ITEM 1. BUSINESS
GENERAL
The Company is a leading U.S. and international air freight carrier and a leading provider of air freight logistics services for the delivery of freight on a highly-reliable, time sensitive basis. The Company also provides air passenger charter services and aircraft maintenance services. The Company's principal executive offices are located at 1515 West 20th Street, P.O. Box 612787, Dallas/Fort Worth International Airport, Texas 75261, its telephone number is (972) 456-2200 and its Internet address is http://www.kha.com. Unless the context otherwise requires, the "Company" or "Kitty Hawk" refers to Kitty Hawk, Inc., its predecessor and its subsidiaries.
THE MERGER
On September 22, 1997, Kitty Hawk and certain of its subsidiaries, M. Tom Christopher, Conrad A. Kalitta, American International Airways, Inc. ("AIA"), American International Travel, Inc. ("AIT"), Flight One Logistics, Inc. ("FOL"), Kalitta Flying Service, Inc. ("KFS") and O.K. Turbines, Inc. ("OKT" and with AIA, AIT, FOL and KFS, collectively, the "Kalitta Companies") entered into an Agreement and Plan of Merger, which was subsequently amended (as so amended, the "Merger Agreement"). Pursuant to the Merger Agreement, on November 19, 1997, separate subsidiaries of Kitty Hawk were merged with and into each of the Kalitta Companies (the "Merger"), with each of the respective Kalitta Companies surviving the Merger as a direct, wholly owned subsidiary of Kitty Hawk. In connection with the Merger, the outstanding shares of capital stock of four of the Kalitta Companies were converted, in the aggregate, into 4,099,150 shares of the Company's Common Stock, par value $0.01 per share ("Common Stock"), and the outstanding shares of the remaining Kalitta Company were converted into $20 million cash.
PURCHASE OF BOEING 727S FROM THE KALITTA COMPANIES
In September 1997, prior to the Merger, the Kalitta Companies sold to Kitty Hawk for $51 million 16 Boeing 727 aircraft, comprising 15 aircraft in freighter configuration and one aircraft in passenger configuration. As part of the transaction, the Kalitta Companies assigned to Kitty Hawk all of their customer contracts relating to the aircraft sold.
THE COMMON STOCK OFFERING, THE NOTE OFFERING, THE CREDIT FACILITY AND THE TERM LOAN
Concurrently with the Merger, the Company consummated a 3,000,000 share Common Stock offering (the "Common Stock Offering") at $19 per share and a $340 million 9.95% Senior Secured Note offering (the "Note Offering"). Of the 3,000,000 shares offered in the Common Stock Offering, 2,200,000 shares were sold by the Company and 800,000 shares were sold by certain stockholders of the Company.
Concurrently with the Merger, the Company also entered into a new senior secured revolving credit facility providing for borrowings of up to $100 million, subject to a current borrowing base limitation of approximately $59.3 million (the "Credit Facility"), and a new $45.9 million term loan (the "Term Loan"). See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
The net proceeds of the Common Stock Offering, the Note Offering and the Term Loan, after deducting underwriting discounts, placement fees and offering expenses, were approximately $413 million. Of the approximately $413 million of net proceeds, the Company used approximately $249.8 million to pay off substantially all of the Kalitta Companies' pre-Merger indebtedness, $78.9 million to refinance Kitty Hawk's pre-Merger indebtedness, $39.6 million to acquire two Boeing 747s, $20 million to pay the cash portion of the consideration for the Kalitta Companies, $16.4 million to fund a portion of the costs to modify two recently acquired Boeing 747s from freighter to cargo configuration, $6.0 million for working capital purposes and $2.3 million to pay expenses incurred in connection with the Merger, the Credit Facility and the Term Loan.
RECENT FINANCIAL PERFORMANCE OF THE KALITTA COMPANIES
The Kalitta Companies on a combined basis posted net losses of $17,000 in 1996 and of $40.8 million during the period from January 1, 1997 to November 18, 1997 (the day immediately preceding the consummation of the Merger). The Company believes that the recent negative financial performance prior to the Merger can be attributed to a number of factors, including (i) the incurrence of abnormally high engine overhaul expenses due to Federal Aviation Administration ("FAA") Airworthiness Directives ("Directives"), (ii) the loss of revenue resulting from the effective grounding of two Boeing 747s in January 1996 due to a series of Directives, (iii) the incurrence principally in 1997 of start-up costs associated with establishing the Kalitta Companies' wide-body passenger charter business, (iv) the incurrence of costs to add and maintain flight crews in anticipation of increased air freight carrier business which has not yet materialized in part due to delays in acquiring aircraft and (v) lower revenues from the U.S. Military. Since January 1, 1998, AIA, which accounts for a substantial proportion of the combined operating results of the Kalitta Companies, has continued to suffer losses. The Company is striving to implement changes to improve the operating performance of AIA and AIA's relationships with its customers. The Company expended approximately $800,000 towards Merger-related integration during the fourth quarter of 1997 and has budgeted another $1.5 million for Merger-related costs for 1998. The Company believes AIA's results of operations for the first quarter of 1998 will be better than AIA's results of operations for the first quarter of 1997. Generally, the Company believes that AIA's losses for the first quarter of 1998 are the result of problems related to crew scheduling, maintenance scheduling and parts logistics.
