##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One) x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended September 30, 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
    
    (I.R.S. Employerincorporation or organization)
    
    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 x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes o No x 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 x No o The number of shares of common stock, par value $0.000001 per share,
outstanding at November 4, 2004 was 46,354,287.




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KITTY HAWK, INC. INDEX  
 PAGE NUMBERPART I. FINANCIAL INFORMATIONItem 1. Financial Statements
    
    
    3Condensed Consolidated Balance Sheets September 30, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations Three months ended September
30, 2004 and 2003 and the Nine months ended September 30, 2004 and 2003
    
    
    4Condensed Consolidated Statement of Stockholders Equity Nine months ended
September 30, 2004
    
    
    5Condensed Consolidated Statements of Cash Flows Nine months ended September
30, 2004 and 2003
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    27Item 2. Changes in Securities and Use of Proceeds
    
    
    27Item 3. Defaults upon Senior Securities
    
    
    27Item 4. Submission of Matters to a Vote of Security Holders
    
    
    27Item 5. Other Information
    
    
    27Item 6. Exhibits
    
    
    28Certification of Principal Executive Officer Pursuant to Section 302Certification of Principal Financial Officer Pursuant to Section 302Certification Pursuant to Section 906
 2




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##### 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) September 30,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,928
    
    
    $
    15,729Restricted cash and short-term investments
    
    
    1,379
    
    
    
    579Trade accounts receivable, net of allowance for doubtful accounts of $0.8
million and $0.5 million, respectively
    
    
    16,952
    
    
    
    11,539Assets held for sale
    
    
    74
    
    
    
    114Inventory and aircraft supplies
    
    
    5,537
    
    
    
    5,441Deposits and prepaid expenses
    
    
    1,811
    
    
    
    1,135Prepaid fuel
    
    
    1,903
    
    
    
    1,122Settlement receivable
    
    
    265
    
    
    
    1,765Other current assets, net
    
    
    195
    
    
    
    143Total current assets
    
    
    37,044
    
    
    
    37,567Property and equipment, net
    
    
    8,913
    
    
    
    9,058Other assets, net
    
    
    399
    
    
    
    485Total assets
    
    $
    46,356
    
    
    $
    47,110LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Current liabilities:Accounts payable  trade
    
    $
    2,217
    
    
    $
    2,880Accrued wages
    
    
    1,113
    
    
    
    761Other accrued expenses
    
    
    7,992
    
    
    
    5,519Other taxes payable
    
    
    1,948
    
    
    
    2,270Current portion of accrued maintenance reserves
    
    
    400
    
    
    
    2,617Current portion of lease return provisions
    
    
    
    
    
    
    2,459Current maturities of long-term debt
    
    
    1,949
    
    
    
    2,348Total current liabilities
    
    
    15,619
    
    
    
    18,854Long-term debt
    
    
    
    
    
    
    34Accrued maintenance reserves
    
    
    4,265
    
    
    
    3,311Other long-term liabilities
    
    
    934
    
    
    
    1,307Total liabilities
    
    
    20,818
    
    
    
    23,506Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Preferred stock, $0.01 par value: Authorized shares - 10,000,000; none issued
    
    
    
    
    
    
    Common stock, $0.000001 par value:Authorized shares - 100,000,000; issued and outstanding - 46,354,287 and
40,760,084 at September 30, 2004 and December 31, 2003, respectively
    
    
    
    
    
    
    Additional capital
    
    
    19,125
    
    
    
    18,311Retained earnings
    
    
    6,413
    
    
    
    5,293Total stockholders equity
    
    
    25,538
    
    
    
    23,604Total liabilities and stockholders equity
    
    $
    46,356
    
    
    $
    47,110
 The accompanying notes are an integral part of these financial statements. 3




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KITTY HAWK, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share data)
(unaudited) Three months ended September 30,
    
    Nine months ended September 30,2004
    
    2003
    
    2004
    
    2003Revenue:Scheduled freight
    
    $
    40,603
    
    
    $
    33,484
    
    
    $
    110,991
    
    
    $
    91,422ACMI
    
    
    1,197
    
    
    
    
    
    
    
    1,837
    
    
    
    3,375Miscellaneous
    
    
    702
    
    
    
    141
    
    
    
    1,291
    
    
    
    1,082Total revenue
    
    
    42,502
    
    
    
    33,625
    
    
    
    114,119
    
    
    
    95,879Cost of revenue:Flight expense
    
    
    6,955
    
    
    
    6,783
    
    
    
    21,525
    
    
    
    19,451Transportation expense
    
    
    4,254
    
    
    
    2,304
    
    
    
    10,504
    
    
    
    13,038Fuel expense
    
    
    12,102
    
    
    
    7,539
    
    
    
    32,181
    
    
    
    22,713Maintenance expense
    
    
    2,446
    
    
    
    2,793
    
    
    
    8,623
    
    
    
    8,878Freight handling expense
    
    
    7,234
    
    
    
    6,232
    
    
    
    20,584
    
    
    
    18,030Depreciation and amortization
    
    
    790
    
    
    
    1,011
    
    
    
    2,290
    
    
    
    2,804Operating overhead expense
    
    
    2,924
    
    
    
    2,166
    
    
    
    8,421
    
    
    
    6,810Total cost of revenue
    
    
    36,705
    
    
    
    28,828
    
    
    
    104,128
    
    
    
    91,724Gross profit
    
    
    5,797
    
    
    
    4,797
    
    
    
    9,991
    
    
    
    4,155General and administrative expense
    
    
    2,954
    
    
    
    2,119
    
    
    
    8,330
    
    
    
    7,159Operating income (loss)
    
    
    2,843
    
    
    
    2,678
    
    
    
    1,661
    
    
    
    (3,004
    )Other (income) expense:Interest expense
    
    
    72
    
    
    
    106
    
    
    
    240
    
    
    
    325Other, net
    
    
    (196
    )
    
    
    (3,218
    )
    
    
    (343
    )
    
    
    (3,738
    )Income before income taxes
    
    
    2,967
    
    
    
    5,790
    
    
    
    1,764
    
    
    
    409Income taxes
    
    
    644
    
    
    
    
    
    
    
    644
    
    
    
    Net income
    
    $
    2,323
    
    
    $
    5,790
    
    
    $
    1,120
    
    
    $
    409Basic net income per share
    
    $
    0.05
    
    
    $
    0.12
    
    
    $
    0.02
    
    
    $
    0.01Weighted average common shares
outstanding
    
    
    50,791,723
    
    
    
    50,025,109
    
    
    
    50,688,309
    
    
    
    50,008,350Diluted net income per share
    
    $
    0.04
    
    
    $
    0.11
    
    
    $
    0.02
    
    
    $
    0.01Weighted average diluted common
shares outstanding
    
    
    54,405,449
    
    
    
    50,760,162
    
    
    
    54,206,167
    
    
    
    50,199,959
 The accompanying notes are an integral part of these financial statements. 4




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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 income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,120
    
    
    
    1,120Compensation expense associated with stock
option grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70
    
    
    
    
    
    
    
    70Issuance of common stock related to
exercise of warrants to acquire stock
    
    
    5,261,494
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock related to
exercise of stock options
    
    
    438,959
    
    
    
    
    
    
    
    
    
    
    
    131
    
    
    
    
    
    
    
    131Tax expense allocated to additional capital
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    644
    
    
    
    
    
    
    
    644Repurchase of restricted shares
    
    
    
    
    
    
    (106,250
    )
    
    
    
    
    
    
    (31
    )
    
    
    
    
    
    
    (31
    )Vesting of restricted shares
    
    
    31,250
    
    
    
    (31,250
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at September 30, 2004
    
    
    46,354,287
    
    
    
    
    
    
    $
    
    
    
    $
    19,125
    
    
    $
    6,413
    
    
    $
    25,538
 The accompanying notes are an integral part of this financial statement. 5




