.4% increase in revenue block
hours flown by our owned and leased aircraft resulting in correspondingly
higher aircraft lease and pilot wage expense, offset in part by a $0.1 million
decrease in simulator training expense and a $0.1 million decrease in aircraft
liability insurance expense. Simulator training expense decreased due to the
elimination of a 16




---



##### Table of Contents



minimum usage requirement in our simulator usage agreement. Aircraft
liability insurance expense decreased primarily as a result of lower insurance
rates. The 22.4% or 1,102 increase in revenue block hours flown was due to our
cargo airline flying 1,805 more hours for the scheduled freight network and 703
fewer hours for our ACMI and ad-hoc charter customers for the three months
ended March 31, 2004 as compared to the three months ended March 31, 2003. The
increase in hours flown by the cargo airline on behalf of the scheduled freight
network was primarily a result of using fewer third party cargo aircraft (on a
block hour basis) during the three months ended March 31, 2004 as compared to
the three months ended March 31, 2003. The expenses related to chartering these
aircraft in 2003 are included in transportation expense as opposed to flight
expense. Transportation Expense.For the three months ended March 31, 2004,
transportation expense decreased $3.2 million, or 53.2%, from the three months
ended March 31, 2003. This decrease is comprised of a $3.5 million decrease in
third party cargo aircraft charters flown on behalf of the scheduled freight
network during the three months ended March 31, 2004 as compared to the three
months ended March 31, 2003, offset in part by higher aircraft ground
operating costs due to more aircraft operating during the three months ended March 31, 2004 as compared to the
three months ended March 31, 2003. In December 2002, we signed a one-year agreement with an affiliate of BAX
Global to charter two Douglas DC-8 cargo aircraft. This contract was cancelled
by mutual agreement effective May 31, 2003. These chartered aircraft allowed us
to carry higher freight volumes at a more economical rate per hour as compared
to four Boeing 727-200 cargo aircraft. However, due to lower than expected
demand during March and April 2003, the freight volumes did not justify the
continued charter of these two Douglas DC-8 cargo aircraft. The use of these
chartered aircraft caused transportation expense to increase as a percent of
total revenue as costs were shifted from flight expense. Fuel.For the three months ended March 31, 2004, fuel expense increased
$1.3 million, or 16.2%, as compared to the three months ended March 31, 2003.
Fuel expense is comprised of two elements: our average cost per gallon and the
number of gallons used by the aircraft. Our average cost per gallon of fuel
increased $0.03, or 2.7%, for the three months ended March 31, 2004 as compared
to the three months ended March 31, 2003 which we believe was offset entirely
by the fuel surcharge included in scheduled freight revenue. To mitigate the
increase in our average cost per gallon of jet fuel, we continue to assess a
fuel surcharge. The number of gallons used for the three months ended March
31, 2004 increased by approximately 840,000 gallons, or 12.2%, as compared to
the three months ended March 31, 2003. The increase in fuel consumption is
primarily due to a 12.2% increase in revenue block hours flown by our cargo
airline for our scheduled freight network. Maintenance Expense.For the three months ended March 31, 2004,
maintenance expense increased $0.02 million, or 0.6%, as compared to the three
months ended March 31, 2003. Included in maintenance expense during the three
months ended March 31, 2004 is a $1.2 million charge to maintenance expense to
meet the estimated incremental lease return obligations on four Boeing 727-200
cargo aircraft. See  Recent Developments. Also included in maintenance
expense in the three months ended March 31, 2004 is a $0.5 million reversal of
excess maintenance reserves on one Boeing 727-200 cargo aircraft that completed
a heavy maintenance event in March 2004. Not including the $1.2 million lease return charge and the $0.5 million
heavy maintenance reserve reversal, maintenance expense would have decreased
$0.6 million, or 18.8%, for the three months ended March 31, 2004, as compared
to the three months ended March 31, 2003. This decrease is partially due to a
reduction in the engine maintenance reserve rate per flight hour, lower usage
of engines requiring maintenance reserves and lower expense incurred for parts
used in maintenance during the three months ended March 31, 2004, as compared
to the three months ended March 31, 2003. In addition, during the three months
ended March 31, 2004, we did not increase our airframe maintenance reserves for
owned airframes for which we plan to use maintenance reserves to perform heavy
maintenance, because we previously reached the maximum reserve amount for those
airframes in accordance with our maintenance reserve policy. Freight Handling Expense.For the three months ended March 31, 2004,
freight handling expense increased $0.8 million, or 13.2%, as compared to the
three months ended March 31, 2003. The increase in freight handling expense was
due to a 13.5% increase in chargeable weight and the inclusion in freight
handling expense of certain costs, such as rent and utilities, of our third
party handlers at our outsourced stations for the three months ended March 31,
2004 that were previously included in operating overhead during the three
months ended March 31, 2003 during which time the handling was performed by
us. These increases in costs were offset in part by a decrease in
other freight handling costs resulting from outsourcing three of the four
remaining outstations operated by us by the end of the first quarter 2003 and
more favorable rates achieved from renegotiating several of the existing third
party freight handling contracts subsequent to the end of the first quarter of
2003. Depreciation and Amortization.For the three months ended March 31, 2004,
depreciation and amortization expense decreased $0.1 million, or
10.3%, as
compared to the three months ended March 31, 2003. This decrease in
depreciation expense is primarily due to an increase in the number of owned
engines becoming fully depreciated during three months ended March 31, 2004 as
compared to the three months ended March 31, 2003, offset in part by the
addition of two Boeing 727-200 cargo airframes acquired in the fourth quarter
of 2003. 17