INDUSTRY OVERVIEW
Air Freight Carrier Services. The market for air freight carrier services is served by an industry which is composed of (i) "door-to-door" express package delivery companies such as Federal Express and United Parcel Service, (ii) "freight-forwarders" that contract for air freight carrier service, (iii) air freight carriers that provide scheduled air freight delivery service and (iv) air freight carriers that provide on-demand charter service. The air freight services industry provides same-day, next-day and/or two-day delivery services. A number of air freight carriers, including the Company, provide a combination of these services.
Air Freight Logistics Services. Demand for air freight charter logistics services is driven by demand for same-day delivery of time sensitive freight. In contrast to the market for next-day and two-day freight delivery services, the Company believes that the market in North America for on-demand charters is served by hundreds of air freight carriers, the vast majority of which are privately held, operate from only one location and do not coordinate "door-to-door" charter delivery services to the extent of the Company's air logistics business.
AIR FREIGHT CARRIER SERVICES
The Company uses a diversified fleet of four Boeing 747s, six Lockheed L-1011s, 19 Douglas DC-8s, 29 Boeing 727s, five Douglas DC-9s and seven turbo-prop Convairs to provide air freight services on (i) a regularly scheduled basis between certain airports, (ii) a contract charter basis and (iii) an on-demand charter basis.
Scheduled Freight Services
Domestic. The Company operates a scheduled airport-to-airport air freight carrier service which provides overnight delivery to and from 47 cities in the United States. Freight received each evening is delivered the next morning, Tuesday through Friday, throughout the year. The majority of overnight deliveries are routed through the Company's 90,000 square foot sorting center located at the Hulman Regional Airport in Terre Haute, Indiana. The Company's right to use its space at the Hulman Regional Airport expires in August 1998. The Company is currently negotiating an extension of this lease through the spring of 1999, at which time the Company anticipates relocating its sorting operations from the Hulman Regional Airport to the Fort Wayne-Allen County Airport in Fort Wayne, Indiana. This new facility is expected to permit the Company to handle nearly twice the sorting capacity of the Terre Haute facility. In addition, the facility is designed to improve productivity by reducing the time to load and unload aircraft and decreasing sorting times. See "Item 2.
ITEM 2. PROPERTIES
General. The Company's facilities consist of office space, hangars, maintenance facilities and warehouse and storage space. Some of the Company's hangar facilities are constructed on property ground leased from airport owners. Accordingly, the hangar improvements revert to the owner when the ground lease expires. These leases expire on various dates through December 2015. The Company also has various agreements with municipalities and governmental authorities that own and operate airports throughout the United States. These agreements generally relate to the Company's use of general airport facilities, but may also include leases or licenses to use hangar and maintenance space. In addition, the Company owns a number of aircraft. See "Item 1. Business -- Aircraft Fleet."
The following is a summary of the Company's major facilities:
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(1) The Company owns the building and improvements and leases the land from the Dallas/Fort Worth International Airport.
(2) The Company leases this building from a limited liability company owned by Mr. Kalitta, his son Scott Kalitta and his nephew Doug Kalitta.
(3) The Company has constructed a warehouse at the Honolulu International Airport which it leases to AIC.
Proposed New Sorting Facility. The Company currently licenses its sorting space at the Hulman Regional Airport in Terre Haute, Indiana from Roadway Global Air for a term which will expire in August 1998. Because of the growth in the volume of freight shipped in its domestic scheduled service, the lack of available expansion space and the limited airport facilities in Terre Haute, the Company plans to move this sorting center to Fort Wayne, Indiana in the spring of 1999. The Company has entered into discussions with the Hulman Regional Airport Authority to obtain an interim lease of its current space in Terre Haute until it is able to move to Fort Wayne. There is no assurance that the Company will be able to obtain an interim lease of its Terre Haute facility.
Oscoda Base. The Company subleases its maintenance facility at the former Wurtsmith Air Force Base in Oscoda, Michigan from the Oscoda-Wurtsmith Airport Authority pursuant to a prime lease from the U.S. Government. These subleases vary in duration from month-to-month to long-term (the last of which expires in December 2015) and are subject to earlier termination upon termination of the prime lease between the U.S. Government and the Wurtsmith Authority. Under the subleases, the Company has access to an 11,800 foot lighted runway equipped for full instrument approach, as well as office, hangar, maintenance and storage space. The hangar space includes seven hangars, two of which can completely enclose a single
wide-bodied aircraft or two narrow-bodied aircraft. Because the Oscoda facility is a former U.S. Air Force base, it is also complete with living quarters and support buildings, which the Company leases from Oscoda Township under leases of varying duration from month-to-month to long-term, the last of which expires in August 2005. Until 2011, the Oscoda facility is part of a "renaissance" zone which means that the Company does not pay real or personal property taxes on its facilities and equipment in Oscoda.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
GATX Litigation. In January 1997, the Kalitta Companies filed suit against GATX (the "GATX Litigation") to recover damages related to the January 1996 effective grounding of two of the Kalitta Companies' Boeing 747s pursuant to the Directive affecting GATX-modified Boeing 747s. See "Item 1. Business -- Aircraft Fleet -- Boeing 747 Airworthiness Directive." Other defendants include Pemco Aeroplex Co. (the successor to Hayes International, Inc.) which developed the design for the STC relating to the modifications and Central Texas Airborne Systems, Inc. (successor to Chrysler Technologies Airborne Systems, Inc.) which modified the Kalitta Companies' Boeing 747s as a subcontractor for GATX. The suit is pending in the Federal District Court for the Northern District of California and covers a variety of claims.
