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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One) x
 For the quarterly period ended June 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 August 11, 2004 was 43,757,306.




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KITTY HAWK, INC. INDEX PAGE NUMBERPART I. FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets
June 30, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations
Three months ended June 30, 2004 and 2003 and the
Six months ended June 30, 2004 and 2003
    
    
    4Condensed Consolidated Statement of Stockholders Equity
Six months ended June 30, 2004
    
    
    5Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2004 and 2003
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    24PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    25Item 2. Changes in Securities and Use of Proceeds
    
    
    25Item 3. Defaults upon Senior Securities
    
    
    25Item 4. Submission of Matters to a Vote of Security Holders
    
    
    25Item 5. Other Information
    
    
    27Item 6. Exhibits and Reports on Form 8-K
    
    
    27Aircraft Lease Common Terms AgreementForm of Lease for Boeing 737-300 Cargo Aircraft2004 Leadership Performance PlanCertification of Principal Executive Officer - Section 302Certification of Principal Financial Officer - Section 302Certification Pursuant to Section 906
  2




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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) June 30,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    11,945
    
    
    $
    15,729Restricted cash and short-term investments
    
    
    1,379
    
    
    
    579Trade accounts receivable, net of allowance for doubtful accounts of $0.6
million and $0.5 million, respectively
    
    
    13,881
    
    
    
    11,539Assets held for sale
    
    
    80
    
    
    
    114Inventory and aircraft supplies
    
    
    5,400
    
    
    
    5,441Deposits and prepaid expenses
    
    
    1,903
    
    
    
    1,135Prepaid fuel
    
    
    1,629
    
    
    
    1,122Settlement receivable
    
    
    765
    
    
    
    1,765Other current assets, net
    
    
    106
    
    
    
    143Total current assets
    
    
    37,088
    
    
    
    37,567Property and equipment, net
    
    
    8,964
    
    
    
    9,058Other assets, net
    
    
    400
    
    
    
    485Total assets
    
    $
    46,452
    
    
    $
    47,110LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Current liabilities:Accounts payable  trade
    
    $
    3,445
    
    
    $
    2,880Accrued wages
    
    
    886
    
    
    
    761Other accrued expenses
    
    
    6,823
    
    
    
    5,519Other taxes payable
    
    
    2,151
    
    
    
    2,270Current portion of accrued maintenance reserves
    
    
    2,482
    
    
    
    2,617Current portion of lease return provisions
    
    
    2,196
    
    
    
    2,459Current maturities of long-term debt
    
    
    1,949
    
    
    
    2,348Total current liabilities
    
    
    19,932
    
    
    
    18,854Long-term debt
    
    
    
    
    
    
    34Accrued maintenance reserves
    
    
    2,954
    
    
    
    3,311Other long-term liabilities
    
    
    1,061
    
    
    
    1,307Total liabilities
    
    
    23,947
    
    
    
    23,506Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Preferred stock, $0.01 par value: Authorized shares  3,000,000; none issued
    
    
    
    
    
    
    Common stock, $0.000001 par value: Authorized shares  62,000,000; issued
and outstanding  43,757,306 and 40,760,084 at June 30, 2004 and December
31, 2003, respectively
    
    
    
    
    
    
    Additional capital
    
    
    18,415
    
    
    
    18,311Retained earnings
    
    
    4,090
    
    
    
    5,293Total stockholders equity
    
    
    22,505
    
    
    
    23,604Total liabilities and stockholders equity
    
    $
    46,452
    
    
    $
    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 June 30,
    
    Six months ended June 30,2004
    
    2003
    
    2004
    
    2003Revenue:Scheduled freight
    
    $
    37,164
    
    
    $
    29,510
    
    
    $
    70,388
    
    
    $
    57,939ACMI
    
    
    640
    
    
    
    1,610
    
    
    
    640
    
    
    
    3,996Miscellaneous
    
    
    71
    
    
    
    152
    
    
    
    589
    
    
    
    321Total revenue
    
    
    37,875
    
    
    
    31,272
    
    
    
    71,617
    
    
    
    62,256Cost of revenue:Flight expense
    
    
    7,381
    
    
    
    6,405
    
    
    
    14,570
    
    
    
    12,668Transportation expense
    
    
    3,424
    
    
    
    4,695
    
    
    
    6,249
    
    
    
    10,734Fuel expense
    
    
    10,876
    
    
    
    7,254
    
    
    
    20,079
    
    
    
    15,174Maintenance expense
    
    
    2,797
    
    
    
    2,725
    
    
    
    6,177
    
    
    
    6,085Freight handling expense
    
    
    6,862
    
    
    
    6,067
    
    
    
    13,350
    
    
    
    11,798Depreciation and amortization
    
    
    688
    
    
    
    888
    
    
    
    1,500
    
    
    
    1,793Operating overhead expense
    
    
    2,842
    
    
    
    2,210
    
    
    
    5,497
    
    
    
    4,644Total cost of revenue
    
    
    34,870
    
    
    
    30,244
    
    
    
    67,422
    
    
    
    62,896Gross profit (loss)
    
    
    3,005
    
    
    
    1,028
    
    
    
    4,195
    
    
    
    (640
    )General and administrative expense
    
    
    2,460
    
    
    
    2,355
    
    
    
    5,377
    
    
    
    5,039Operating income (loss)
    
    
    545
    
    
    
    (1,327
    )
    
    
    (1,182
    )
    
    
    (5,679
    )Other (income) expense:Interest expense
    
    
    72
    
    
    
    103
    
    
    
    167
    
    
    
    219Other, net
    
    
    (112
    )
    
    
    (38
    )
    
    
    (146
    )
    
    
    (519
    )Net income (loss)
    
    $
    585
    
    
    $
    (1,392
    )
    
    $
    (1,203
    )
    
    $
    (5,379
    )Basic net income (loss) per share
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.11
    )Weighted average common shares outstanding
    
    
    50,698,234
    
    
    
    49,999,970
    
    
    
    50,636,602
    
    
    
    49,999,970Diluted net income (loss) per share
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.11
    )Weighted average diluted common shares outstanding
    
    
    53,994,513
    
    
    
    49,999,970
    
    
    
    50,636,602
    
    
    
    49,999,970
 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 loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,203
    )
    
    
    (1,203
    )Compensation expense
associated with stock option
grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    60
    
    
    
    
    
    
    
    60Issue common stock related to
exercise of warrants to
acquire stock
    
    
    2,852,222
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issue common stock related to
exercise of stock options
    
    
    251,250
    
    
    
    
    
    
    
    
    
    
    
    75
    
    
    
    
    
    
    
    75Repurchase of restricted
shares
    
    
    
    
    
    
    (106,250
    )
    
    
    
    
    
    
    (31
    )
    
    
    
    
    
    
    (31
    )Vesting of restricted shares
    
    
    31,250
    
    
    
    (31,250
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at June 30, 2004
    
    
    43,757,306
    
    
    
    
    
    
    $
    
    
    
    $
    18,415
    
    
    $
    4,090
    
    
    $
    22,505
 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) Six months ended June 30,2004
    
    2003Operating activities:Net loss
    
    $
    (1,203
    )
    
    $
    (5,379
    )Adjustments to reconcile loss to net cash
used in operating activities:Depreciation and amortization expense
    
    
    1,728
    
    
    
    1,968Gain on disposal of property and equipment
    
    
    (22
    )
    