---



##### Table of Contents



Operating Overhead.For the three months ended March 31, 2004, operating
overhead increased $0.2 million, or 9.1%, as compared to the three months ended
March 31, 2003. The increase is primarily due to an increase in sales and
administration expense for our scheduled freight network and ACMI and ad-hoc
charter business during the three months ended March 31, 2004 as compared to
the three months ended March 31, 2003, offset in part by the elimination of
certain costs that are now included in third party freight handling contracts
and are reported as freight handling expense during the three months ended
March 31, 2004. GROSS PROFIT As a result of the foregoing, for the three months ended March 31, 2004, we recognized gross profit of
$1.2 million, which was an improvement of $2.9 million as compared to the three
months ended March 31, 2003. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense increased $0.2 million, or 8.6%, for
the three months ended March 31, 2004 as compared to the three months ended
March 31, 2003. The increase is primarily due to accruing expense for
performance based compensation, severance costs, and Sarbanes-Oxley compliance,
offset in part by lower legal and trailing bankruptcy costs. INTEREST EXPENSE Interest expense declined by $0.02 million, or 17.2%, for the three months
ended March 31, 2004 as compared to the three months ended March 31, 2003.
This decrease is primarily due to a net $0.8 million reduction in interest
bearing obligations since the quarter ended March 31, 2003. OTHER (INCOME) EXPENSE Other income decreased $0.4 million for the three months ended March 31,
2004 as compared to the three months ended March 31, 2003. The decrease in
other income is primarily due to a reduction in surplus asset sales during the
three months ended March 31, 2003. INCOME TAXES We have recognized no tax benefit from our operating losses and have
provided a valuation allowance against our deferred tax assets. Due to
historical operating losses and the potential for future limitations on the
utilization of our tax assets, we have recorded a valuation allowance because
it is unclear how much, if any, tax benefit we will realize. To the extent that
we generate income in the future, we will likely be able to offset any income
with our existing deductions and, as a result, we will not pay any taxes on the
income. In addition, as a result of recent and future transfers of our stock by our
shareholders and the exercise of options and warrants, we may undergo a change
in ownership as defined by the U.S. tax laws. This change may result in
limitations on our ability to offset any income with our existing deductions. LIQUIDITY AND CAPITAL RESOURCES General.Currently, our primary source of liquidity is our cash flow from
operations. In addition, we may supplement our liquidity by accessing our $10.0
million credit facility with Wells Fargo Business Credit, Inc., or WFB. At March 31, 2004, we had cash and cash equivalents of $11.3 million as
compared to $15.7 million at December 31, 2003. The decrease in cash of $4.4
million is a result of $2.8 million used for operations, $1.0 million used in
investing activities and $0.6 million used for repayments of our outstanding debt.
The $1.0 million used 18