In connection with the Merger, the Company entered into an agreement with Mr. Kalitta which provides that any amounts recovered by the Company through the GATX Litigation are first to be applied to reimburse the Company for its legal costs incurred in connection with the GATX Litigation and then to correct the mechanical problems associated with the grounded Boeing 747s. Any additional amounts will be allocated 10% to the Company and 90% to Mr. Kalitta. In the event the amounts recovered by the Company, if any, are insufficient to reimburse the Company for its legal costs incurred in connection with the GATX Litigation, Mr. Kalitta will reimburse the Company for the unreimbursed portion of its legal costs related to the GATX Litigation incurred after November 19, 1997.
U.S. Postal Service Contract. In September 1992, the U.S. Postal Service awarded an air freight services contract to Kitty Hawk and one of the Kalitta Companies, as co-bidders. Emery Worldwide Airlines, Inc. ("Emery") (the incumbent) sued to enjoin the award. This litigation (the "ANET Litigation") was settled in April 1993 by agreements under which the U.S. Postal Service terminated the contract for convenience and awarded the contract to Emery. In lieu of damages for the contract's termination, the U.S. Postal Service paid $10 million into an escrow account to be divided between Kitty Hawk and one of the Kalitta Companies. Also under the settlement, Emery paid $2.7 million into the escrow account and agreed to pay $162,500 into the escrow account each quarter for up to 10 years, so long as the Emery contract remained in effect. Before settling the ANET Litigation, Kitty Hawk, one of the Kalitta Companies and Messrs. Christopher and Kalitta agreed, among other things, to hold the escrowed funds in escrow until they had agreed upon an allocation and distribution, or until the matter was resolved by binding arbitration. Subsequent disagreements led to litigation and arbitration among Kitty Hawk, one of the Kalitta Companies and Messrs. Christopher and Kalitta that were resolved pursuant to a comprehensive settlement reached in August 1994. Under the comprehensive settlement, Kitty Hawk received approximately $3.5 million in cash from the escrowed funds and obtained a Boeing 727-200. Also under the comprehensive settlement agreement, Mr. Christopher received rights to one-half of any future contingent quarterly payments from Emery.
Routine Litigation. The Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are:
M. Tom Christopher has served as Chairman of the Board of Directors and Chief Executive Officer of the Company since Kitty Hawk's inception in 1985 and serves in the class of directors whose terms expire at the 2000 Annual Meeting of Stockholders. He has over 20 years of experience in the air freight industry.
Conrad A. Kalitta has served as Vice Chairman of the Company since November 1997 and serves in the class of directors whose terms expire at the 2000 Annual Meeting of Stockholders. Mr. Kalitta founded American International Airways, Inc., Flight One Logistics, Inc. and Kalitta Flying Service, Inc., each of which were acquired by the Company in November 1997. Mr. Kalitta is also a professional drag racer in the "top-fuel" class and has won three national championships.
Tilmon J. Reeves has served as President of the Company since May 1993 and has over 30 years of aviation experience. From May 1993 to November 1997, Mr. Reeves also served as the Company's Chief Operating Officer. Mr. Reeves became a director in October 1994 and serves in the class of directors whose terms expire at the 1999 Annual Meeting of Stockholders.
Richard R. Wadsworth has served as Senior Vice President -- Finance since October 1992, Chief Financial Officer since September 1994 and Secretary since October 1994. From October 1994 to November 1997, Mr. Wadsworth served on the Company's Board of Directors.
In addition, beginning on April 1, 1998, James R. Craig will become Vice President and General Counsel of the Company. From October 1994 to November 1997, Mr. Craig served on the Company's Board of Directors. Prior to April 1998, Mr. Craig was of counsel to Burke, Wright & Keiffer, P.C. Prior to his affiliation with Burke, Wright & Keiffer, P.C., Mr. Craig was in private law practice in Dallas since 1971 and in 1989 served as President of Whitehall Development Company, a real estate development firm, of which he is now a director.
Pursuant to the Merger Agreement, the Company has agreed to cause the election of Mr. Kalitta as President of AIA until November 19, 1998 and Messrs. Christopher and Kalitta have agreed to vote their Common Stock or other voting securities in favor of Mr. Christopher as the Company's Chairman of the Board and Chief Executive Officer and Mr. Kalitta as the Company's Vice Chairman until November 19, 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has traded on the Nasdaq National Market System under the symbol "KTTY" since the Company's initial public offering on October 9, 1996. The following table sets forth the range of high and low sale prices of the Common Stock for the periods shown below.
At March 24, 1998, the Company had approximately 3,600 holders of record and beneficial owners of the Company's Common Stock.