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KITTY HAWK, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
(unaudited) Nine months ended September 30,2004
    
    2003Operating activities:Net income
    
    $
    1,120
    
    
    $
    409Adjustments to reconcile income to net cash used in operating activities:Depreciation and amortization
    
    
    2,520
    
    
    
    3,063Gain on disposal of property and equipment
    
    
    (143
    )
    
    
    (25
    )Compensation expense related to stock options
    
    
    70
    
    
    
    11Claim settlement
    
    
    
    
    
    
    (2,996
    )Tax expense allocated to additional capital
    
    
    644
    
    
    
    Provision for doubtful accounts
    
    
    286
    
    
    
    348Changes in operating assets and liabilities:Trade accounts receivable
    
    
    (5,698
    )
    
    
    (1,123
    )Settlement receivable
    
    
    1,500
    
    
    
    Inventory and aircraft supplies
    
    
    (57
    )
    
    
    394Prepaid expenses and other
    
    
    (1,314
    )
    
    
    526Accounts payable and accrued expenses
    
    
    1,467
    
    
    
    (2,108
    )Accrued lease return provision
    
    
    (2,459
    )
    
    
    Accrued maintenance reserves
    
    
    (1,264
    )
    
    
    (171
    )Net cash used in operating activities
    
    
    (3,328
    )
    
    
    (1,672
    )Investing activities:Proceeds from sale of assets
    
    
    446
    
    
    
    1,827Change in restricted cash
    
    
    (800
    )
    
    
    66Buyout of aircraft lease
    
    
    
    
    
    
    (1,300
    )Capital expenditures
    
    
    (2,677
    )
    
    
    (207
    )Net cash provided by (used in) investing activities
    
    
    (3,031
    )
    
    
    386Financing activities:Issuance of common stock
    
    
    131
    
    
    
    124Repurchase of restricted common stock
    
    
    (31
    )
    
    
    Borrowings of long-term debt
    
    
    1,949
    
    
    
    440Loan origination cost
    
    
    (109
    )
    
    
    Repayments of long-term debt
    
    
    (2,382
    )
    
    
    (2,369
    )Net cash used in financing activities
    
    
    (442
    )
    
    
    (1,805
    )Net decrease in cash and cash equivalents
    
    
    (6,801
    )
    
    
    (3,091
    )Cash and cash equivalents at beginning of period
    
    
    15,729
    
    
    
    10,353Cash and cash equivalents at end of period
    
    $
    8,928
    
    
    $
    7,262
 The accompanying notes are an integral part of these financial statements. 6




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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 In 2001, 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 were
seeking to recover approximately $4.6 million from General Motors and Delphi
Automotive. General Motors had named the Company as a third party defendant in
the litigation and was seeking indemnification of up to $4.6 million against
the Company. In February 2004, the parties agreed that the indemnification
claim would 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. On November 3, 2004, the Bankruptcy Court granted the
Companys motion that the General Motors claim for indemnification be denied
in its entirety. 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




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Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Risk free interest rate
    
    
    4.32
    %
    
    
    4.68
    %
    
    
    4.48
    %
    
    
    4.68
    %Expected life (years)
    
    
    10
    
    
    
    7
    
    
    
    10
    
    
    
    7Volatility
    
    
    50
    %
    
    
    50
    %
    
    
    50
    %
    
    
    50
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    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 Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share data)Net income, as reported
    
    $
    2,323
    
    
    $
    5,790
    
    
    $
    1,120
    
    
    $
    409Add: Total stock-based employee
compensation expense determined under
the intrinsic method for all awards
    
    
    11
    
    
    
    11
    
    
    
    70
    
    
    
    11Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all
awards
    
    
    (103
    )
    
    
    (207
    )
    
    
    (271
    )
    
    
    (207
    )Pro forma net income
    
    $
    2,231
    
    
    $
    5,594
    
    
    $
    919
    
    
    $
    213Basic income per share  as reported
    
    $
    0.05
    
    
    $
    0.12
    
    
    $
    0.02
    
    
    $
    0.01Basic income per share  pro forma
    
    $
    0.05
    
    
    $
    0.11
    
    
    $
    0.02
    
    
    $
    0.00Diluted income per share  as reported
    
    $
    0.04
    
    
    $
    0.11
    
    
    $
    0.02
    
    
    $
    0.01Diluted income per share  pro forma
    
    $
    0.04
    
    
    $
    0.11
    
    
    $
    0.02
    
    
    $
    0.00
 The Plan currently 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 nine months ended September 30, 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 $1.07)
    
    
    (827,000
    )
    
    
    827,000
    
    
    $
    1.47Exercised
    
    
    
    
    
    
    (438,959
    )
    
    $
    0.30Canceled
    
    
    551,041
    
    
    
    (551,041
    )
    
    $
    0.30Outstanding at September 30, 2004:
    
    
    1,189,041
    
    
    
    4,297,000
    
    
    $
    0.53
 8




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The following table summarizes information about the stock options outstanding
at September 30, 2004: Weighted
    
    Weighted AverageNumber of
    
    Average
    
    Exercise Price
    
    Number of
    
    Weighted AverageOptions
    
    Remaining
    
    of Options
    
    Vested
    
    Exercise PriceExercise Prices
    
    Outstanding
    
    Life (Years)
    
    Outstanding
    
    Options(1)
    
    of Vested Options$
    0.30
    
    
    
    3,460,000
    
    
    
    8.83
    
    
    $
    0.30
    
    
    
    1,351,666
    
    
    $
    0.30$
    1.105
    
    
    
    10,000
    
    
    
    9.33
    
    
    $
    1.105
    
    
    
    2,500
    
    
    $
    1.105$
    1.40
    
    
    
    377,000
    
    
    
    10.00
    
    
    $
    1.40
    
    
    
    
    
    
    
    $
    1.41
    
    
    
    200,000
    
    
    
    9.42
    
    
    $
    1.41
    
    
    
    44,444
    
    
    $
    1.41$
    1.62
    
    
    
    250,000
    
    
    
    9.67
    
    
    $
    1.62
    
    
    
    37,500
    
    
    $
    1.624,297,000
    
    
    
    9.37
    
    
    $
    0.53
    
    
    
    1,436,110
    
    
    $
    0.37
    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
    
    Cargo
    
    
    
    
    
    
    
    
    
    ConsolidatedNetwork
    
    Airline
    
    Other
    
    Eliminations
    
    Balance(in thousands)Three months ended September 30, 2004:Revenue from external customers
    
    $
    40,603
    
    
    $
    1,899
    
    
    $
    
    
    
    $
    
    
    
    $
    42,502Revenue from intersegment operations
    
    
    
    
    
    
    9,521
    
    
    
    
    
    
    
    (9,521
    )
    
    
    Depreciation and amortization
    
    
    122
    
    
    
    668
    
    
    
    
    
    
    
    
    
    
    
    790Operating income (loss)
    
    
    2,836
    
    
    
    219
    
    
    
    (212
    )
    
    
    
    
    
    
    2,843Total assets
    
    $
    13,665
    
    
    $
    10,285
    
    
    $
    22,406
    
    
    $
    
    
    
    $
    46,356Three months ended September 30, 2003:Revenue from external customers
    
    $
    33,484
    
    
    $
    141
    
    
    $
    
    
    
    $
    
    
    
    $
    33,625Revenue from intersegment operations
    
    
    
    
    
    
    10,895
    
    
    
    
    
    
    
    (10,895
    )
    
    
    Depreciation and amortization
    
    
    86
    
    
    
    925
    
    
    
    
    
    
    
    
    
    
    
    1,011Operating income (loss)
    
    
    2,693
    
    
    
    68
    
    
    
    (83
    )
    
    
    
    
    
    
    2,678Total assets
    
    $
    8,052
    
    
    $
    15,919
    
    
    $
    17,986
    
    
    $
    
    
    