---



##### Table of Contents



in investing activities included $0.3 million for the acquisition of
operating assets and $0.7 million to increase restricted cash. At March 31, 2004, our net working capital was $17.8 million compared to
$18.7 million at December 31, 2003. We anticipate our capital expenditures for the remainder of 2004 will be
approximately $5.7 million, including $2.3 million related to heavy airframe
maintenance and heavy shop visits for aircraft engines, $1.6 million related to
complying with airworthiness directives on our fleet of Boeing 727-200 cargo
aircraft and $1.8 million to upgrade our information technology systems. We
anticipate spending $2.3 million to perform heavy airframe maintenance and
heavy shop visits for aircraft engines which are accrued for in our maintenance
reserves. In addition, we anticipate $3.2 million of cash outlays related to meeting the
lease return conditions on four leased airframes and 12 aircraft engines. In
addition, we expect integration and additional lease deposit costs of approximately $1.3
million during 2004 to integrate the Boeing 737-300 cargo aircraft into our
fleet. We believe our current assets, cash flows from operations, and
availability under our credit facility are sufficient to meet our anticipated
normal working capital and operating needs for the next 12 months as well as
support our anticipated capital expenditures requirements. Credit Facility.On March 22, 2004, we entered into a $10.0 million
revolving credit facility with WFB. Unless earlier terminated, the credit
facility matures on March 22, 2007 and automatically renews for successive
one-year periods thereafter unless terminated by us or WFB by giving the other
party 90 days written notice prior to the maturity date. The credit facility
bears interest at an annual rate equal to WFBs prime rate plus a margin of
1.0%. At March 31, 2004 the interest rate on the credit facility was 4.0%. The
credit facility is secured by substantially all of our receivables and personal
property, other than airframes, aircraft engines and aviation parts. In
connection with entering into the credit facility, we repaid
$1.8 million of outstanding debt. Availability under the credit facility is subject to a borrowing base
equal to the lesser of $10.0 million and 85% of eligible receivables. WFB may
reject any receivable deemed ineligible in the exercise of its business
judgment. As of March 31, 2004, we had $1.9 million borrowed under the credit
facility. As of May 11, 2004, we had a borrowing base of
$10.0 million and $8.1 million of availability. Each year, we will pay an unused line fee of 0.375% of the daily unused
amount under the credit facility. In addition, we must pay to WFB a minimum of
$8,500 per month in interest. We will incur additional fees if the credit
facility is terminated by WFB upon default or if we terminate the credit
facility prior to its termination date or reduce the maximum availability under
the credit facility. These fees are up to $200,000 during the first year of the
credit facility, $100,000 during the second year of the credit facility and
$50,000 during the third year of the credit facility. Finally, we may utilize
the credit facility to issue letters of credit in the aggregate amount of up to
$5.0 million. We incur a fee computed at an annual rate of 2.0% of the face
amount of each letter of credit issued under the credit facility. The credit facility provides for specified events of default that allow
WFB to terminate the credit facility and accelerate any payments due
by us, including if we suffer a material adverse change in our
business or financial condition. In
addition, the credit facility requires us to meet certain financial and
operating covenants, limits capital expenditures other than capitalized
maintenance on our aircraft, and restricts our ability to commit to or enter
into any new aircraft operating leases unless certain financial covenants are
met. See Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital Resources included
in our Annual Report on Form 10-K for the year ended December 31, 2003 for more
details on the credit facility. 19




---



##### Table of Contents



Contractual Obligations.The following table sets forth our contractual
obligations for the periods shown (dollars in thousands): Nine Months Ending
    
    Two Years Ending
    
    Two Years EndingContractual Obligations
    
    Total
    
    December 31, 2004
    
    December 31, 2006
    
    December 31, 2008
    
    ThereafterDebt
    
    $
    1,887
    
    
    $
    
    
    
    $
    
    
    
    $
    1,887
    
    
    $
    Non-aircraft operating leases
    
    
    37,908
    
    
    
    2,123
    
    
    
    5,670
    
    
    
    4,814
    
    
    
    25,301Aircraft operating leases and use
agreements
    
    
    95,189
    
    
    
    3,244
    
    
    
    18,008
    
    
    
    18,280
    
    
    
    55,657Estimated lease return conditions
    
    
    3,216
    
    
    
    3,216
    
    
    
    
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    138,200
    
    
    $
    8,583
    
    
    $
    23,678
    
    
    $
    24,981
    
    
    $
    80,958
 SEASONALITY OF RESULTS AND OPERATING LEVERAGE Our current business is seasonal in nature. In a typical year, we
experience improving revenue with each passing quarter, beginning with the
first quarter. In the first quarter of 2003, we experienced normal seasonal trends
in our expedited scheduled freight business with a slight dampening effect
toward the end of the first quarter due to among other things the increasing
uncertainty surrounding the anticipated war in Iraq. In the first quarter
of 2004, we believe we experienced normal seasonal trends in our expedited freight
business. Additionally, we believe we continued to benefit in the first
quarter of 2004 from what appears to be a continuation of the strengthening of the
U.S. domestic economy. We currently derive substantially all of our revenue from our expedited
scheduled freight business. This business has significant operating costs that
are fixed and cannot be materially reduced in the short-term if the expedited
scheduled freight business does not generate expected levels of revenue. Once
revenue reaches the break-even point in a given period, each additional dollar
of revenue contributes a relatively high percentage to operating income.
However, if revenue does not reach the break-even point in a given period, the
operations will sustain losses, which could be significant depending on the
amount of the deficit. We have, and will continue to have, capital requirements
for the requisite periodic and major overhaul maintenance checks for our fleet
and for debt service. We also have seasonal working capital needs, because we
generate higher revenue in the third and fourth calendar quarters and lower
revenue in the first calendar quarter. Funding requirements have historically
been met through internally generated funds, bank borrowings, aircraft and
other asset sales and from public and private offerings of equity and debt
securities. From time to time, we have entered into sale/leaseback transactions
to acquire aircraft and may do so in the future. FORWARD-LOOKING STATEMENTS This
quarterly report on Form 10-Q contains forward-looking statements
concerning our business, operations and financial performance and condition.
When we use the words estimates, expects, forecasts, anticipates,
projects, plans, intends, believes and variations of such words or
similar expressions, we intend to identify forward-looking statements. We have based our forward-looking statements on our current assumptions
and expectations about future events. We have expressed our assumptions and
expectations in good faith, and we believe there is a reasonable basis for
them. However, we cannot assure you that our assumptions or expectations will
prove to be accurate. A number of risks and uncertainties could cause our actual results to
differ materially from the forward-looking statements contained in this
quarterly report on Form 10-Q. Important factors that could cause actual
results to differ materially from the forward-looking statements are set forth
in this quarterly report on Form 10-Q. These risks, uncertainties and other
important factors include, but are not limited to, among others: 20