Kitty Hawk has never declared or paid any cash dividends on the Common Stock. The Company presently intends to retain earnings, if any, for development and growth of its business and does not anticipate paying cash dividends on the Common Stock in the foreseeable future. The Credit Facility and the indenture under which the Company's 9.95% Senior Secured Notes due 2004 (the "Notes") were issued contain significant limitations on the Company's ability to pay dividends. Payment of future dividends, if any, will be at the discretion of the Company's Board of Directors, after taking into account various factors, including the Company's earnings, capital requirements and surplus, financial position, contractual restrictions and other relevant business considerations and there can be no assurance that dividends will be paid. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
On November 19, 1997, the Company issued 4,099,150 unregistered shares of Common Stock to Mr. Kalitta in connection with the Merger. These shares were issued as consideration for Mr. Kalitta's sole ownership of AIA, AIT, FOL and OKT and were issued pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), and Rule 506 promulgated pursuant thereto. Immediately prior to the issuance of these shares, Mr. Kalitta represented to the Company that he was an accredited investor, as defined in Regulation D promulgated pursuant to the Securities Act.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and operating data with respect to the Company for each of the fiscal years indicated and for the four months ended December 31, 1995 and 1996. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements, including the notes thereto, appearing elsewhere in this Form 10-K. The selected statement of operations data for each of the fiscal years ended August 31, 1995 and 1996, for the four months ended December 31, 1996 and for the year ended December 31, 1997 has been derived from audited consolidated financial statements of the Company appearing elsewhere in this Form 10-K. The selected balance sheet data as of August 31, 1995 and 1996 has been derived from audited consolidated financial statements of the Company not appearing in this Form 10-K. The selected balance sheet data as of December 31, 1996 and 1997 has been derived from audited consolidated financial statements of the Company appearing elsewhere in this Form 10-K. The selected statement of operations and balance sheet data as of and for each of the fiscal years ended August 31, 1993 and 1994 has been derived from audited consolidated financial statements of the Company not appearing in this Form 10-K. Operating results for the four months ended December 31, 1995 and 1996 are not necessarily indicative of results that may be expected for a calendar year. In the opinion of management of the Company, the selected statement of operations data for the four months ended December 31, 1995, which are derived from the Company's unaudited consolidated financial statements appearing elsewhere in this Form 10-K, reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial position and results of operations for such periods. On December 4, 1996, the Company changed its fiscal year end from August 31 to December 31. In November 1997, the Company acquired the Kalitta Companies. See "Item 1. Business -- The Merger." The results of operations for the Kalitta Companies for the period November 19, 1997 through December 31, 1997 are included in the selected financial and operating data for the fiscal year ended December 31, 1997.
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(1) Results for the fiscal year ended August 31, 1996 and the year ended December 31, 1996 lack comparability to other periods because such periods include nonrecurring grants to two executive officers of stock options that resulted in a charge to earnings of approximately $4,231. Had these grants of stock options not occurred, net income for the fiscal year ended August 31, 1996 and year ended December 31, 1996 would have been approximately $6,648 and $7,187 and net income per share would have been $0.84 and $0.85, respectively.
(2) Reflects sums received in settlement of litigation. See "Item. 3. Legal Proceedings -- U.S. Postal Service Contract" and Note 7 of Notes to Consolidated Financial Statements.
(3) The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, "Earnings Per Share." For further discussion of earnings per share and the impact of Statement No. 128, see the Notes to the consolidated financial statements.
(4) Adjusted EBITDA represents net income before minority interest, income tax expense, interest expense, depreciation, amortization and certain items described below. Adjusted EBITDA excludes approximately $4,231 from stock options granted to executives in 1996 and approximately $725 and $1,178 in contract settlements in fiscal 1993 and 1994, respectively. Adjusted EBITDA is presented because it is a financial indicator of the Company's ability to incur and service debt. However, adjusted EBITDA is not calculated under GAAP, is not necessarily comparable to similarly titled measures of other companies and should not be considered in isolation, as a substitute for operating income, net income or cash flow data prepared in accordance with GAAP or as a measure of the Company's profitability or liquidity.
(5) In calculating the ratio of earnings to fixed charges, earnings consist of income before minority interest and income tax expense and fixed charges (less capitalized interest). Fixed charges consist of capitalized interest, interest expense, amortization of debt expense and one-third of rental payments on operating leases (such factor having been deemed by the Company to represent the interest portion of such payments).
(6) As reported by the Company to the Federal Aviation Administration. Flight hours reported are less than block hours, which also include the time an aircraft is operating under its own power whether or not airborne. The Company generally bills its customers on a block hour basis.
(7) Includes on-demand charters flown by the Company's aircraft.
(8) Working capital includes a $10 million Revolving Credit Facility classified as a current liability that was subsequently repaid.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Acquisition of the Kalitta Companies. On November 19, 1997, the Company acquired all of the outstanding stock of the Kalitta Companies. The results of operations for fiscal year 1997 include the results of operations of the Kalitta Companies for the period November 19, 1997 to December 31, 1997, which is generally the highest volume and most profitable period of the year. See "Item 1. Business -- Recent Financial Performance of the Kalitta Companies" and "-- Seasonality."