    $
    41,957Nine months ended September 30, 2004:Revenue from external customers
    
    $
    110,991
    
    
    $
    3,128
    
    
    $
    
    
    
    $
    
    
    
    $
    114,119Revenue from intersegment operations
    
    
    
    
    
    
    31,862
    
    
    
    
    
    
    
    (31,862
    )
    
    
    Depreciation and amortization
    
    
    322
    
    
    
    1,968
    
    
    
    
    
    
    
    
    
    
    
    2,290Operating income (loss)
    
    
    2,090
    
    
    
    (9
    )
    
    
    (420
    )
    
    
    
    
    
    
    1,661Total assets
    
    $
    13,665
    
    
    $
    10,285
    
    
    $
    22,406
    
    
    
    
    
    
    $
    46,356Nine months ended September 30, 2003:Revenue from external customers
    
    $
    91,422
    
    
    $
    4,457
    
    
    $
    
    
    
    $
    
    
    
    $
    95,879Revenue from intersegment operations
    
    
    
    
    
    
    28,960
    
    
    
    
    
    
    
    (28,960
    )
    
    
    Depreciation and amortization
    
    
    262
    
    
    
    2,542
    
    
    
    
    
    
    
    
    
    
    
    2,804Operating income (loss)
    
    
    (3,431
    )
    
    
    751
    
    
    
    (324
    )
    
    
    
    
    
    
    (3,004
    )Total assets
    
    $
    8,052
    
    
    $
    15,919
    
    
    $
    17,986
    
    
    $
    
    
    
    $
    41,957
 9




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##### Table of Contents



5. EARNINGS PER SHARE In March 2003, the Company issued warrants to purchase 9,814,886 shares of
common stock to its former creditors in accordance with its Plan of
Reorganization. Such warrants are treated as outstanding common shares for
purposes of calculating earnings per share because the exercise price of the
warrants is nominal. As of September 30, 2004, warrants to purchase 4,553,392
shares of common stock remain outstanding. These warrants expire in 2013. For the three and nine month periods ended September 30, 2004, the Company
excluded outstanding options to purchase 827,000 and 250,000 shares of common
stock in the diluted earnings per share calculation because their
exercise price exceeded the average fair market value of the
Companys stock for the period. For the three and nine month periods ended September 30, 2003,
the Company included outstanding options to purchase
5,125,000 shares of common stock in the diluted earnings per share calculation
as their effect was dilutive. 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 S-3 dated
September 27, 2004 and Form 8-Ks dated May 8, 2004 and June 25, 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.
Effective November 1, 2004, the Company amended its existing Aircraft and
Engine Use Agreement with the Kitty Hawk Collateral Liquidating Trust. See
Note 8  Subsequent Events below. 7. 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. 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 no less than 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. The Company took a charge of $1.7 million in the first six months of 2004
because the Companys estimate of the costs to meet these aircraft lease return
obligations exceeded the $2.4 million of lease return reserves the Company had
recorded as of December 31, 2003 for these aircraft. As of September 30, 2004,
the Company had fully satisfied the lease return obligations under all four of
the leases. The cost of the lease return obligations did not exceed the amount
estimated at June 30, 2004. In addition, the Company incurred additional lease
expense related to these aircraft in the amount of $0.2 million in each of the
second and third quarters of 2004 for the time between the expiration of the
lease and the date the aircraft were ultimately returned to the lessor. 8. SUBSEQUENT EVENTS On September 30, 2002, the Company entered into a two year Aircraft and
Engine Use Agreement with the Kitty Hawk Collateral Liquidating Trust, or the
Trust, to make 12 Boeing 727-200 cargo airframes and 33 aircraft engines
available for operation by Kitty Hawk Aircargo. These airframes and aircraft
engines had been pledged as collateral to secure the Companys former 9.95%
Senior Secured Notes. The holders of the Companys former 9.95% Senior Secured
Notes formed the Trust to manage these airframes and aircraft engines. The
beneficiaries of the Trust include Resurgence Asset Management, Everest Capital
Limited and Stockton, LLC, each of which beneficially owns greater than 5% of
the Companys common stock. For a description of the Companys material
relationships with these entities, see Note 6  Related Party Transactions
above. The Company amended this agreement effective January 1, 2004. 10




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##### Table of Contents



The amended agreement primarily extended, with certain minimum usage
commitments, the lease terms for 11 Boeing 727-200 cargo airframes from
September 30, 2004 to dates ranging from December 31, 2004 to December 31, 2006
and extended the use of 29 aircraft engines from September 30, 2004 until the
aircraft engines reach the earlier of the estimated time of their next heavy
maintenance event or December 31, 2007. In addition, the amended agreement
gave the Company the option, at its discretion by November 1, 2004, to further
extend the leases on two of these airframes from December 31, 2004 up to
December 31, 2007 and on two more of these airframes from December 31, 2004 up
to June 30, 2008. On November 8, 2004, the Company entered into a second
amendment to this agreement with an effective date of November 1, 2004. The second amended agreement primarily reduces the block hour rates,
modifies the lease terms for 11 Boeing 727-200 cargo airframes and modifies
certain minimum usage requirements. The lease terms were modified to coincide
with the approximate date of the expected next heavy maintenance event of each
particular airframe and range from December 31, 2004 to December 31, 2006. The
second amendment also extends the use of 29 aircraft engines until the aircraft
engines reach the earlier of the estimated time of their next heavy maintenance
event or December 31, 2008. In addition, the second amended agreement cancels the amended agreements
extension options on four airframes and provides the Company with new options
to further extend, at its discretion, the leases on two of the airframes from
March 31, 2006 to June 30, 2009, on one of the airframes from September 30,
2006 to December 31, 2009 and on one of the airframes from December 31, 2004 to
December 31, 2009. Concurrently with the execution of the second amended
agreement, the Company exercised its option to extend the lease term on one of
these airframes from December 31, 2004 to December 31, 2009. Pursuant to the
exercise of each of the four airframe options, the Trust will be required to
fund up to a majority of the currently anticipated costs of the next heavy
maintenance event on each of the airframes and the Company will be required to
meet minimum usage guarantees during each extended lease term. In the event a
specific airframe option is exercised, the Company will be responsible for any
heavy maintenance costs in excess of the amount paid by the Trust. 11




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##### 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 serving selected cities in the continental
U.S. and Canada and San Juan, Puerto Rico, providing next-morning and two-day
freight service. In addition, we have business alliances that allow us to
provide freight services to Alaska, Hawaii and Mexico. 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 March 2004, we began offering an airport-to-door delivery
option to our customers by contracting with local cartage agents in major
metropolitan areas of the continental U.S. Additionally, we occasionally
arrange for the initial pick up of freight from shippers as well as the final
delivery to recipients for an additional fee. For the nine months ended
September 30, 2004, we generated approximately 97% 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, when its aircraft are not being used in our expedited
scheduled freight network, Kitty Hawk Aircargo provides air freight
transportation services which include the aircraft, crew, maintenance and
insurance, also known as ACMI, and ad-hoc charters for a variety of customers.
On September 30, 2004, Kitty Hawk Aircargo had 19 owned and leased aircraft
available for operation in revenue service. ACMI and ad-hoc charters generated
approximately 3% of our revenues during the nine months ended September 30,
2004. By providing such operations, Kitty Hawk Aircargo improves the
utilization of its aircraft and generates 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 a significant portion
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 subject to increasing 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 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 third and fourth
quarters of the year to the extent that our revenues do not allow us to cover
our relatively high fixed costs. One of our most significant and variable costs is jet fuel. Because our
network bears the 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 include 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, we may be forced to
absorb increases in jet fuel costs which could materially negatively affect our
results of operations. In addition, as we attempt to recapture the increase in
jet fuel costs through increasing our prices to our customers and/or through
temporary fuel surcharges, our customers may seek lower cost freight
transportation alternatives to our scheduled freight network which could
materially negatively affect our results of 12