    
    (274
    )Compensation expense related to stock options
    
    
    60
    
    
    
    Provision for doubtful accounts
    
    
    120
    
    
    
    265Changes in operating assets and liabilities:Trade accounts receivable
    
    
    (2,462
    )
    
    
    991Settlement receivable
    
    
    1,000
    
    
    
    Inventory and aircraft supplies
    
    
    80
    
    
    
    123Prepaid expenses and other
    
    
    (1,043
    )
    
    
    (391
    )Accounts payable and accrued expenses
    
    
    1,629
    
    
    
    (998
    )Accrued maintenance reserves
    
    
    (755
    )
    
    
    247Net cash used in operating activities
    
    
    (868
    )
    
    
    (3,448
    )Investing activities:Proceeds from sale of assets
    
    
    171
    
    
    
    565Change in restricted cash
    
    
    (800
    )
    
    
    66Capital expenditures
    
    
    (1,789
    )
    
    
    (173
    )Net cash provided by (used in) investing activities
    
    
    (2,418
    )
    
    
    458Financing activities:Issue common stock
    
    
    75
    
    
    
    Repurchase restricted common stock
    
    
    (31
    )
    
    
    Borrowings of long-term debt
    
    
    1,949
    
    
    
    439Loan origination cost
    
    
    (109
    )
    
    
    Repayments of long-term debt
    
    
    (2,382
    )
    
    
    (1,717
    )Net cash used in financing activities
    
    
    (498
    )
    
    
    (1,278
    )Net decrease in cash and cash equivalents
    
    
    (3,784
    )
    
    
    (4,628
    )Cash and cash equivalents at beginning of period
    
    
    15,729
    
    
    
    10,353Cash and cash equivalents at end of period
    
    $
    11,945
    
    
    $
    6,085
 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 General Motors and Delphi Automotive were sued in Wayne County, Michigan
by a number of air charter carriers in connection with air transportation
services the Company arranged with them on behalf of General Motors and Delphi
Automotive and for which the air charter carriers were not paid as a result of
the Companys bankruptcy. The air charter carriers are seeking to recover
approximately $4.6 million from General Motors and Delphi Automotive. General
Motors has named the Company as a third party defendant in the litigation and
is seeking indemnification of up to $4.6 million against the Company. The
parties have agreed that the indemnification claim will be heard in bankruptcy
court in Fort Worth, Texas (the Bankruptcy Court). In May 2004, the Company
was dismissed from the litigation in Wayne County, Michigan. The Company
believes this claim should have been discharged when its Plan of Reorganization
was confirmed by the Bankruptcy Court. No amounts have been accrued for this
contingency. In the normal course of business, the Company is a party to various legal
proceedings and other claims. While the outcome of these other proceedings and
other claims cannot be predicted with certainty, management does not believe
these matters will have a material adverse affect on the Companys financial
condition or results of operations. 3. STOCK OPTIONS In September 2003, the Companys stockholders approved the Kitty Hawk 2003
Long Term Equity Incentive Plan (the Plan). Options granted under the Plan
are accounted for under the provisions of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The Company is required to disclose the pro forma effect of accounting for
stock options using the fair value recognition provisions of SFAS Statement No.
123, Accounting for Stock-Based Compensation and SFAS Statement No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure. The
Company uses 7




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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: Six Months EndedJune 30,2004
    
    2003Risk free interest rate
    
    
    4.05
    %
    
    
    Expected life (years)
    
    
    10
    
    
    
    Volatility
    
    
    50
    %
    
    
    Dividend yield
    
    
    0
    %
    
    
    
 Some of these assumptions are judgmental and highly sensitive in the
determination of pro forma compensation expense. The following table
illustrates the effect on net income and earnings per share if the Company had
applied fair value accounting. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share data)Net income (loss), as reported
    
    $
    585
    
    
    $
    (1,392
    )
    
    $
    (1,203
    )
    
    $
    (5,379
    )Add: Total stock-based employee compensation
expense determined under the intrinsic method for
all awards
    
    
    50
    
    
    
    
    
    
    
    60
    
    
    
    Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards
    
    
    (91
    )
    
    
    
    
    
    
    (168
    )
    
    
    Pro forma net income (loss)
    
    $
    544
    
    
    $
    (1,392
    )
    
    $
    (1,311
    )
    
    $
    (5,379
    )Basic income (loss) per share  as reported
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.11
    )Basic income (loss) per share  pro forma
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    (0.03
    )
    
    $
    (0.11
    )Diluted income (loss) per share  as reported
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.11
    )Diluted income (loss) per share  pro forma
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    (0.03
    )
    
    $
    (0.11
    )
 The Plan provides for the issuance of up to 6,500,000 shares of common
stock. The options granted generally have an exercise price equal to the quoted
market price of the stock on the date of grant. The options granted vest over
periods of 36 to 48 months. The options expire ten years from the date of
grant, subject to earlier forfeiture provisions. The following table summarizes the stock option activity under the Plan
for the six months ended June 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 $1.09)
    
    
    (450,000
    )
    
    
    450,000
    
    
    $
    1.53Exercised
    
    
    
    
    
    
    (251,250
    )
    
    $
    0.30Canceled
    
    
    525,000
    
    
    
    (525,000
    )
    
    $
    0.30Outstanding at June 30, 2004:
    
    
    1,540,000
    
    
    
    4,133,750
    
    
    $
    0.44
 8




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The following table summarizes information about the stock options
outstanding at June 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
    
    
    3,673,750
    
    
    
    9.08
    
    
    $
    0.30
    
    
    
    1,267,500
    
    
    $
    0.30$1.105
    
    
    10,000
    
    
    
    9.58
    
    
    $
    1.105
    
    
    
    1,667
    
    
    $
    1.105$  1.41
    
    
    200,000
    
    
    
    9.67
    
    
    $
    1.41
    
    
    
    27,778
    
    
    $
    1.41$  1.62
    
    
    250,000
    
    
    
    9.92
    
    
    $
    1.62
    
    
    
    9,375
    
    
    $
    1.624,133,750
    
    
    
    9.48
    
    
    $
    0.44
    
    
    
    1,306,320
    
    
    $
    0.33
    (1)   Each of the outstanding options are currently exercisable. Option
holders who exercise unvested options will receive restricted stock for such
unvested options. The restrictions on such restricted stock will lapse on
the same schedule that the underlying options would have vested. 4. SEGMENT REPORTING The Companys operations are comprised of two segments  an expedited
scheduled freight network and a cargo airline. Each segments respective
financial performance is detailed below. Each segment is currently evaluated on
financial performance at the operating income line. The column labeled other consists of corporate activities. Business
assets are owned by or allocated to each of the business segments. Assets
included in the column labeled other include cash, allowance for doubtful
accounts and the corporate headquarters building. The accounting policies of
each segment are the same as those reported in Note 2 of the Annual Report on
Form 10-K for the year ended December 31, 2003. ScheduledFreight
    
    Air Freight
    
    
    
    
    
    
    
    
    
    ConsolidatedNetwork
    
    Carrier
    
    Other
    
    Eliminations
    
    Balance(in thousands)Three months ended June 30, 2004:Revenue from external customers
    
    $
    37,164
    
    
    $
    711
    
    
    $
    
    
    
    $
    
    
    
    $
    37,875Revenue from intersegment
operations
    
    
    
    
    
    
    10,777
    
    
    
    
    
    
    
    (10,777
    )
    