Revenues. The Company's revenues are derived from two related businesses (i) air freight carrier and (ii) air logistics. Air freight carrier revenues are derived substantially from ACMI contract and on-demand charters flown with the Company's aircraft. In addition, revenues from the Company's scheduled overnight freight service, passenger charter service and third party maintenance operations are also included in air freight carrier revenues. Air logistics revenues are derived substantially from on-demand air freight charters arranged by the Company for its customers utilizing the flight services of third party air freight carriers. With respect to on-demand charters that are arranged by the Company and flown with its own aircraft, charges to the customer for air transportation are accounted for as air freight carrier revenues and charges for ground handling and transportation are accounted for as air logistics revenues.
The principal factors that have contributed to revenue growth over the past several years have been increases in the size of the Company's fleet (from 10 aircraft at December 31, 1993 to 124 aircraft at December 31, 1997 (including 82 aircraft from the acquisition of the Kalitta Companies), the general U.S. economic expansion since 1992 and increased global demand for time sensitive air freight services.
Costs of Revenues. The principal components of the costs of revenues attributable to the air freight carrier business consist of the costs for maintenance and operation of aircraft, including the salaries of pilots and maintenance personnel, charges for fuel, insurance and maintenance and depreciation of engines and airframes. Generally, charges for fuel are only applicable for the on-demand charters flown by the air freight carrier because fuel for the ACMI contract charters is generally provided by the customer or billed to the customer on a direct pass-through basis, although the Company absorbs the cost of fuel in its scheduled freight operations. Cost of revenues also includes cost of sales associated with third party maintenance revenues. The principal components of the costs of revenues attributable to air logistics consist of sub-charter costs paid to third party air freight carriers and costs paid for ground handling and transportation. With respect to on-demand charters that are flown on the Company's aircraft, all related air transportation expenses are allocated to the air freight carrier business and all related cargo ground handling and transportation are allocated to the air logistics business.
Under the Company's Amended and Restated Annual Incentive Compensation Plan, the Company awards semiannual cash bonuses to its employees. The aggregate amount of bonuses for fiscal years 1995 and 1996, the year ended December 31, 1997 and the four months ended December 31, 1996 have equaled 11.7%, 9.5%, 7.3%, and 10%, respectively, of the Company's income before the deduction of income taxes, stock option grants to executives and the bonuses that were expensed under this plan.
The Company's gross margins have been substantially higher in its air freight carrier business (which uses Company aircraft) than in its air logistics business (which principally uses third party aircraft). In addition, the air freight carrier business historically has provided a more predictable revenue base. Accordingly, the Company is continuing to shift its aircraft from on-demand service to ACMI contracts.
Significant Events Affecting Comparability of Results of Operations. Since September 1, 1994, several events have affected the comparability of results of operations for each of the last three fiscal years. In fiscal year 1995, the Company expensed approximately $727,000 relating to its attempted initial public offering. In fiscal year 1996, the Company granted Messrs. Reeves and Wadsworth options to purchase 390,707 and 153,567 shares of Common Stock, respectively, for an exercise price of $0.01 per share that resulted in a charge to earnings of approximately $4,231,000. In 1997, the Company acquired the Kalitta Companies and included their results of operations for the period November 19, 1997 to December 31, 1997 in the Company's
results of operations, which increased revenues by approximately $58.9 million, costs of revenues by approximately $49.4 million and income before interest, minority interest and income taxes by approximately $6.5 million.
Reduced Dependence of Significant Customers. Historically, the Company derived a substantial amount of revenue from a limited number of customers. Subsequent to November 19, 1997, as a result of the acquisition of the Kalitta Companies, the Company is significantly less dependent on revenues from these customers, although revenues from the U.S. Postal Service are expected to be a significant portion of the Company's revenues.
Change in Fiscal Year. On December 4, 1996, the Company changed its fiscal year end from August 31 to December 31. The following discussion is of the Company's financial condition and results of operations (i) for the years ended December 31, 1996 and 1997, (ii) for the four months ended December 31, 1995 and 1996 and (iii) for the fiscal years ended August 31, 1995 and 1996.
RESULTS OF OPERATIONS
The following table sets forth, on a comparative basis for the periods indicated, the components of the Company's gross profit and the gross profit margin by revenue type:
The following table presents, for the periods indicated, consolidated income statement data expressed as a percentage of total revenues:
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE UNAUDITED YEAR ENDED DECEMBER 31,
The results of operations data for the year ended December 31, 1996 referred to below, are taken from the Company's unaudited financial statements, which are not separately presented herein, and are presented for comparative purposes only. In the opinion of management, the 1996 results of operations include all adjustments management believes are necessary for a fair presentation.
Revenues -- Air Freight Carrier. Air freight carrier revenues increased to $137.3 million, or 147.3%, for 1997 from $55.5 million for 1996, principally due to an increase in fleet size and the acquisition of the Kalitta Companies. Approximately $58.9 million of the increase was due to revenues generated by the Kalitta Companies from November 19, 1997 to December 31, 1997, which is the highest volume and most profitable portion of the year. See "-- Seasonality." The remaining increase of approximately $22.9 million is primarily attributable to the growth in the Company's aircraft fleet from 25 aircraft at December 31, 1996 to 42 aircraft immediately prior to the acquisition of the Kalitta Companies. Air freight carrier on-demand and ACMI contract charter revenues were $31.4 million and $108.7 million, or 21.3% and 73.5%, respectively, of total air freight carrier revenues for 1997, as compared to $15.9 million and $37.8 million, or 28.7% and 68.1%, respectively, of total air freight carrier revenues for 1996. Passenger charter and third party maintenance services represent approximately 3.8% of 1997 air freight carrier revenues. Revenues from on-demand charters flown by Company aircraft for 1997 decreased 25.8% as a percent of air freight carrier revenues from the prior year due to aircraft being shifted from on-demand to ACMI contract charter service, consistent with the Company's strategy of using more of its fleet in ACMI business which produces relatively stable revenues. Prices for the Company's on-demand and ACMI contract charters remained relatively constant during this period.