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##### Table of Contents



operation. If jet fuel prices remain at recent historically high levels
for an extended period, and we are unable to continue to maintain or raise our
fuel surcharge and/or our prices sufficiently and/or customers seek lower cost
freight transportation alternatives, our financial condition and results of
operation could be materially negatively affected. The rising cost of jet fuel
increases our working capital requirements because we pay for fuel in advance
of providing air freight transportation services and typically do not recover
these increases through our fuel surcharges until the billing for the air
freight transportation service is collected, which is usually between 30 to 45
days after the service is performed. During the nine months ended September 30, 2004 and 2003, we purchased jet
fuel from various suppliers at then current market prices. We do not currently
have any long-term contracts for jet fuel, nor do we currently have any
agreements to hedge against increases 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 long-term 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 and nine months ended
September 30, 2004, our jet fuel averaged $1.40 and $1.28 per gallon,
respectively. Jet fuel costs per gallon includes the cost of jet fuel and the
cost of all taxes, fees and surcharges necessary to deliver the jet fuel into
the aircraft. During the nine months ended September 30, 2004, we used between
2.3 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 and the number of days the network is operated during each
month. At current levels of operations in our expedited scheduled freight
business, each $0.01 change in the price per gallon of jet fuel results in a
change in our annual fuel cost of approximately $325,000. At
November 8, 2004, we had
$9.8 million of cash on hand. To supplement
our liquidity, we have a $10.0 million revolving credit facility with Wells
Fargo Business Credit, Inc., or WFB. 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 the remainder of 2004 include, but are not limited to,
projected capital expenditures, investments in information technology and the
integration of Boeing 737-300 cargo aircraft into our fleet. In addition, the
Transportation Security Administration, or TSA, could adopt additional
regulations regarding cargo and other security screening procedures which may
have a material impact on our costs and cash flow. Additionally, if these
regulations and procedures are not met on a timely basis, we may be subject to
civil penalties and fines assessed by the TSA. Boeing 737-300 Cargo Aircraft Leases 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. We expect to take delivery of
the first Boeing 737-300 cargo aircraft during the first quarter of 2005, with
the remaining six aircraft to be delivered to us during the remainder of 2005. The Boeing 737-300 cargo aircraft has higher lease and insurance costs
than our current fleet of Boeing 727-200 cargo aircraft. In addition, the
Boeing 737-300 cargo aircraft has 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 from operating 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. 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 for which its
capacity is better suited. While we have not yet fully developed our combined
Boeing 727-200 and Boeing 737-300 cargo aircraft fleet operating and
utilization schedule, our objective is to develop a plan that largely offsets
the higher lease and insurance costs of the Boeing 737-300 cargo aircraft by
operating with higher average utilization per cargo aircraft in our operations
as compared to 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. Future reviews of inventory levels 13




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##### Table of Contents



and maintenance reserves may result in an adjustment to earnings. See
Critical Accounting Policies  Airframe and Aircraft Engine Maintenance
Reserves and Critical Accounting Policies  Aircraft Parts Inventory
Accounting in our Annual Report on Form 10-K for the year ended December 31,
2003. We are required to make lease deposits on each Boeing 737-300 cargo
aircraft and 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. Through
September 30, 2004, we have incurred $1.3 million related to the induction
costs of the Boeing 737-300 cargo aircraft and lease deposits to GECAS. We
anticipate that the additional induction costs and lease deposits could be in
excess of $3.6 million in the aggregate during the remainder of 2004 and 2005. In addition, we must receive the approval of the Federal Aviation
Administration, or the FAA, to place the Boeing 737-300 cargo aircraft into
revenue service. This approval is contingent on our meeting certain regulatory
requirements relating to maintenance, operation, training and record keeping.
Any delay by the FAA in granting us approval to place these Boeing 737-300
cargo aircraft into revenue service will require us to pay lease and other
costs associated with maintaining the aircraft without deriving any revenue
from the aircraft until we are granted approval from the FAA. There can be no
assurance that we will obtain FAA approval to operate the aircraft in a timely
fashion and we do not have the ability to terminate the leases for failure to
obtain FAA approval to operate the aircraft. If we experience delays in putting
these Boeing 737-300 cargo aircraft into revenue service, we may not have
sufficient aircraft to operate our expedited scheduled freight network and may
be required to lease or acquire additional aircraft, which may not be available
to us on economical terms. The occurrence of any of these or similar events
could have a material adverse effect on our results of operations. Second Amended and Restated Aircraft and Engine Use Agreement On September 30, 2002, we entered into a two year Aircraft and Engine Use
Agreement with the Kitty Hawk Collateral Liquidating Trust, or the Trust, to
make 12 Boeing 727-200 cargo airframes and 33 aircraft engines available for
operation by Kitty Hawk Aircargo. These airframes and aircraft engines had been
pledged as collateral to secure our former 9.95% Senior Secured Notes. The
holders of our former 9.95% Senior Secured Notes formed the Trust to manage
these airframes and aircraft engines. The beneficiaries of the Trust include
Resurgence Asset Management, Everest Capital Limited and Stockton, LLC, each of
which beneficially owns greater than 5% of our common stock. For a description
of our material relationships with these entities, see Item 13. Certain
Relationships and Related Party Transactions of our Annual Report on Form
10-K/A, our Form S-3 dated September 27, 2004 and Form 8-Ks dated May 8, 2004
and June 25, 2004. The Company amended this agreement effective January 1,
2004. The amended agreement primarily extended, with certain minimum usage
commitments, the lease terms for 11 Boeing 727-200 cargo airframes from
September 30, 2004 to dates ranging from December 31, 2004 to December 31, 2006
and extended the use of 29 aircraft engines from September 30, 2004 until the
aircraft engines reach the earlier of the estimated time of their next heavy
maintenance event or December 31, 2007. In addition, the amended agreement
gave us the option, at our discretion by November 1, 2004, to further extend
the leases on two of these airframes from December 31, 2004 up to December 31,
2007 and on two more of these airframes from December 31, 2004 up to June 30,
2008. On November 8, 2004, we entered into a second amendment to this
agreement with an effective date of November 1, 2004. The second amended agreement primarily reduces the block hour rates,
modifies the lease terms for 11 Boeing 727-200 cargo airframes and modifies
certain minimum usage requirements. The lease terms were modified to coincide
with the approximate date of the expected next heavy maintenance event of each
particular airframe and range from December 31, 2004 to December 31, 2006. The
second amendment also extends the use of 29 aircraft engines until the aircraft
engines reach the earlier of the estimated time of their next heavy maintenance
event or December 31, 2008. In addition, the second amended agreement cancels the amended agreements
extension options on four airframes and provides us with new options to further
extend, at our discretion, the leases on two of the airframes from March 31,
2006 to June 30, 2009, on one of the airframes from September 30, 2006 to
December 31, 2009 and on one of the airframes from December 31, 2004 to
December 31, 2009. Concurrently with the execution of the second amended
agreement, we exercised our option to extend the lease term on one of these
airframes from December 31, 2004 to December 31, 2009. Pursuant to the
exercise of each of the four airframe options, the Trust will be required to
fund up to a majority of the currently anticipated costs of the next heavy
maintenance event on each of the airframes and we will be required to meet
minimum usage guarantees during each extended lease term. In the event a
specific airframe option is exercised, we will be responsible for any heavy
maintenance costs in excess of the amount paid by the Trust. Results of Operations Revenue.Included in our revenue are the following major categories:  
    
    Scheduled freight revenue,which is generated from freight
transportation services provided by our expedited scheduled freight
network. It also includes revenue generated from our fuel and security
surcharges. The fuel surcharge seeks to mitigate the increases in our
fuel expense resulting from higher fuel prices. The security surcharge
seeks to mitigate the increased costs of security measures that have
been implemented as a result of regulations adopted by the TSA.
    