    
    Depreciation and amortization
    
    
    106
    
    
    
    582
    
    
    
    
    
    
    
    
    
    
    
    688Operating income (loss)
    
    
    885
    
    
    
    (259
    )
    
    
    (81
    )
    
    
    
    
    
    
    545Total assets
    
    $
    11,424
    
    
    $
    13,056
    
    
    $
    21,972
    
    
    
    
    
    
    $
    46,452Three months ended June, 2003:Revenue from external customers
    
    $
    29,510
    
    
    $
    1,762
    
    
    $
    
    
    
    $
    
    
    
    $
    31,272Revenue from intersegment
operations
    
    
    
    
    
    
    9,113
    
    
    
    
    
    
    
    (9,113
    )
    
    
    Depreciation and amortization
    
    
    85
    
    
    
    803
    
    
    
    
    
    
    
    
    
    
    
    888Operating income (loss)
    
    
    (1,642
    )
    
    
    333
    
    
    
    (18
    )
    
    
    
    
    
    
    (1,327
    )Total assets
    
    $
    2,417
    
    
    $
    18,749
    
    
    $
    18,447
    
    
    
    
    
    
    $
    39,613Six months ended June 30, 2004:Revenue from external customers
    
    $
    70,388
    
    
    $
    1,229
    
    
    $
    
    
    
    $
    
    
    
    $
    71,617Revenue from intersegment
operations
    
    
    
    
    
    
    22,272
    
    
    
    
    
    
    
    (22,272
    )
    
    
    Depreciation and amortization
    
    
    199
    
    
    
    1,301
    
    
    
    
    
    
    
    
    
    
    
    1,500Operating income (loss)
    
    
    (745
    )
    
    
    (228
    )
    
    
    (209
    )
    
    
    
    
    
    
    (1,182
    )Total assets
    
    $
    11,424
    
    
    $
    13,056
    
    
    $
    21,972
    
    
    
    
    
    
    $
    46,452Six months ended June 30, 2003:Revenue from external customers
    
    $
    57,939
    
    
    $
    4,317
    
    
    $
    
    
    
    $
    
    
    
    $
    62,256Revenue from intersegment
operations
    
    
    
    
    
    
    18,065
    
    
    
    
    
    
    
    (18,065
    )
    
    
    Depreciation and amortization
    
    
    176
    
    
    
    1,617
    
    
    
    
    
    
    
    
    
    
    
    1,793Operating income (loss)
    
    
    (6,125
    )
    
    
    688
    
    
    
    (242
    )
    
    
    
    
    
    
    (5,679
    )Total assets
    
    $
    2,417
    
    
    $
    18,749
    
    
    $
    18,447
    
    
    $
    
    
    
    $
    39,613
 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 (loss) per share because the exercise price of
the warrants is nominal. As of June 30, 2004, warrants to purchase 6,962,649 shares of common stock remain
outstanding. For the six month period ended June 30, 2004, the Company did not
include outstanding options to purchase 4,133,750 shares of common stock
in the diluted loss per share calculation since their effect was
antidilutive due to the reported loss. For the three and six month periods
ended June 30, 2003, there were no options outstanding. 6. RELATED PARTY TRANSACTIONS The Company has various agreements and relationships with beneficial
owners of 5% or more of the Companys common stock. See Item 13. Certain
Relationships and Related Party Transactions of the Companys Annual Report of
Form 10-K/A for the year ended December 31, 2003 for information on these
agreements and relationships. In addition, see the Companys Form 8-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. 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 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. 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, the Company took a
charge of $1.7 million in the first six months of 2004. As of August 11, 2004,
the Company has satisfied the lease return obligations under three of the
leases and is in the process of satisfying the lease return obligations under the fourth lease. While the Company believes its current
lease return reserve pertaining to the return of this aircraft is sufficient to meet the lease return obligations, the final cost
will not be known until the aircraft is returned and the lease return obligation is satisfied in accordance with the lease. In
addition, until the lease return condition is satisfied, the Company may be subject to continuing lease payments. 10




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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 and Hawaii. As an independent freight
network, we typically do not transport freight from shippers to our cargo
facilities or from our cargo facilities to recipients. As a result, we
primarily provide freight services to freight forwarders and logistics
companies who either transport the freight to and from our cargo facilities in
the origin and destination cities we serve or arrange for others to provide
these services. In 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 six months ended June 30,
2004, we generated approximately 98% of our revenue from our expedited
scheduled freight network. Kitty Hawk Aircargo, our cargo airline, provides air freight
transportation services for Kitty Hawk Cargos expedited scheduled freight
network. In addition, Kitty Hawk Aircargo provides 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 when its aircraft
are not being used in our expedited scheduled freight network. On June 30,
2004, Kitty Hawk Aircargo had 19 owned and leased aircraft available for
operation in revenue service. By providing ACMI and ad-hoc charters, Kitty
Hawk Aircargo is able to improve the utilization of its aircraft and generate
additional revenue when its aircraft would otherwise be idle. Our expedited scheduled freight business relies on customers who need
time-definite delivery on an as-needed basis. Because the freight is shipped on
an as-needed basis, we do not have long-term contracts with our customers.
Without long-term customer contracts, the overall demand for our expedited
freight services is primarily influenced by the health of the U.S. economy,
which is cyclical in nature. In addition, we believe that 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. During the six months ended June 30, 2004, we have continued to focus on
reducing both our fixed and variable costs while maintaining the efficiency and
reliability of our network. Our on time performance to our customers remains at
99.6%. One of our most significant and variable costs is the cost of jet fuel.
Because our network bears the cost of increases in jet fuel costs, we seek to
recapture the increase in jet fuel costs through increasing our prices to our
customers and/or through temporary fuel surcharges. We record these fuel
surcharges in our scheduled freight revenue. Historically, we have been able to
largely offset the rising costs of jet fuel through these fuel surcharges 11




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##### Table of Contents



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 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 negatively affect our results of operation. The
rising cost of jet fuel affects our working capital because we pay for fuel in
advance of providing air freight transportation services and typically do not
recover these increases through our fuel surcharge 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 six months ended June 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 six months ended June 30, 2004, our jet fuel
averaged $1.21 per gallon and we used between 2.4 million and 3.0 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
August 11, 2004, we had $9.7 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, working
capital requirements, projected capital expenditures, heavy aircraft
maintenance events, investments in information technology, future investments
in aircraft, payment of performance based compensation and the integration of
Boeing 737-300 cargo aircraft into our fleet. In addition, the Transportation
Security Administration, or TSA, may adopt additional regulations regarding
stringent cargo security screening procedures which may have a material impact
on our costs and cash flow. Additionally, if these regulations and procedures
are not met, we may be subject to civil penalties and fines assessed by the
TSA. Recent Developments Boeing 737-300 Cargo Aircraft Lease.On May 4, 2004, Kitty Hawk Aircargo
entered into ten year operating leases, with two 30-month extension options,
with affiliates of General Electric Capital Aviation Services, or GECAS, for
seven Boeing 737-300 cargo aircraft. The obligations of Kitty Hawk Aircargo
under the operating leases are guaranteed by Kitty Hawk and Kitty Hawk Cargo.
The first Boeing 737-300 cargo aircraft is scheduled for delivery to us late in
the fourth quarter of 2004, with the remaining six aircraft to be delivered to
us during 2005. The Boeing 737-300 cargo aircraft has higher lease costs and approximately
30% less cargo capacity than our current fleet of Boeing 727-200 cargo
aircraft. However, the Boeing 737-300 cargo aircraft generally has lower
operating costs than our Boeing 727-200 cargo aircraft as a result of
significantly lower jet fuel consumption rates, lower crew costs as it operates
with a two person crew instead of three, lower landing fees and reduced
maintenance costs over the long-term. In addition, the Boeing 737-300 cargo
aircraft has improved performance capabilities and range over the Boeing
727-200 cargo aircraft. As a result of the addition of the Boeing 737-300
cargo aircraft to our fleet, we may be required to adjust our Boeing 727-200
cargo aircraft parts inventory levels and maintenance reserves. A future review of
inventory levels 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 intend to deploy the Boeing 737-300 cargo aircraft in our operations in
situations where we can take advantage of its improved operating cost and
performance characteristics and where its capacity is better suited. While we
have not yet fully developed our combined Boeing 727-200 cargo aircraft and
Boeing 737-300 cargo 12