Revenues -- Air Logistics. Air logistics revenues increased $35.4 million, or 45.9%, to $112.6 million in 1997 from $77.2 million in 1996. The increase was primarily due to increased demand for on-demand charters generally and specifically for charters that require larger aircraft, which generate greater revenues. Prices for
the Company's air logistics services remained relatively constant during this period. The number of on-demand charters managed increased by 995 charters, or 6.9% to 15,402 charters for 1997 from 14,407 charters for 1996. Additionally, revenues from the Company's Christmas contract with the U.S. Postal Service increased by $18.5 million, or 79.6%, for 1997 from $23.3 million for 1996.
Costs of Revenues -- Air Freight Carrier. Air freight carrier costs of revenues increased $59.1 million, or 142.7%, to $100.6 million in 1997, from $41.4 million in 1996, reflecting increased costs associated with increased fleet size. Maintenance expenses increased $17.2 million, or 150%, to $28.7 million in 1997 from $11.5 million in 1996. Maintenance expenses increased as a percentage of revenues to 11.5% from 8.7%. The increase was primarily attributable to adding the aircraft fleet of the Kalitta Companies which generally have greater maintenance costs as a percentage of revenue. During 1997, the Kalitta Companies accounted for $15.5 million of these maintenance expenses. The gross profit margin from the air freight carrier business increased from 25.3% for 1996 to 26.7% for 1997. The Kalitta Companies and their fleet of aircraft contributed $9.4 million, or 25.7%, of gross profit for 1997 with the remainder of the fleet of the Company contributing $27.2 million, or 74.3%, of gross profit. The increase in margins related to the remainder of the fleet was primarily the result of lower maintenance costs resulting from operational efficiencies associated with increased fleet size, higher utilization of aircraft during 1997 and lower average fuel prices in 1997 as compared to 1996. Fuel prices may increase during 1998 due to reduced oil exports by certain countries.
Costs of Revenues -- Air Logistics. Air logistics costs of revenues increased $27.2 million, or 40%, to $95.1 million for 1997, from $67.9 million for 1996. The gross profit margin from air logistics increased from 12% for 1996 to 15.5% for 1997. The increase in gross profit margin is mainly attributable to the Company's 1997 Christmas contract with the U.S. Postal Service.
General and Administrative Expenses. General and administrative expenses increased $6.2 million, or 68.9%, to $15.1 million for 1997 from $8.9 million for 1996. Not including costs associated with the Merger, the Common Stock Offering, the Note Offering, the Term Loan and Credit Facility, the acquisition of the Kalitta Companies contributed approximately $3 million to the increase in general and administrative expenses for 1997, representing costs for administrative support after the Merger. Excluding the effect of the acquisition of the Kalitta Companies, the Company experienced an increase in general and administrative expenses from $8.9 million for 1996 to $12.2 million for 1997 primarily as a result of an increase in support functions and administrative costs associated with the growth in the aircraft fleet (from 25 aircraft at December 31, 1996 to 42 aircraft at November 18, 1997) and the increased volume of business of the air freight carrier. As a percentage of revenues, general and administrative expenses decreased to 6% in 1997 from 6.7% for 1996.
Non-qualified Employee Profit Sharing Expense. Employee profit sharing expense increased $1.2 million, or 95.9%, to $2.4 million for 1997 from $1.2 million for 1996, reflecting the increase of net income before taxes for 1997.
Operating Income. As a result of the above, operating income increased $27.7 million, or 312.8%, to $36.6 million for 1997 from $8.9 million for 1996. Operating margin increased to 14.7% for 1997 from 6.7% for 1996.
Interest Expense. Interest expense increased to $6.9 million for 1997, as compared to $2.1 million for 1996, an increase of $4.9 million, or 235.8%. The increase is primarily a result of incurring $45.9 million of debt under the Term Loan for the acquisition of 16 Boeing 727 aircraft in September 1997 and issuing the Notes in November 1997 in connection with the acquisition of the Kalitta Companies. Because these borrowings are expected to remain outstanding, interest expense for 1998 will be substantially higher.
Other Income. Other income increased to $1.1 million for 1997 from $0.9 million for 1996. The increase was primarily due to increased interest income during 1997 from the investment of net proceeds from the Company's initial public offering and of approximately $56 million of net proceeds from the Note Offering.
Minority Interest. Minority interest represents the earnings attributable to the 40% of AIC owned by a third party, which was approximately $497,000. The results are for the period November 19, 1997 to December 31, 1997, which is generally the highest volume and most profitable portion of the year. See "-- Seasonality."
Income Taxes. The Company's effective tax rate increased to 41% for 1997 as compared to 39.4% for 1996. The increase is primarily due to increased state income taxes.