    ACMI revenue,which is generated from short to medium-term contracts
with third parties by our cargo airline under which we generally provide
the aircraft, crew, maintenance and insurance; 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:  
    
    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; 14




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##### Table of Contents




    
    aircraft ground operating costs, such as landing and parking
fees charged by airports and the 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 Expense,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 outstation cargo facilities; 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.  
    
    Operating Overhead Expense,which consists of direct overhead costs
related to operating our expedited scheduled freight network and cargo
airline, including:  
    
    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;
    
    general operational office expenses; and
    
    induction costs related to the Boeing 737-300 cargo aircraft. 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 costs
associated with the performance based compensation program, legal and
professional fees and consulting fees. 15




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##### Table of Contents



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 to the critical accounting policies discussed in our Annual Report on
Form 10-K for the year ended December 31, 2003. QUARTER ENDED SEPTEMBER 30, 2004 COMPARED TO QUARTER ENDED SEPTEMBER 30, 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 September 30,2004
    
    2003Revenue:Scheduled freight
    
    
    95.5
    %
    
    
    99.6
    %Other
    
    
    4.5
    
    
    
    0.4Total revenue
    
    
    100.0
    
    
    
    100.0Cost of revenue
    
    
    86.4
    
    
    
    85.7Gross profit
    
    
    13.6
    
    
    
    14.3General and administrative expenses
    
    
    7.0
    
    
    
    6.3Operating income
    
    
    6.6
    
    
    
    8.0Other (income) expense:Interest expense
    
    
    0.1
    
    
    
    0.3Other (income) expense
    
    
    (0.5
    )
    
    
    (9.6
    )Total other (income) expense
    
    
    (0.4
    )
    
    
    (9.3
    )Income before income taxes
    
    
    7.0
    
    
    
    17.3Income taxes
    
    
    1.5
    
    
    
    Net income
    
    
    5.5
    %
    
    
    17.3
    %
 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: Three months ended September 30,2004
    
    2003Percentage
    
    
    
    
    
    Percentage
    
    Percentage Changeof Total
    
    
    
    
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Scheduled freight
    
    $
    40,603
    
    
    
    95.5
    %
    
    $
    33,484
    
    
    
    99.6
    %
    
    
    21.3
    %Other:ACMI
    
    
    1,197
    
    
    
    2.8
    
    
    
    
    
    
    
    
    
    
    
    Miscellaneous
    
    
    702
    
    
    
    1.7
    
    
    
    141
    
    
    
    0.4
    
    
    
    397.9Total revenue
    
    $
    42,502
    
    
    
    100.0
    %
    
    $
    33,625
    
    
    
    100.0
    %
    
    
    26.4
    %
 Scheduled Freight.For the three months ended September 30, 2004, the $7.1
million increase in our scheduled freight revenue was due to an increase of
3.8% in our average yield and a 16.8% increase in our chargeable weight from
the three months ended September 30, 2003. Our yield increase was due to an
increase in the fuel surcharge and the addition of a security surcharge. The
fuel and security surcharge increase was offset in part by competitive
pressures in certain markets and higher proportion of our chargeable weights
from lower yielding markets. Our chargeable weight increase was largely due to
our expansion into San Juan, Puerto Rico during the second quarter of 2004 and
an overall general strengthening of the economy towards the end of 2003 which
carried over into 2004. 16




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##### Table of Contents



ACMI.During the three months ended September 30, 2004, ACMI revenue
included $1.0 million of revenue related to a contract with Alaska Airlines,
which expired during September 2004. No ACMI revenue was generated during the
three months ended September 30, 2003. Miscellaneous.During the three months ended September 30, 2004, we
generated $0.7 million of miscellaneous revenue through ad-hoc charter services
by our cargo airline. During the three months ended September 30, 2003, our
miscellaneous revenue resulted from ad-hoc charter services and performing
maintenance on an aircraft operated by us, but owned by a third party, on which
we were not obligated to perform maintenance under our aircraft use agreement. 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 September 30,2004
    
    2003Cost
    
    Percentage
    
    Cost
    
    Percentage
    
    Percent Changeof
    
    of Total
    
    of
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Flight expense
    
    $
    6,955
    
    
    
    16.4
    %
    
    $
    6,783
    
    
    
    20.2
    %
    
    
    2.5
    %Transportation expense
    
    
    4,254
    
    
    
    10.0
    
    
    
    2,304
    
    
    
    6.9
    
    
    
    84.6Fuel expense
    
    
    12,102
    
    
    
    28.5
    
    
    
    7,539
    
    
    
    22.4
    
    
    
    60.5Maintenance expense
    
    
    2,446
    
    
    
    5.8
    
    
    
    2,793
    
    
    
    8.3
    
    
    
    (12.4
    )Freight handling expense
    
    
    7,234
    
    
    
    17.0
    
    
    
    6,232
    
    
    
    18.5
    
    
    
    16.1Depreciation and amortization
    
    
    790
    
    
    
    1.8
    
    
    
    1,011
    
    
    
    3.0
    
    
    
    (21.9
    )Operating overhead expense
    
    
    2,924
    
    
    
    6.9
    
    
    
    2,166
    
    
    
    6.4
    
    
    
    35.0Total cost of revenue
    
    $
    36,705
    
    
    
    86.4
    %
    
    $
    28,828
    
    
    
    85.7
    %
    
    
    27.3
    %
 Flight Expense.For the three months ended September 30, 2004, flight
expense increased $0.2 million, or 2.5%, compared to the three months ended
September 30, 2003. This increase was primarily a result of an 11.4% increase
in revenue block hours flown by our owned and leased aircraft and higher crew
costs per revenue block hour flown. The 11.4% increase in revenue block hours
flown was due to our cargo airline flying 623 more hours for our ACMI and
ad-hoc charter customers for the three months ended September 30, 2004 as
compared to the three months ended September 30, 2003. In December 2003, we
entered into a new labor contract with our crew members which contributed to
the increase in crew costs per revenue block hour flown. This increase in
revenue block hours and crew costs was offset in part by a $0.6 million
decrease in aircraft lease expense. Aircraft lease expense decreased in part
due to the expiration of four aircraft leases on May 8, 2004, offset in part by
the continuation of rent on some of these aircraft as the aircraft underwent
maintenance to meet lease return obligations. Transportation Expense.For the three months ended September 30, 2004,
transportation expense increased $1.9 million, or 84.6%, from the three months
ended September 30, 2003. This increase is comprised of a $1.4 million increase
in third party cargo aircraft charters flown on behalf of the scheduled freight
network during the three months ended September 30, 2004 as compared to the
three months ended September 30, 2003 as well $0.2 million of higher trucking
expense incurred in the road feeder markets due to an increase in chargeable
weight carried and the addition of several road feeder markets subsequent to
June 30, 2003 and a $0.2 million increase in aircraft ground operating costs
due to more aircraft operations during the three months ended September 30,
2004 as compared to the three months ended September 30, 2003. The $1.4 million in third party cargo aircraft charters relates to a May
2004 agreement with Express.Net Airlines LLC to charter one Airbus A-300 under
an ACMI arrangement. This aircraft allows us to carry higher freight volumes
more economically for our Los Angeles, California market compared to operating
two Boeing 727-200 cargo aircraft in this market. This agreement is cancelable
by either party with 90 days written notice. We gave notice to Express.Net
Airlines LLC to terminate the contract effective December 14, 2004. 17