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##### Table of Contents



aircraft fleet operating and utilization schedule, we expect that
the higher lease costs of the Boeing 737-300 cargo aircraft will be offset by
its higher utilization in our operations and its lower operating costs as
compared to the Boeing 727-200 cargo aircraft. As a result of adding Boeing 737-300 cargo aircraft to our fleet, we will
incur significant, one-time aircraft induction costs for, among other things,
pilot training, maintenance training, purchases of additional tooling and spare
parts and costs to rewrite our operational manuals and maintenance program to
include Boeing 737-300 cargo aircraft. Through June 30, 2004, we have paid
$1.1 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 up to $3.8 million in the aggregate
during the remainder of 2004 and 2005. In addition, we must receive the approval of the Federal Aviation
Administration (the FAA) to place the Boeing 737-300 cargo aircraft 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, which could have a material adverse effect on our results of
operations. Pegasus Aviation Aircraft Lease Return.In October 2002, we entered into
four operating leases for Boeing 727-200 cargo aircraft with affiliates of
Pegasus Aviation. These leases expired on May 8, 2004. Under these leases, in addition to rental payments, we were required to
pay maintenance reserves each month with the amount determined based on flight
hours or cycles of utilization during the previous month. In addition, under
the terms of these leases, each aircraft had to be returned to the lessor with
the same number of available flight hours or cycles on the airframe, aircraft
engines, landing gear and auxiliary power units until the next scheduled
maintenance event as were available at the time we originally took delivery of
each of the aircraft. Because our estimate of the costs to meet these aircraft lease return
obligations exceeded the $2.4 million of lease return reserves we had recorded as
of December 31, 2003 for these aircraft, we took a charge of $1.7 million in
the first six months of 2004. As of August 11, 2004, we had satisfied the
lease return obligations under three of the leases and is in the process of satisfying the lease return obligations under the fourth lease.
While we believe the current lease return reserve pertaining to the return of this aircraft is sufficient to meet the lease return
obligations, the final cost will not be known until the aircraft is returned and the lease return obligation is satisfied in
accordance with the lease. In addition, until the lease return condition is satisfied, we may be subject to continuing lease
payments. Results of Operations Revenue.Scheduled freight revenue is generated from freight
transportation services provided by our expedited scheduled freight network.
Other revenue includes:  
    
    ACMI revenue,which is generated from contracts with third parties by
our cargo airline under which we generally provide the aircraft, crew,
maintenance and insurance, known as ACMI, on short to medium-term
contacts; and  
    
    Miscellaneous revenue,which is generated from ad-hoc charters
provided by our cargo airline, maintenance revenue and freight handling
services provided for third parties. Cost of Revenue.Included in our cost of revenue are the following major
categories:  
    
    Flight Expense,which consists of costs related to the flight operations of our cargo airline, including:  °
    
    flight crew member wages, benefits, training and travel;°
    
    operating lease expense for leased aircraft operated and flown by Kitty Hawk Aircargo; 13




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##### Table of Contents



°
    
    insurance costs related to aircraft operated and flown by Kitty Hawk Aircargo; and°
    
    flight operations and airline management costs, including associated wages and benefits.  
    
    Transportation Expense,which consists of costs related to the
physical movement of freight between our cargo facilities and which is
not otherwise classified as flight expense, including:  °
    
    third party aircraft charter expense;°
    
    aircraft ground operating costs, such as landing and parking fees
charged by airports and 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,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,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 14




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##### Table of Contents



°
    
    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. Critical Accounting Policies For a discussion of our critical accounting policies refer to Item 7.
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Critical Accounting Policies included in our Annual Report on
Form 10-K for the year ended December 31, 2003. There have been no material
changes, except as discussed above in Item 2. Managements Discussion and
Analysis of Financial Condition and Results of Operations  Recent Developments
 Pegasus Aviation Aircraft Lease Return, to the critical accounting policies
discussed in our Annual Report on Form 10-K for the year ended December 31,
2003. QUARTER ENDED JUNE 30, 2004 COMPARED TO QUARTER ENDED JUNE 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 June 30,2004
    
    2003Revenue:Scheduled freight
    
    
    98.1
    %
    
    
    94.4
    %Other
    
    
    1.9
    
    
    
    5.6Total revenue
    
    
    100.0
    
    
    
    100.0Cost of revenue
    
    
    92.1
    
    
    
    96.7Gross profit (loss)
    
    
    7.9
    
    
    
    3.3General and administrative expenses
    
    
    6.5
    
    
    
    7.5Operating income (loss)
    
    
    1.4
    
    
    
    (4.2
    )Other (income) expense:Interest expense
    
    
    0.2
    
    
    
    0.3Other (income) expense
    
    
    (0.3
    )
    
    
    (0.1
    )Total other (income) expense
    
    
    (0.1
    )
    
    
    0.2Net income (loss)
    
    
    1.5
    %
    
    
    (4.4
    )%
 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 June 30,2004
    
    2003Percentage
    
    
    
    
    
    Percentage
    
    Percentage Changeof Total
    
    
    
    
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Scheduled freight
    
    $
    37,164
    
    
    
    98.1
    %
    
    $
    29,510
    
    
    
    94.4
    %
    
    
    25.9
    %Other:ACMI
    
    
    640
    
    
    
    1.7
    
    
    
    1,610
    
    
    
    5.1
    
    
    
    (60.2
    )Miscellaneous.
    