Net Income. As a result of the above, net income increased to $17.9 million for 1997, compared to $4.7 million for 1996. Net income as a percentage of total revenues increased to 7.2% for 1997 from 3.5% in 1996.
FOUR MONTHS ENDED DECEMBER 31, 1996 COMPARED TO FOUR MONTHS ENDED DECEMBER 31,
Revenues -- Air Freight Carrier. Air freight carrier revenues increased to $20.6 million, or 14.4%, from $18 million for the four months ended December 31, 1996 compared to the four months ended December 31, 1995, principally from an increase in fleet size from 21 aircraft to 26 aircraft during the comparable periods. Air freight carrier on-demand and ACMI contract charter revenues were $3 million and $16.9 million, or 14.5% and 82.3%, respectively, of total air freight carrier revenues for the four months ended December 31, 1996, as compared to $7.8 million and $9.2 million, or 43.2% and 51.3%, respectively, for the four months ended December 31, 1995. Revenues from on-demand charters flown by Kitty Hawk aircraft for the four months ended December 31, 1996 decreased 61.6% from the comparable prior year period primarily as the result of Kitty Hawk's strategy to use as many aircraft as possible under ACMI contracts, which provide more stable, predictable revenues. Prices for Kitty Hawk's on-demand and ACMI contract charters remained relatively constant.
Revenues -- Air Logistics. Air logistics revenues decreased $12.3 million, or 23.8%, to $39.4 million in the four months ended December 31, 1996, from $51.7 million in the four months ended December 31, 1995. This decrease was primarily due to decreased demand for on demand charters from the automobile industry in the fourth quarter of calendar year 1996 and is partially offset by an increase in the number of managed charters for the U.S. Postal Service during December 1996. Prices for Kitty Hawk's air logistics services remained relatively constant.
Costs of Revenues -- Air Freight Carrier. Air freight carrier costs of revenues increased $2.1 million, or 18%, to $13.8 million in the four months ended December 31, 1996, from $11.7 million in the four months ended December 31, 1995, reflecting the increased volume of business from Boeing 727-200 ACMI contract charters. Gross profit margin from the air freight carrier decreased to 33% in the four months ended December 31, 1996, from 35.1% in the comparable prior year period. This decrease reflects the increase in ACMI contract charters, which produce lower gross margins than on-demand charters.
As reported to the FAA, overall aircraft utilization increased to 7,670 flight hours for the four months ended December 31, 1996, from 6,320 in the four months ended December 31, 1995, a 21.4% increase. This increase was primarily due to the increased hours flown for ACMI contract charters.
Costs of Revenues -- Air Logistics. Air logistics costs of revenues decreased $12.2 million, or 26.5%, to $33.8 million in the four months ended December 31, 1996, from $46 million in the four months ended December 31, 1995, reflecting the decreased volume of business. The gross profit margin from air logistics increased to 14.2% in the four months ended December 31, 1996, from 11.1% in the comparable prior year period, an increase of 27.9%. This increase was primarily due to Kitty Hawk's additional revenues and increased gross profit margin from the U.S. Postal Service Christmas contract in December 1996 and Kitty Hawk's success in reducing its costs paid to third party air freight carriers and ground service providers.
General and Administrative Expenses. General and administrative expenses decreased $137,000, or 4.8%, to $2.7 million in the four months ended December 31, 1996, from $2.9 million in the four months ended December 31, 1995. This decrease was primarily due to a reduction of professional fees and bank charges in the four months ended December 31, 1996. As a percentage of total revenues, general and administrative expenses increased to 4.5% in the four months ended December 31, 1996, from 4.1% in the four months ended December 31, 1995.
Non-qualified Employee Profit Sharing Expense. Employee profit sharing expense increased $73,000, or 8.2%, to $962,000 in the four months ended December 31, 1996, from $889,000 in the four months ended
December 31, 1995, reflecting the increased profitability from operating activities of Kitty Hawk in the four months ended December 31, 1996.
Operating Income. Operating income increased $423,000, or 5.1%, to $8.7 million in the four months ended December 31, 1996, from $8.3 million in the four months ended December 31, 1995. Operating income margin increased to 14.6% from 11.9%, for the four months ended December 31, 1996 and 1995, respectively.
Interest Expense. Interest expense increased to $684,000 for the four months ended December 31, 1996 from $482,000 in the four months ended December 31, 1995, a 42% increase. The increase was primarily the result of the incurrence of additional long-term debt to finance the acquisition of Boeing 727-200 aircraft subsequent to December 31, 1995.
Other Income (Expense). Other income increased to $626,000 in the four months ended December 31, 1996, from $38,000 in the comparable prior year period. The increase was primarily due to the temporary investment of the net proceeds of Kitty Hawk's initial public offering.
Income Taxes. Income taxes as a percentage of income before income taxes decreased to 38.9% for the four months ended December 31, 1996, from 39.4% for the comparable prior year period. The decrease was primarily due to decreased state income taxes.
Net Income. As a result of the above, net income increased to $5.3 million in the four months ended December 31, 1996, from $4.8 million in the four months ended December 31, 1995, a 11.3% increase. Net income as a percentage of total revenues increased to 8.8% in the four months ended December 31, 1996, from 6.9% in the comparable prior year period.