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##### Table of Contents



Fuel Expense.For the three months ended September 30, 2004, fuel expense
increased $4.6 million, or 60.5%, as compared to the three months ended
September 30, 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 $0.41, or 41.3%, for the three months ended September
30, 2004 as compared to the three months ended September 30, 2003. To mitigate
the increase in our average cost per gallon of jet fuel, we continue to assess
a fuel surcharge which is included in scheduled freight revenue. The number of
gallons used for the three months ended September 30, 2004 increased by
approximately 1.0 million gallons, or 13.4%, as compared to the three months
ended September 30, 2003. The increase in fuel consumption is primarily due to
a net 9.0% increase in revenue block hours flown by our cargo airline and by
third party aircraft in our scheduled freight network. Maintenance Expense.For the three months ended September 30, 2004,
maintenance expense decreased $0.3 million, or 12.4%, compared to the three
months ended September 30, 2003. This decrease is primarily due to a reduction
in the engine maintenance reserve cost per flight hour and lower usage of
airframes and engines requiring maintenance reserves during the three months
ended September 30, 2004, as compared to the three months ended September 30,
2003. In addition, during the three months ended September 30, 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 have
fully accrued the reserve amount for those airframes based on our estimate of
the cost to perform the heavy maintenance. These decreases in engine and
airframe maintenance reserve expense were partially offset by increases in our
maintenance expense related to the use of more inventory parts on our Boeing
727-200 cargo aircraft during the three months ended September 30, 2004 as
compared to the three months ended September 30, 2003. Freight Handling Expense.For the three months ended September 30, 2004,
freight handling expense increased $1.0 million, or 16.1%, as compared to the
three months ended September 30, 2003. The increase in freight handling expense
was due to a 16.8% increase in chargeable weight and an increase in security
costs offset in part by reporting scheduled freight operations management wages
as operating overhead expense as a result of a management reorganization in
2004. On a per chargeable weight pound, freight handling expense decreased 0.6%
due to more favorable rates from renegotiating third party freight handling
contracts and more efficient labor usage at the hub sort facility in Fort
Wayne, Indiana. Depreciation and Amortization.For the three months ended September 30,
2004, depreciation and amortization expense decreased $0.2 million, or 21.9%,
as compared to the three months ended September 30, 2003. This decrease in
depreciation expense is primarily due to an increase in the number of owned
engines becoming fully depreciated during the three months ended September 30,
2004 as compared to the three months ended September 30, 2003, offset in part
by the addition of two Boeing 727-200 cargo airframes acquired in the fourth
quarter of 2003. Operating Overhead Expense.For the three months ended September 30, 2004,
operating overhead increased $0.8 million, or 35.0%, as compared to the three
months ended September 30, 2003. The increase is partially due to $0.2 million
incurred related to the induction of Boeing 737-300 cargo aircraft. During the
three months ended September 30, 2004 as compared to the three months ended
September 30, 2003, we also incurred increases in our sales and administration
expense for our scheduled freight network and ACMI and ad-hoc charter business,
workers compensation expense and higher expenses due to reporting operations
management wages as operating overhead expense versus freight handling expense
as a result of a management reorganization in 2004. GROSS PROFIT As a result of the foregoing, for the three months ended September 30,
2004, we recognized gross profit of $5.8 million, which was an improvement of
$1.0 million as compared to the three months ended September 30, 2003. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense increased $0.8 million, or 39.4%, for
the three months ended September 30, 2004 as compared to the three months ended
September 30, 2003. The increase is primarily due to accruing $0.5 million
expense for performance based compensation, higher bankruptcy related expenses
as we resolve the 18




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##### Table of Contents



remaining claims of our former unsecured creditors and professional fees
related to compliance with the Sarbanes-Oxley Act. OTHER (INCOME) EXPENSE Other income for the three months ended September 30, 2004 resulted
primarily from gains recognized on the sale of property and equipment that was
determined to be in excess of requirements to operate our expedited scheduled
freight network and our cargo airline. Other income for the three months ended
September 30, 2003 relates primarily to the recovery of $2.9 million of bad
debt expense and other operating expenses incurred in 2001 related to a dispute
with one of our customers and the recovery of retroactive adjustments on a
workers compensation policy. INCOME TAXES Upon our emergence from bankruptcy in 2002, we had $48.2 million in future
deductible tax attributes for which no deferred tax asset was recorded due to
the uncertainty of realizing the related tax benefits. When our operations are
profitable, we realize these tax benefits through the reduction of any current
federal income taxes payable. For financial reporting purposes, we recognize a
deferred tax expense, at our effective tax rate of 36.5%, equal to the amount
of tax attributes realized and record the benefit as an increase in additional
capital because these tax attributes are associated with our pre-bankruptcy
operations. If we determine that the realization of our remaining
pre-bankruptcy tax attributes is more likely than not, we will eliminate the
valuation allowance on our deferred tax asset and recognize a corresponding
increase in additional capital. In addition, as 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. If such a change were to occur,
we may be limited in our ability to offset any income with our future
deductible tax attributes. NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 2003 The following table presents, for the periods indicated, condensed
consolidated statement of operations data expressed as a percentage of total
revenue: Nine months ended September 30,2004
    
    2003Revenue:Scheduled freight
    
    
    97.3
    %
    
    
    95.4
    %Other
    
    
    2.7
    
    
    
    3.6Total revenue
    
    
    100.0
    
    
    
    100.0Cost of revenue
    
    
    91.3
    
    
    
    95.7Gross profit
    
    
    8.7
    
    
    
    4.3General and administrative expenses
    
    
    7.3
    
    
    
    7.4Operating income
    
    
    1.4
    
    
    
    (3.1
    )Other (income) expense:Interest expense
    
    
    0.2
    
    
    
    0.3Other (income) expense
    
    
    (0.3
    )
    
    
    (3.9
    )Total other (income) expense
    
    
    (0.1
    )
    
    
    (3.6
    )Income before income taxes
    
    
    1.5
    
    
    
    0.5Income taxes
    
    
    0.6
    
    
    
    Net income
    
    
    0.9
    %
    
    
    0.5
    %
 19




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##### Table of Contents



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: Nine months ended September 30,2004
    
    2003Percentage
    
    
    
    
    
    Percentage
    
    Percentage Changeof Total
    
    
    
    
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Scheduled freight
    
    $
    110,991
    
    
    
    97.3
    %
    
    $
    91,422
    
    
    
    95.4
    %
    
    
    21.4
    %Other:ACMI
    
    
    1,837
    
    
    
    1.6
    
    
    
    3,375
    
    
    
    3.5
    
    
    
    (45.6
    )Miscellaneous
    
    
    1,291
    
    
    
    1.1
    
    
    
    1,082
    
    
    
    1.1
    
    
    
    19.3Total revenue
    
    $
    114,119
    
    
    
    100.0
    %
    
    $
    95,879
    
    
    
    100.0
    %
    
    
    19.0
    %
 Scheduled Freight.For the nine months ended September 30, 2004, the $19.6
million increase in our scheduled freight revenue was due to an increase of
3.7% in our average yield and a 17.1% increase in our chargeable weight from
the nine months ended September 30, 2003. Our yield increase was due to an
increase in the fuel surcharge and the implementation of a security surcharge.
Higher rates in the six months ended June 30, 2004 as compared to the six
months ended June 30, 2003 were largely offset by lower rates in the three
months ended September 30, 2004 as compared to the three months ended September
30, 2003. Competitive pressures affecting our yields during the third quarter
2004 as compared to third quarter 2003 offset slightly stronger yields
experienced during the first half of 2004 relative to the first half of 2003.
Our chargeable weight increase was largely due to our second quarter 2004
expansion into San Juan, Puerto Rico, a strengthening economy toward the end of
2003 which carried over to 2004, lower than expected freight volumes for the
second quarter of 2003 due to the war in Iraq, 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 June 30, 2003. ACMI.During the nine months ended September 30, 2004, we generated $1.6
million of ACMI revenue through a four month contract with Alaska Airlines,
which began in May 2004. This contract expired on September 11, 2004. During
the nine months ended September 30, 2003, we generated $3.4 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. Miscellaneous.For the nine months ended September 30, 2004, our
miscellaneous revenue resulted from flying ad-hoc charter services for several
customers which generated $1.2 million of revenue. We also performed
maintenance on an aircraft operated by us, but owned by a third party on which
we were not obligated to perform maintenance which generated $0.1 million of
revenue. Our miscellaneous revenue for the nine months ended September 30, 2003
included generating $1.0 million from flying ad-hoc charter services and $0.1
million generated from maintenance work. 20