---



##### Table of Contents




    
    loss of key suppliers, significant customers or key management personnel;
    
    increased competition;
    
    limited operating flexibility due to the terms of our credit facility;
    
    change in our capital resources and liquidity;
    
    financial costs and operating limitations imposed by both the
current and the potential additional future unionization of our
workforce;
    
    payment defaults by our customers;
    
    writedowns of the value of our parts, airframes or aircraft engines;
    
    changes in the cost of airframe or aircraft engine maintenance and in our maintenance reserves;
    
    changes in general economic conditions;
    
    changes in the cost and availability of jet fuel;
    
    changes in the cost and availability of ground handling and storage services;
    
    changes in the cost and availability of aircraft or replacement parts;
    
    changes in our business strategy or development plans;
    
    changes in government regulation and policies;
    
    foreign political instability and acts of war or terrorism;
    
    adverse litigation judgments or awards;
    
    the ability to efficiently integrate the Boeing 737-300 cargo aircraft into our operations;
    
    delays in placing the Boeing 737-300 cargo aircraft into revenue service; and
    
    the ability to negotiate reasonable maintenance agreements to
maintain the Boeing 737-300 cargo aircraft. Other factors may cause our actual results to differ materially from the
forward-looking statements contained in this quarterly report on Form 10-Q.
These forward-looking statements speak only as of the date of this quarterly
report on Form 10-Q and, except as required by law, we do not undertake any
obligation to publicly update or revise our forward-looking statements. We
caution you not to place undue reliance on these forward-looking statements. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have not experienced any significant changes in our market risk since
the disclosures made in Item 7A: Quantitative and Qualitative Disclosures
About Market Risk of our Annual Report on Form 10-K for the year ended
December 31, 2003. 
 ITEM 4. CONTROLS AND PROCEDURES The term disclosure controls and procedures is defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, or the Exchange
Act. This term refers to the controls and procedures of a company that are
designed to ensure that information required to be disclosed by a company in
the reports that it files under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified by the Securities
Exchange Commission. Our management, including our Chief Executive Officer and
our Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this quarterly
report. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures
were effective. There were no changes to our internal control over financial reporting
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS General Motors.General Motors and Delphi Automotive were sued in Wayne
County, Michigan by a number of air charter carriers in connection with air
transportation services we arranged with them on behalf of General Motors and
Delphi Automotive and for which the air charter carriers were not paid as a
result of our bankruptcy. 21




---



##### Table of Contents



The air charter carriers are seeking to recover approximately $4.6 million
from General Motors and Delphi Automotive. General Motors has named us as a
third party defendant in the litigation and is seeking indemnification of up to
$4.6 million against us. The parties have agreed that the indemnification claim
will be heard in bankruptcy court in Fort Worth, Texas. In May 2004, we were
dismissed from the litigation in Wayne County, Michigan. While we cannot
predict the outcome of this claim at this time, we believe this claim should
have been discharged when our plan of reorganization was confirmed by the
bankruptcy court. We will vigorously defend against General Motors
allegations. No amounts have been accrued for this contingency. Other.We are also subject to various legal proceedings and other claims
which have arisen in the ordinary course of business. While the outcome of such
other legal proceedings and other claims cannot be predicted with certainty,
our management does not believe that the outcome of any of these matters will
have a material adverse effect on our business. 
 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 
 ITEM 5. OTHER INFORMATION Not applicable. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the Securities and Exchange Commission. Exhibit No.
    
    
    
    Exhibit31.1*
    
    
    
    Certification of Principal Executive Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    
    
    Certification of Principal Financial Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
   *
    
    Each document marked with an asterisk is filed or furnished herewith. (b) Reports on Form 8-K: On January 26, 2004, the Company filed a Form 8-K under Items 5 and 7
announcing the adoption of a stockholder rights plan. 22




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on May 14, 2004. KITTY HAWK, INC.By:
    /s/ RANDY S. LEISERRandy S. LeiserVice President  Finance and
Chief Financial Officer
(Authorized officer and
principal financial
officer) 23