    
    71
    
    
    
    0.2
    
    
    
    152
    
    
    
    0.5
    
    
    
    (53.3
    )Total revenue
    
    $
    37,875
    
    
    
    100.0
    %
    
    $
    31,272
    
    
    
    100.0
    %
    
    
    21.1
    %
 15




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##### Table of Contents



Scheduled Freight.For the three months ended June 30, 2004, the $7.7
million increase in our scheduled freight revenue was due to an increase of
4.2% in our average yield and a 20.8% increase in our chargeable weight from
the three months ended June 30, 2003. Our yield increase was primarily due to
an increase in the fuel surcharge to mitigate the increases in our fuel expense
resulting from higher fuel prices, and to a lesser extent a larger proportion
of higher yielding next morning freight in our total chargeable weight and the
addition of a security surcharge. We implemented a security surcharge to
mitigate the increased costs of security measures that have been implemented as
a result of regulations adopted by the TSA. Our chargeable weight increase was
largely due to lower than expected freight volumes in the second quarter of
2003 as a result of the war in Iraq, general strengthening of the economy
towards the end of 2003 which carried over into 2004, our second quarter 2004
expansion into San Juan, Puerto Rico, and the expansion of our network through
the addition of several road feeder markets and the conversion of one road
feeder market to an air market subsequent to June 30, 2003. ACMI.During the three months ended June 30, 2004, we generated $0.6
million of ACMI revenue through a four month contract with Alaska Airlines,
which began in May 2004. This contract has been extended to September 11, 2004.
During the second quarter of 2003, we generated $1.6 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. 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 June 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
    
    $
    7,381
    
    
    
    19.5
    %
    
    $
    6,405
    
    
    
    20.5
    %
    
    
    15.2
    %Transportation expense
    
    
    3,424
    
    
    
    9.0
    
    
    
    4,695
    
    
    
    15.0
    
    
    
    (27.1
    )Fuel expense
    
    
    10,876
    
    
    
    28.8
    
    
    
    7,254
    
    
    
    23.2
    
    
    
    49.9Maintenance expense
    
    
    2,797
    
    
    
    7.4
    
    
    
    2,725
    
    
    
    8.7
    
    
    
    2.6Freight handling expense
    
    
    6,862
    
    
    
    18.1
    
    
    
    6,067
    
    
    
    19.4
    
    
    
    13.1Depreciation and amortization
    
    
    688
    
    
    
    1.8
    
    
    
    888
    
    
    
    2.8
    
    
    
    (22.5
    )Operating overhead expense
    
    
    2,842
    
    
    
    7.5
    
    
    
    2,210
    
    
    
    7.1
    
    
    
    28.6Total cost of revenue
    
    $
    34,870
    
    
    
    92.1
    %
    
    $
    30,244
    
    
    
    96.7
    %
    
    
    15.3
    %
 Flight Expense.For the three months ended June 30, 2004, flight expense
increased $1.0 million, or 15.2%, compared to the three months ended June 30,
2003. This increase was primarily a result of an 18.3% increase in revenue
block hours flown by our owned and leased aircraft and higher crew costs per
revenue block hour flown. This increase was offset in part by a $0.1 million
decrease in simulator training expense and a $0.1 million decrease in aircraft
lease expense. 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. Simulator training expense decreased due to the elimination of a
minimum usage requirement in our simulator usage agreement. 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 during the
three months ended June 30, 2004. The
18.3%, or increase of 968 revenue block hours flown was due to our
cargo airline flying 1,333, or 28.5%, more hours for the scheduled freight
network and 365, or 58.8%, fewer hours for our ACMI and ad-hoc charter
customers for the three months ended June 30, 2004 as compared to the three
months ended June 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 three
months ended June 30, 2004 as compared to the three months ended June 30, 2003.
The expenses related to chartering these aircraft are included in
transportation expense as opposed to flight expense. 16




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##### Table of Contents



Transportation Expense.For the three months ended June 30, 2004,
transportation expense decreased $1.3 million, or 27.1%, from the three months
ended June 30, 2003. This decrease is comprised of a $1.6 million decrease in
third party cargo aircraft charters flown on behalf of the scheduled freight
network during the three months ended June 30, 2004 as compared to the three
months ended June 30, 2003, offset in part by higher aircraft ground operating
costs due to more aircraft operations during the three months ended June 30,
2004 as compared to the three months ended June 30, 2003 and 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. 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 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. Fuel.For the three months ended June 30, 2004, fuel expense increased
$3.6 million, or 49.9%, as compared to the three months ended June 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 $0.28, or 29.2%, for the three months ended June 30, 2004 as compared
to the three months ended June 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 June 30, 2004 increased by approximately 1.2 million
gallons, or 17.1%, as compared to the three months ended June 30, 2003. The
increase in fuel consumption is primarily due to a 28.5% increase in revenue
block hours flown by our cargo airline in our scheduled freight network which
was partially offset by a 68.7% decrease in revenue block hours flown by third
party aircraft in our scheduled freight network. Maintenance Expense.For the three months ended June 30, 2004,
maintenance expense increased $0.1 million, or 2.6%, compared to the three
months ended June 30, 2003. Included in maintenance expense during the three
months ended June 30, 2004 is a $0.5 million charge to maintenance expense to
meet the estimated incremental lease return obligations on four Boeing 727-200
cargo aircraft. Not including the $0.5 million lease return charge, maintenance expense
would have decreased $0.4 million or 15.7%, for the three months ended June 30,
2004, as compared to the three months ended June 30, 2003. This decrease is
partially due to a reduction in the engine maintenance reserve rate per flight
hour and lower usage of airframes and engines requiring maintenance reserves
during the three months ended June 30, 2004, as compared to the three months
ended June 30, 2003. In addition, during the three months ended June 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 previously reached the maximum reserve amount for those airframes in
accordance with our maintenance reserve policy. Freight Handling Expense.For the three months ended June 30, 2004,
freight handling expense increased $0.8 million, or 13.1%, as compared to the
three months ended June 30, 2003. The increase in freight handling expense was
due to a 20.8% increase in chargeable weight. On a per chargeable weight pound,
freight handling expense decreased 6.5% 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 June 30, 2004,
depreciation and amortization expense decreased $0.2 million, or 22.5%, as
compared to the three months ended June 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 June 30, 2004
as compared to the three months ended June 30, 2003, offset in part by the
addition of two Boeing 727-200 cargo airframes acquired in the fourth quarter
of 2003. 17




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Operating Overhead.For the three months ended June 30, 2004, operating
overhead increased $0.6 million, or 28.6%, as compared to the three months
ended June 30, 2003. The increase is primarily due to costs incurred related to
the induction of Boeing 737-300 cargo aircraft. We also incurred an increase in
sales and administration expense for our scheduled freight network and ACMI and
ad-hoc charter business during the three months ended June 30, 2004 as compared
to the three months ended June 30, 2003. GROSS PROFIT As a result of the foregoing, for the three months ended June 30, 2004, we
recognized gross profit of $3.0 million, which was an improvement of $2.0
million as compared to the three months ended June 30, 2003. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense increased $0.1 million, or 4.5%, for
the three months ended June 30, 2004 as compared to the three months ended June
30, 2003. The increase is primarily due to accruing expense for performance
based compensation, severance costs, and Sarbanes-Oxley compliance, offset in
part by lower legal and trailing bankruptcy costs. INCOME TAXES We have recognized no tax expense from our operating income due to our
operating loss for the six months ended June 30, 2004. We have provided a
valuation allowance against our deferred tax assets. Due to historical
operating losses and the potential for future limitations on the utilization of
our tax assets, we have recorded a valuation allowance because it is unclear
how much, if any, tax benefit we will realize. To the extent that we generate
income in the future, we will likely be able to offset any income with our
existing deductions and, as a result, we will not pay any taxes on the income. In addition, as result of recent and future transfers of our stock by our
shareholders and the exercise of options and warrants, we may undergo a change
in ownership as defined by the U.S. tax laws. This change may result in
limitations on our ability to offset any income with our existing deductions. SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003 The following table presents, for the periods indicated, condensed
consolidated statement of operations data expressed as a percentage of total
revenue: Six months ended June 30,2004
    
    2003Revenue:Scheduled freight
    
    
    98.3
    %
    
    
    93.1
    %Other
    
    

    1.7
    
    
    
    6.9Total revenue
    
    
    100.0
    
    
    
    100.0Cost of revenue
    
    
    94.1
    
    
    
    101.0Gross profit (loss)
    