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##### Table of Contents



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: Nine months ended September 30,2004
    
    2003Cost
    
    Percentage
    
    Cost
    
    Percentage
    
    Percent Changeof
    
    of Total
    
    of
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Flight expense
    
    $
    21,525
    
    
    
    18.9
    %
    
    $
    19,451
    
    
    
    20.3
    %
    
    
    10.7
    %Transportation expense
    
    
    10,504
    
    
    
    9.2
    
    
    
    13,038
    
    
    
    13.6
    
    
    
    (19.4
    )Fuel expense
    
    
    32,181
    
    
    
    28.2
    
    
    
    22,713
    
    
    
    23.7
    
    
    
    41.7Maintenance expense
    
    
    8,623
    
    
    
    7.6
    
    
    
    8,878
    
    
    
    9.3
    
    
    
    (2.9
    )Freight handling expense
    
    
    20,584
    
    
    
    18.0
    
    
    
    18,030
    
    
    
    18.8
    
    
    
    14.2Depreciation and amortization
    
    
    2,290
    
    
    
    2.0
    
    
    
    2,804
    
    
    
    2.9
    
    
    
    (18.3
    )Operating overhead expense
    
    
    8,421
    
    
    
    7.4
    
    
    
    6,810
    
    
    
    7.1
    
    
    
    23.7Total cost of revenue
    
    $
    104,128
    
    
    
    91.3
    %
    
    $
    91,724
    
    
    
    95.7
    %
    
    
    13.5
    %
 Flight Expense.For the nine months ended September 30, 2004, flight
expense increased $2.1 million or 10.7% compared to the nine months ended
September 30, 2003. This increase was primarily a result of a 17.2% increase in
revenue block hours flown by our owned and leased aircraft and higher crew
costs per revenue block hour flown. In December 2003, we entered into a new
labor contract with our crew members which contributed to the increase in crew
costs per revenue block hour flown. This increase is offset in part by a $0.3
million decrease in aircraft lease expense and a $0.2 million decrease in
simulator training expense. Aircraft lease expense decreased due in part to
the expiration of four aircraft leases on May 8, 2004, offset in part by the
continuation of rent on some of these aircraft as the aircraft underwent
maintenance to meet lease return obligations and higher expense on our other
leased aircraft. Simulator training expense decreased due to the elimination
of a minimum usage requirement in our simulator usage agreement. The 17.2%, or 2,693 hours increase in revenue block hours flown was due to
our cargo airline flying 3,138, or 22.2%, more hours for the scheduled freight
network and 445, or 29.5%, fewer hours for our ACMI and ad-hoc charter
customers for the nine months ended September 30, 2004 as compared to the nine
months ended September 30, 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 nine
months ended September 30, 2004 as compared to the nine months ended September
30, 2003. The expenses related to chartering aircraft are included in
transportation expense as opposed to the cost of operating our own aircraft
which are included in flight expense. Transportation Expense.For the nine months ended September 30, 2004,
transportation expense decreased $2.5 million, or 19.4%, from the nine months
ended September 30, 2003. This decrease is comprised of a $3.6 million decrease
in third party cargo aircraft charters flown on behalf of the scheduled freight
network during the nine months ended September 30, 2004 as compared to the nine
months ended September 30, 2003, offset in part by $0.4 million of higher
trucking expense incurred in the road feeder markets due to higher chargeable
weight carried and the addition of several road feeder markets subsequent to
June 30, 2003 and $0.7 million of higher aircraft ground operating costs due to
more aircraft operations during the nine months ended September 30, 2004 as
compared to the nine months ended September 30, 2003. In December 2002, we signed a one-year agreement with an affiliate of BAX
Global to charter two Douglas DC-8 cargo aircraft. 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. This
contract was cancelled by mutual agreement effective May 31, 2003. In May 2004,
we entered into a one-year agreement with Express.Net Airlines LLC to charter
one Airbus A-300 under an ACMI arrangement. This 21




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##### Table of Contents



aircraft allows us to carry higher freight volumes more economically for
our Los Angeles, California market compared to two operating Boeing 727-200
cargo aircraft in this market. This agreement is cancelable by either party
with 90 days written notice. We gave notice to Express.Net Airlines LLC to
terminate the contract effective December 14, 2004. Fuel Expense.For the nine months ended September 30, 2004, fuel expense
increased $9.5 million, or 41.7%, as compared to the nine months ended
September 30, 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 $0.25, or 23.9%, for the nine months ended September
30, 2004 as compared to the nine months ended September 30, 2003. To mitigate
the increase in our average cost per gallon of jet fuel, we continue to assess
a fuel surcharge which is included in scheduled freight revenue. The number of
gallons used for the nine months ended September 30, 2004 increased by
approximately 3.1 million gallons, or 14.2%, as compared to the nine months
ended September 30, 2003. The increase in fuel consumption is primarily due to
a net 12.0% increase in revenue block hours flown by our cargo airline and by
third party aircraft in our scheduled freight network. Maintenance Expense.For the nine months ended September 30, 2004,
maintenance expense decreased $0.3 million, or 2.9%, as compared to the nine
months ended September 30, 2003. Included in maintenance expense during the
nine months ended September 30, 2004 is a $1.7 million charge to maintenance
expense to meet the estimated incremental lease return obligations on four
Boeing 727-200 cargo aircraft. The lease obligations were fully satisfied as of
September 30, 2004. Also included in maintenance expense in the nine months
ended September 30, 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. If not for the $1.7 million lease return charge and the $0.5 million heavy
maintenance reserve reversal, maintenance expense would have decreased $1.5
million, or 17.1%, for the nine months ended September 30, 2004, as compared to
the nine months ended September 30, 2003. This decrease is partially due to a
reduction in the engine maintenance reserve cost per flight hour, lower usage
of airframes and engines requiring maintenance reserves and lower maintenance
wage costs during the nine months ended September 30, 2004, as compared to the
nine months ended September 30, 2003. In addition, during the nine months ended
September 30, 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 have fully accrued the reserve amount for those
airframes based on our estimate of the cost to perform the heavy maintenance. Freight Handling Expense.For the nine months ended September 30, 2004,
freight handling expense increased $2.6 million, or 14.2%, as compared to the
nine months ended September 30, 2003. The increase in freight handling expense
was due to a 17.1% 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 nine months ended September
30, 2004 that were previously included in operating overhead during the nine
months ended September 30, 2003 when we performed the freight handling. These
cost increases were offset in part by a decrease in other freight handling
costs resulting from reporting scheduled freight operations management wages as
operating overhead expense as a result of a management restructuring in 2004
and 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. The remaining outstation
was outsourced during the third quarter of 2003. Freight handling expense
decreased 2.4% on a chargeable weight basis for the nine months ended September
20, 2004 as compared to the nine months ended September 30, 2003. Depreciation and Amortization.For the nine months ended September 30,
2004, depreciation and amortization expense decreased $0.5 million, or 18.3%,
as compared to the nine months ended September 30, 2003. This decrease in
depreciation expense is primarily due to an increase in the number of owned
engines becoming fully depreciated during nine months ended September 30, 2004
as compared to the nine months ended September 30, 2003, offset in part by the
addition of two Boeing 727-200 cargo airframes acquired in the fourth quarter
of 2003. Operating Overhead Expense.For the nine months ended September 30, 2004,
operating overhead increased $1.6 million, or 23.7%, as compared to the nine
months ended September 30, 2003. The increase was partially due to $0.6 million
incurred related to the induction of Boeing 737-300 cargo aircraft. During the
nine months ended 22