    
    5.9
    
    
    
    (1.0
    )General and administrative expenses
    
    
    7.5
    
    
    
    8.1Operating loss
    
    
    (1.6
    )
    
    
    (9.1
    )Other (income) expense:Interest expense
    
    
    0.2
    
    
    
    0.4Other (income) expense
    
    
    (0.2
    )
    
    
    (0.8
    )Total other (income) expense
    
    
    0.0
    
    
    
    (0.4
    )Net loss
    
    
    (1.6
    )%
    
    
    (8.7
    )%
 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: 18




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Six months ended June 30,2004
    
    2003Percentage
    
    
    
    
    
    Percentage
    
    Percentage Changeof Total
    
    
    
    
    
    of Total
    
    fromRevenue
    
    Revenue
    
    Revenue
    
    Revenue
    
    2003 to 2004(dollars in thousands)Scheduled freight
    
    $
    70,388
    
    
    
    98.3
    %
    
    $
    57,939
    
    
    
    93.1
    %
    
    
    21.5
    %Other:ACMI
    
    
    640
    
    
    
    0.9
    
    
    
    3,996
    
    
    
    6.4
    
    
    
    (84.0
    )Miscellaneous
    
    
    589
    
    
    
    0.8
    
    
    
    321
    
    
    
    0.5
    
    
    
    83.5Total revenue
    
    $
    71,617
    
    
    
    100.0
    %
    
    $
    62,256
    
    
    
    100.0
    %
    
    
    15.0
    %
 Scheduled Freight.For the six months ended June 30, 2004, the $12.5
million increase in our scheduled freight revenue was due to an increase of
3.6% in our average yield and a 17.2% increase in our chargeable weight from
the six months ended June 30, 2003. Our yield increase was primarily due to an
increase in the fuel surcharge to mitigate the increases in our fuel expense
resulting from higher fuel prices and, to a lesser extent a larger proportion
of higher yielding next morning freight in our total chargeable weight and the
implementation of a security surcharge. Our chargeable weight increase was
largely due to a strengthening economy toward the end of 2003 which carried
over to the second half of 2004, lower than expected freight volumes for the
second quarter of 2003 due to the war in Iraq, our second quarter 2004
expansion into San Juan, Puerto Rico, 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 six months ended June 30, 2004, we generated $0.6
million of ACMI revenue through a four month contract with Alaska Airlines,
which began in May 2004. This contract has been extended to September 11, 2004.
During the six months ended June 30, 2003, we generated $4.0 million of revenue
from a one-year ACMI contract we entered into in December 2002 to provide BAX
Global with three Boeing 727-200 cargo aircraft. This contract was cancelled by
mutual agreement effective May 31, 2003. Miscellaneous.For the six months ended June 30, 2004, our miscellaneous
revenue resulted from flying ad-hoc charter services for several customers
which generated $0.5 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 six months ended June 30, 2003 included
generating $0.3 million from flying ad-hoc charter services. COST OF REVENUE General.The following table presents, for the periods indicated, the
components of our cost of revenue in dollars and as a percentage of total
revenue and the percentage change from period-to-period: Six months ended June 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
    
    $
    14,570
    
    
    
    20.3
    %
    
    $
    12,668
    
    
    
    20.3
    %
    
    
    15.0
    %Transportation expense
    
    
    6,249
    
    
    
    8.7
    
    
    
    10,734
    
    
    
    17.2
    
    
    
    (41.8
    )Fuel expense
    
    
    20,079
    
    
    
    28.0
    
    
    
    15,174
    
    
    
    24.4
    
    
    
    32.3Maintenance expense
    
    
    6,177
    
    
    
    8.6
    
    
    
    6,085
    
    
    
    9.8
    
    
    
    1.5Freight handling expense
    
    
    13,350
    
    
    
    18.7
    
    
    
    11,798
    
    
    
    19.0
    
    
    
    13.2Depreciation and amortization
    
    
    1,500
    
    
    
    2.1
    
    
    
    1,793
    
    
    
    2.9
    
    
    
    (16.3
    )Operating overhead expense
    
    
    5,497
    
    
    
    7.7
    
    
    
    4,644
    
    
    
    7.5
    
    
    
    18.4Total cost of revenue
    
    $
    67,422
    
    
    
    94.1
    %
    
    $
    62,896
    
    
    
    101.0
    %
    
    
    7.2
    %
 Flight Expense.For the six months ended June 30, 2004, flight expense
increased $1.9 million or 15.0% compared to the six months ended June 30, 2003.
This increase was primarily a result of a 20.3% increase in revenue block hours
flown by our owned and leased aircraft resulting in correspondingly higher
aircraft lease and 19




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higher crew costs per revenue block hour flown, offset in part by a $0.1
million decrease in simulator training expense. 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. Simulator training expense
decreased due to the elimination of a minimum usage requirement in our
simulator usage agreement. The 20.3%, or 2,070 increase in revenue block hours flown was due to our
cargo airline flying 3,138, or 36.0%, more hours for the scheduled freight
network and 1,068, or 71.2%, fewer hours for our ACMI and ad-hoc charter
customers for the six months ended June 30, 2004 as compared to the six months
ended June 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 six months ended
June 30, 2004 as compared to the six months ended June 30, 2003. The expenses
related to chartering these aircraft are included in transportation expense as
opposed to flight expense. Transportation Expense.For the six months ended June 30, 2004,
transportation expense decreased $4.5 million, or 41.8%, from the six months
ended June 30, 2003. This decrease is comprised of a $5.1 million decrease in
third party cargo aircraft charters flown on behalf of the scheduled freight
network during the six months ended June 30, 2004 as compared to the six months
ended June 30, 2003, offset in part by higher aircraft ground operating costs
due to more aircraft operations during the six months ended June 30, 2004 as
compared to the six months ended June 30, 2003 and 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. 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 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. Fuel.For the six months ended June 30, 2004, fuel expense increased $4.9
million, or 32.3%, as compared to the six months ended June 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 $0.16, or 15.4%, for the six months ended June 30, 2004 as compared
to the six months ended June 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 six
months ended June 30, 2004 increased by approximately 2.1 million gallons, or
14.7%, as compared to the six months ended June 30, 2003. The increase in fuel
consumption is primarily due to a 36.0% increase in revenue block hours flown
by our cargo airline in our scheduled freight network which was partially
offset by an 87.6% decrease in third party aircraft block hours flown in our
scheduled freight network. Maintenance Expense.For the six months ended June 30, 2004, maintenance
expense increased $0.1 million, or 1.5%, as compared to the six months ended
June 30, 2003. Included in maintenance expense during the six months ended
June 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. Also included in maintenance expense in the six months ended June
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. Not including the $1.7 million lease return charge and the $0.5 million
heavy maintenance reserve reversal, maintenance expense would have decreased
$1.1 million, or 18.2%, for the six months ended June 30, 2004, as compared to
the six months ended June 30, 2003. This decrease is partially due to a
reduction in the engine maintenance reserve rate per flight hour, lower usage
of airframes and engines requiring maintenance reserves and lower expense
incurred for parts used in maintenance during the six months ended June 30,
2004, as compared to the six months ended June 30, 2003. In addition, during
the six months ended June 30, 2004, we did not increase our airframe
maintenance reserves for owned airframes for which we plan to use maintenance
reserves to perform heavy 20




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maintenance, because we previously reached the maximum reserve amount for
those airframes in accordance with our maintenance reserve policy. Freight Handling Expense.For the six months ended June 30, 2004, freight
handling expense increased $1.6 million, or 13.2%, as compared to the six
months ended June 30, 2003. The increase in freight handling expense was due to
a 17.2% 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 six months ended June 30, 2004 that
were previously included in operating overhead during the six months ended June
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
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. Freight handling expense was virtually
unchanged on a chargeable weight basis for the six months ended June 20, 2004
as compared to the six months ended June 30, 2003. Depreciation and Amortization.For the six months ended June 30, 2004,
depreciation and amortization expense decreased $0.3 million, or 16.3%, as
compared to the six months ended June 30, 2003. This decrease in depreciation
expense is primarily due to an increase in the number of owned engines becoming
fully depreciated during six months ended June 30, 2004 as compared to the six
months ended June 30, 2003, offset in part by the addition of two Boeing
727-200 cargo airframes acquired in the fourth quarter of 2003. Operating Overhead.For the six months ended June 30, 2004, operating
overhead increased $0.9 million, or 18.4%, as compared to the six months ended
June 30, 2003. The increase is primarily due to costs incurred related to the
induction of Boeing 737-300 cargo aircraft. We also incurred an increase in
sales and administration expense for our scheduled freight network and ACMI and
ad-hoc charter business during the six months ended June 30, 2004 as compared
to the six months ended June 30, 2003, offset in part by the elimination of
certain costs that are now included in third party freight handling contracts
and are reported as freight handling expense during the six months ended June
30, 2004. GROSS PROFIT As a result of the foregoing, for the six months ended June 30, 2004, we
recognized gross profit of $4.2 million, which was an improvement of $4.8
million as compared to the six months ended June 30, 2003. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense increased $0.3 million, or 6.7%, for
the six months ended June 30, 2004 as compared to the six months ended June 30,
2003. The increase is primarily due to accruing expense for performance based
compensation, severance costs, and Sarbanes-Oxley compliance, offset in part by
lower legal and trailing bankruptcy costs. OTHER (INCOME) EXPENSE Other income decreased $0.4 million for the six months ended June 30, 2004
as compared to the six months ended June 30, 2003. This decrease is primarily
due to gains recognized on sales of miscellaneous equipment that became surplus
as we transitioned three of our company operated outstations to third-party
service providers during the six months ended June 30, 2003. INCOME TAXES We have recognized no tax benefit from our operating losses and have
provided a valuation allowance against our deferred tax assets. Due to
historical operating losses and the potential for future limitations on the
utilization of our tax assets, we have recorded a valuation allowance because
it is unclear how much, if any, tax benefit we will realize. To the extent that
we generate income in the future, we will likely be able to offset any income
with our existing deductions and, as a result, we will not pay any taxes on the
income. 21




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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. This change may result in
limitations on our ability to offset any income with our existing deductions. LIQUIDITY AND CAPITAL RESOURCES General.Currently, our primary source of liquidity is our cash flow from
operations. In addition, we may supplement our liquidity by accessing our $10.0
million credit facility with WFB. At June 30, 2004, we had cash and cash equivalents of $11.9 million as
compared to $15.7 million at December 31, 2003. The decrease in cash of $3.8
million is a result of $0.9 million used for operations, $2.4 million used in
investing activities and $0.5 million used for repayments of our outstanding
debt. The $2.4 million used in investing activities included $1.8 million for
capitalized maintenance and the acquisition of operating assets and $0.8
million increase to restricted cash. At June 30, 2004, our net working capital was $17.2 million compared to
$18.7 million at December 31, 2003. We anticipate our capital expenditures for the remainder of 2004 will be
approximately $4.6 million, including $1.9 million related to heavy airframe
maintenance and heavy shop visits for aircraft engines which is already accrued
in our maintenance reserves, $1.2 million related to complying with
airworthiness directives on our fleet of Boeing 727-200 cargo aircraft and $1.5
million to upgrade our information technology systems and acquire other
miscellaneous assets. We expect to use $0.4 million for a mid-year progress payment of performance
bonuses to eligible employees and executive officers under our recently adopted
Leadership Performance Plan. In addition, we expect integration and additional
lease deposit costs of approximately $1.8 million during 2004 to integrate the
Boeing 737-300 cargo aircraft into our fleet. As of August 11, 2004, we had
net cash outlays of $1.3 million in July and August of 2004 related to meeting
the lease return conditions on three leased airframes and ten aircraft engines.
We expect to pay another $0.9 million related to
the lease return conditions on one remaining leased airframe and two aircraft
engines. Our working capital is also affected 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
surcharge 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 expenditures
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 June 30, 2004 the interest
rate on the credit facility was 5.0%. 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 August 11, 2004, we had $1.9 million borrowed under the credit
facility and $0.3 million of letters of credit issued under the credit
facility. As of August 11, 2004, we had a borrowing base of $10.0 million and
$7.8 million of availability. Each year, we will pay an unused line fee of 0.375% of the daily unused
amount under the credit facility. In addition, we must pay to WFB a minimum of
$8,500 per month in interest. We will incur additional fees if the credit
facility is terminated by WFB upon default or if we terminate the credit
facility prior to its termination date or reduce the maximum availability under
the credit facility. These fees are up to $200,000 during the first year of the
credit facility, $100,000 during the second year of the credit facility and
$50,000 during the third year of the credit facility. Finally, we may utilize
the credit facility to issue letters of credit in the aggregate amount of up to
$5.0 million. We incur a fee computed at an annual rate of 2.0% of the face
amount of each letter of credit issued under the credit facility. 22




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##### Table of Contents



The credit facility provides for specified events of default that allow
WFB to terminate the credit facility and accelerate any payments due by us,
including if we suffer a material adverse change in our business or financial
condition. In addition, the credit facility requires us to meet certain
financial and operating covenants, limits capital expenditures other than
capitalized maintenance on our aircraft, and restricts our ability to commit to
or enter into any new aircraft operating leases unless certain financial
covenants are met. See Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations  Liquidity and Capital
Resources included in our Annual Report on Form 10-K for the year ended
December 31, 2003 for more details on the credit facility. Contractual Obligations.There have been no significant changes in our
contractual obligations since those disclosed in our Quarterly Report on Form
10-Q for the period ended March 31, 2004. 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 second quarter of 2003, we experienced normal seasonal
trends in our expedited scheduled freight business with a slight dampening
effect toward the end of the second quarter due to among other things the
increasing uncertainty surrounding the anticipated war in Iraq. In the second
quarter of 2004, we believe we experienced normal seasonal trends in our
expedited freight business. Additionally, we believe we continued to benefit
in the second quarter of 2004 from what appeared to be a stronger U.S. domestic
economy than in the second 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:  
    
    loss of key suppliers, significant customers or key management personnel;  
    
    increased competition;  
    
    limited operating flexibility due to the terms of our credit facility; 23




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
    
    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;  
    
    foreign political instability and acts of war or terrorism;  
    
    adverse litigation judgments or awards;  
    
    the ability to efficiently integrate the Boeing 737-300 cargo aircraft into our operations;  
    
    delays in placing the Boeing 737-300 cargo aircraft into revenue service; and  
    
    the ability to negotiate 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. 
 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 24




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##### Table of Contents



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 There have been no material changes to the legal proceedings disclosed in our Form 10-Q for quarter ended March 31, 2004. 
 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS PURCHASES OF EQUITY SECURITIES Total Number of
    