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##### Table of Contents



September 30, 2004 as compared to the nine months ended September 30,
2003, we also incurred increases in our sales and administration expense for
our scheduled freight network and ACMI and ad-hoc charter business, our
workers compensation expense and higher expense related to reporting scheduled
freight operations management wages as operating overhead expense versus
freight handling expense as a result of a management restructuring in 2004.
These increases were offset in part by the elimination of certain costs that
are now included in third party freight handling contracts, such as rent and
utilities, and are reported as freight handling expense during the nine months
ended September 30, 2004. GROSS PROFIT As a result of the foregoing, for the nine months ended September 30,
2004, we recognized gross profit of $10.0 million, which was an improvement of
$5.8 million as compared to the nine months ended September 30, 2003. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense increased $1.2 million, or 16.4%, for
the nine months ended September 30, 2004 as compared to the nine months ended
September 30, 2003. The increase is primarily due to accruing $0.9 million
expense for performance based compensation, severance costs, higher bankruptcy
related expenses as we resolve the remaining claims or our former unsecured creditors
and professional fees related to compliance with the Sarbanes-Oxley Act. OTHER (INCOME) EXPENSE Other income for the nine months ended September 30, 2004 resulted
primarily from gains recognized on the sale of property and equipment that was
determined to be in excess of requirements to operate our expedited scheduled
freight network and our cargo airline. Other income for the nine months ended
September 30, 2003 relates primarily to the recovery of $2.9 million of bad
debt expense and other operating expenses incurred in 2001 related to a dispute
with one of our customers, the recovery of retroactive adjustments on a workers
compensation policy and gains recognized on the sale of excess property and
equipment. INCOME TAXES Upon our emergence from bankruptcy in 2002, we had $48.2 million in future
deductible tax attributes for which no deferred tax asset was recorded due to
the uncertainty of realizing the related tax benefits. When our operations are
profitable, we realize these tax benefits through the reduction of any current
federal income taxes payable. For financial reporting purposes, we recognize a
deferred tax expense, at our effective tax rate of 36.5%, equal to the amount
of tax attributes realized and record the benefit as an increase in additional
capital because these tax attributes are associated with our pre-bankruptcy
operations. If we determine that the realization of our remaining
pre-bankruptcy tax attributes is more likely than not, we will eliminate the
valuation allowance on our deferred tax asset and recognize a corresponding
increase in additional capital. In addition, as 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. If such a change were to occur,
we may be limited in our ability to offset any income with our future
deductible tax attributes. 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 the
remaining availability of our $10.0 million credit facility with WFB. As of
November 8, 2004, we had a borrowing base of $10.0 million and $7.7 million of
availability. At September 30, 2004, we had cash and cash equivalents of $8.9 million as
compared to $15.7 million at December 31, 2003. The decrease in cash of $6.8
million is a result of $3.3 million used for operations, $3.0 million used in
investing activities and $0.5 million used for repayments of our outstanding
debt. The $3.0 million used in investing activities included $2.7 million for
capitalized maintenance expenditures and the acquisition of operating 23




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assets and $0.8 million increase to restricted cash for certificates of
deposits to secure our bank issued letters of credit. At September 30, 2004, our net working capital was $21.4 million compared
to $18.7 million at December 31, 2003. We anticipate our capital expenditures for the remainder of 2004 will be
approximately $0.7 million, including $0.5 million related to complying with
airworthiness directives on our fleet of Boeing 727-200 cargo aircraft and $0.2
million to upgrade our information technology systems and acquire other
miscellaneous assets. In addition, we expect integration costs of approximately
$0.7 million during the remainder of 2004 to continue the integration of the
Boeing 737-300 cargo aircraft into our fleet. Our working capital requirements
are also increased by the rising cost of jet fuel because we pay for fuel in
advance of providing air freight transportation services and typically do not
recover these increases through our fuel surcharges until the billing for the
air freight transportation service is collected, which is usually between 30 to
45 days after the service is performed. Based on our current projections, 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 expenditure requirements. Credit Facility.We have 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 September 30, 2004, the
interest rate on the credit facility was 5.75%. The credit facility is secured
by substantially all of our receivables and personal property, other than
airframes, aircraft engines and aviation parts. Availability under the credit facility is subject to a borrowing base
equal to the lesser of $10.0 million or 85% of eligible receivables. WFB may
reject any receivable deemed ineligible in the exercise of its business
judgment. As of November 5, 2004, we had $1.9 million borrowed under the credit
facility and $0.4 million of letters of credit issued under the credit
facility. 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
required 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. Although the credit facility has a final maturity date of March 22,
2007, we classify any balances outstanding under the credit facility as
current, pursuant to EITF Issue 95-22, as the agreement contains a subjective
acceleration clause if in the opinion of the lenders there is a material
adverse change in our business, and provides the lenders direct access to our
cash receipts. We are in compliance with all requirements of the credit
facility as of September 30, 2004. 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. 24




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Contractual ObligationsThe following table sets forth our contractual
obligations for the period shown (dollars in thousands): Three Months
    
    Two Years
    
    Two YearsContractual
    
    
    
    
    
    Ending
    
    Ending
    
    EndingObligation
    
    Total
    
    December 31, 2004
    
    December 31, 2006
    
    December 31, 2008
    
    ThereafterDebt
    
    $
    1,949
    
    
    $
    1,949
    
    
    $
    
    
    
    $
    
    
    
    $
    Non-aircraft
operating leases
    
    
    36,899
    
    
    
    782
    
    
    
    5,772
    
    
    
    4,814
    
    
    
    25,531Aircraft operating
leases and use
agreements
    
    
    95,114
    
    
    
    873
    
    
    
    19,324
    
    
    
    18,279
    
    
    
    56,188Purchase
Commitments (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total contractual
cash obligations
    
    $
    133,963
    
    
    $
    3,605
    
    
    $
    25,096
    
    
    $
    23,542
    
    
    $
    81,719
   (1)
    
    Excludes purchase orders entered into in the ordinary course of
business. 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 third quarter of 2003, we experienced normal seasonal
trends in our expedited scheduled freight business. In the third quarter of
2004, we believe we experienced normal seasonal trends in our expedited freight
business. Additionally, we believe we continued to benefit in the third quarter
of 2004 from what appeared to be a stronger U.S. domestic economy than in the
third quarter of 2003. 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 and second calendar quarters. Funding requirements have
historically been met through internally generated funds, bank borrowings, and
aircraft and other asset sales. 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: 25




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
    
    loss of key suppliers, significant customers or key management
personnel;
    
    increased competition, including the possible impact of any mergers,
alliances or combinations of competitors;
    
    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 and our ability to
recapture increases in the cost of jet fuel through the use of fuel
surcharges;
    
    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, including regulations
affecting maintenance requirements for, and availability of aircraft;
    
    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;
    
    further delays in receiving or placing the Boeing 737-300 cargo aircraft into revenue service; and
    
    the ability to negotiate reasonably economical 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. 26




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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 In 2001, 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. The air charter carriers were seeking to recover
approximately $4.6 million from General Motors and Delphi Automotive. General
Motors had named us as a third party defendant in the litigation and was
seeking indemnification of up to $4.6 million against us. In February 2004, the
parties agreed that the indemnification claim would be heard in bankruptcy
court in Fort Worth, Texas, or the Bankruptcy Court. In May 2004, we were
dismissed from the litigation in Wayne County, Michigan. On November 3, 2004,
the Bankruptcy Court granted our motion that the General Motors claim for
indemnification be denied in its entirety. 
 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. 27




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ITEM 6. 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. 28




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 8, 2004. KITTY HAWK, INC.By:
    /s/ RANDY S. LEISERRandy S. LeiserVice President - Finance and
Chief Financial Officer
(Authorized officer and principal financial officer) 29