    Maximum Number (orShares Purchased as
    
    Approximate Dollar Value)Part of Publicly
    
    of Shares that May Yet BeTotal Number of
    
    Average Price Paid
    
    Announced Plans or
    
    PurchasedPeriod
    
    Shares Purchased
    
    per Share
    
    Programs
    
    Under the Plans or ProgramsMarch 31  June 30,
2004 (1)
    
    
    106,250
    
    
    $
    0.30
    
    
    
    
    
    
    
    Total
    
    
    106,250
    
    
    $
    0.30
    
    
    
    
    
    
    
    
  (1) In June 2004, we repurchased 106,250 shares of restricted stock from Tamir
(Tom) Hacker that he received upon exercise of a stock option. We were
entitled to repurchase the shares of restricted stock at the lesser of fair
market value or $0.30 per share (the per share exercise price of the stock
option) upon Mr. Hackers resignation from our Board of Directors. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our Annual Meeting of Stockholders on July 13, 2004, at which our
stockholders elected six directors and voted to:  
    
    amend our Second Amended and Restated Certificate of
Incorporation to increase the number of authorized shares of common
stock from 62,000,000 shares to 100,000,000 shares and increase the
number of authorized shares of preferred stock from 3,000,000 shares
to 10,000,000 shares;  
    
    amend our Second Amended and Restated Certificate of
Incorporation to permit our stockholders to act only at annual and
special meetings and not by written consent;  
    
    amend our Second Amended and Restated Certificate of
Incorporation to increase the vote required to amend our Second
Amended and Restated Bylaws;  
    
    amend our Second Amended and Restated Certificate of
Incorporation to elect to be governed by Section 203 of the Delaware
General Corporation Law;  
    
    amend our Second Amended and Restated Certificate of
Incorporation to increase the vote required to make certain
amendments to our Second Amended and Restated Certificate of
Incorporation; and 25




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##### Table of Contents




    
    amend the Kitty Hawk 2003 Long Term Equity Incentive Plan, to
increase the number of shares of common stock authorized to be issued
under the Plan from 6,500,000 to 7,000,000, effective June 30, 2005. The results of the voting in connection with each issue was as follows:  
    
    The election of directors: Director
    
    For
    
    WithheldRobert W. Zoller, Jr.
    
    
    39,246,179
    
    
    
    691,469Gerald L. Gitner
    
    
    39,246,179
    
    
    
    691,469Myron Kaplan
    
    
    39,246,179
    
    
    
    691,469Robert A. Peiser
    
    
    39,246,179
    
    
    
    691,469Joseph D. Ruffolo
    
    
    39,246,179
    
    
    
    691,469Laurie M. Shahon
    
    
    39,246,179
    
    
    
    691,469
  
    
    The proposal to amend our Second Amended and Restated Certificate
of Incorporation to increase the number of authorized shares of common
stock from 62,000,000 shares to 100,000,000 shares and increase the
number of authorized shares of preferred stock from 3,000,000 shares to
10,000,000 shares. BrokerFor
    
    Against
    
    Abstain
    
    Non-vote28,040,831
    
    2,575,113
    
    189,575
    
    12,714,287
  
    
    The proposal to amend our Second Amended and Restated Certificate
of Incorporation to permit our stockholders to act only at annual and
special meetings and not by written consent. BrokerFor
    
    Against
    
    Abstain
    
    Non-vote27,814,557
    
    3,916,262
    
    68,400
    
    11,720,587
  
    
    The proposal to amend our Second Amended and Restated Certificate
of Incorporation to increase the vote required to amend our Second
Amended and Restated Bylaws. BrokerFor
    
    Against
    
    Abstain
    
    Non-vote28,101,379
    
    3,611,240
    
    86,600
    
    11,720,587
  
    
    The proposal to amend our Second Amended and Restated Certificate
of Incorporation to elect to be governed by Section 203 of the Delaware
General Corporation Law. BrokerFor
    
    Against
    
    Abstain
    
    Non-vote28,005,482
    
    2,710,962
    
    88,475
    
    12,715,887
  
    
    The proposal to amend our Second Amended and Restated Certificate
of Incorporation to increase the vote required to make certain
amendments to our Second Amended and Restated Certificate of
Incorporation. BrokerFor
    
    Against
    
    Abstain
    
    Non-vote27,823,734
    
    3,831,710
    
    143,775
    
    12,715,887
  
    
    The proposal to amend the Kitty Hawk 2003 Long Term Equity
Incentive Plan, to increase the number of shares of common stock
authorized to be issued under the Plan from 6,500,000 to 7,000,000,
effective June 30, 2005. 26




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##### Table of Contents



BrokerFor
    
    Against
    
    Abstain
    
    Non-vote29,558,793
    
    2,069,476
    
    168,950
    
    12,715,887
 
 ITEM 5. OTHER INFORMATION The Board of Directors approved the Kitty Hawk, Inc. 2004 Leadership
Performance Plan. This plan provides for eligible employees and executive
officers to receive a cash payment if we meet certain financial performance
measures in 2004. A portion of the payout is based on our financial performance
with the remainder of the payout being discretionary and based on the
individual performance of the employee. The plan also provides for a mid-year
progress payment if the targeted financial performance as of June 30, 2004 is
met. We have met the targeted financial performance as of June 30, 2004 and are
eligible to pay a total of $0.5 million to eligible employees and executive
officers under the plan. We expect to make these payments in August 2004. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the Securities and Exchange Commission. Exhibit No.
    
    
    
    Exhibit10.1*
    
    
    
    Aircraft Lease Common Terms Agreement between
Aviation Financial Services Inc and Kitty Hawk
Aircargo, Inc. dated May 4, 2004. (Confidential
treatment has been requested for certain portions of
this exhibit pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934. In accordance with
Rule 24b-2, these confidential portions have been
omitted from this exhibit and filed separately with
the SEC).10.2*
    
    
    
    Form of Lease for Boeing 737-300 cargo aircraft 
serial numbers 23538, 24462, 23708, 24020, 24022,
24902, and 24916. (Confidential treatment has been
requested for certain portions of this exhibit
pursuant to Rule 24b-2 under the Securities Exchange
Act of 1934. In accordance with Rule 24b-2, these
confidential portions have been omitted from this
exhibit and filed separately with the SEC).10.3*
    
    
    
    Kitty Hawk, Inc. 2004 Leadership Performance Plan31.1*
    
    
    
    Certification of Principal Executive Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    
    
    Certification of Principal Financial Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
   *
    
    Each document marked with an asterisk is filed or furnished herewith. (b) Reports on Form 8-K: On May 11, 2004, we filed a Form 8-K under Items 5 and 7 announcing a new
Registration Rights Agreement dated May 8, 2004 which replaced a previous
agreement among three of our largest stockholders and us. On May 28, 2004, we filed a Form 8-K under Items 6 and 7 announcing the
resignation of one of our directors. 27




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On June 25, 2004, we filed a Form 8-K under Item 5 announcing one of our
stockholders exercised a demand resale registration right pursuant to the
Registration Rights Agreement dated May 8, 2004. We also responded to a request
from Institutional Shareholder Services to provide additional information about
fees we paid to our independent auditors. 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 August 12, 2004. KITTY HAWK, INC.By:
    
    /s/ RANDY S. LEISERRandy S. LeiserVice President  Finance andChief Financial Officer(Authorized officer and principal financial
officer)
 29