FISCAL YEAR ENDED AUGUST 31, 1996 COMPARED TO FISCAL YEAR ENDED AUGUST 31, 1995
Revenues -- Air Freight Carrier. Air freight carrier revenues increased $11.8 million or 28.7% from $41.1 million for fiscal year 1995 to $52.9 million for fiscal year 1996. Air freight carrier on-demand and ACMI contract charter revenues were $20.7 million and $30.1 million, or 39.2% and 56.8%, respectively, of total air freight carrier revenues for fiscal year 1996, as compared to $18.1 million and $20.9 million, or 44.2% and 50.8%, respectively, for fiscal year 1995. Revenues from on-demand charters flown by Kitty Hawk aircraft for fiscal year 1996 increased 14% from the prior year. The increase in ACMI revenues of $9.2 million from 1995 to 1996 was principally due to Kitty Hawk's strategy to increase its Boeing 727 fleet and dedicate more aircraft to ACMI contract service. Prices for Kitty Hawk's on-demand and ACMI contract charters remained relatively constant.
Revenues -- Air Logistics. Air logistics revenues increased $26.9 million, or 43%, to $89.5 million in fiscal year 1996, from $62.6 million in fiscal year 1995. This increase was primarily due to increased demand for on demand charters from the automobile industry in the fourth quarter of calendar year 1995 and a substantial increase in the number of managed charters for the U.S. Postal Service during December 1995. Prices for Kitty Hawk's air logistics services remained relatively constant.
Costs of Revenues -- Air Freight Carrier. Air freight carrier costs of revenues increased $10.7 million, or 37.9%, to $38.8 million in fiscal year 1996, from $28.1 million in fiscal year 1995, reflecting the increased volume of business from Boeing 727-200 ACMI contract charters. Gross profit margin from the air freight carrier decreased to 26.8% in fiscal year 1996, from 31.6% in the comparable prior year period. This decrease reflects the increase in ACMI contract charters, which produce lower gross margins than on-demand charters.
As reported to the FAA, overall aircraft utilization increased to 20,237 flight hours for fiscal year 1996, from 15,183 in fiscal year 1995, a 33.3% increase. This increase was primarily due to the increased hours flown for ACMI contract charters.
Costs of Revenues -- Air Logistics. Air logistics costs of revenues increased $22.7 million, or 39.5%, to $80.1 million in fiscal year 1996, from $57.4 million in fiscal year 1995, reflecting the increased volume of business. The gross profit margin from air logistics increased to 10.5% in fiscal year 1996, from 8.3% in the comparable prior year period, a 26.5% increase. This increase was primarily due to Kitty Hawk's success in
reducing its costs paid to third party air freight carriers and ground service providers and increased gross profit margin from the U.S. Postal Service Christmas contract in December 1995.
General and Administrative Expenses. General and administrative expenses increased $1.2 million, or 15.9%, to $9.1 million in fiscal year 1996, from $7.8 million in fiscal year 1995. This increase was primarily due to an increase in support functions and administrative costs associated with the growth in the aircraft fleet and the increased revenue volume for the air freight carrier in fiscal year 1996. As a percentage of total revenues, general and administrative expenses decreased to 6.4% in fiscal year 1996, from 7.6% in fiscal year 1995.
Non-qualified Employee Profit Sharing Expense. Employee profit sharing expense increased $169,000, or 16.9%, to $1.2 million in fiscal year 1996, from $1 million in fiscal year 1995, reflecting the increased profitability from operating activities of Kitty Hawk in fiscal year 1996.
Stock Option Grants to Executives. During fiscal year 1996, Kitty Hawk granted two executive officers options to purchase 544,274 shares of Common Stock that resulted in a charge to earnings of approximately $4,231,000.
Operating Income. Operating income decreased $311,000, or 3.3%, to $9 million in fiscal year 1996, from $9.3 million in fiscal year 1995. Operating income margin decreased to 6.3% from 9%, for fiscal year 1996 and 1995, respectively.
Interest Expense. Interest expense increased to $1.9 million for fiscal year 1996 from $1.2 million in fiscal year 1995, a 56.9% increase. The increase was primarily the result of the incurrence of additional long-term debt to finance the acquisition of two Boeing 727-200 aircraft in the second half of fiscal year 1995 and two additional Boeing 727-200 aircraft in fiscal year 1996.
Loss on Asset Disposal. Loss on asset disposal for fiscal year 1996 was $589,000, which resulted from write-downs associated with equipment dispositions. There were no losses on asset disposal in fiscal year 1995.
Other Income (Expense). Other income increased to $291,000 in fiscal year 1996, from an expense of $601,000 in the comparable prior year period. The increase was primarily due to the write-off of costs associated with Kitty Hawk's attempted initial public offering in fiscal year 1995 and increased interest income in fiscal year 1996.
Income Taxes. Income taxes as a percentage of income before income taxes decreased to 40.3% for fiscal year 1996, from 41.6% for the comparable prior year period. The decrease was primarily due to decreased state income taxes.
Net Income. As a result of the above, net income decreased to $4.1 million in fiscal year 1996, from $4.4 million in fiscal year 1995, a 7% decrease. Net income as a percentage of total revenues decreased to 2.9% in fiscal year 1996, from 4.3% in the comparable prior year period.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements are primarily for the acquisition and modification of aircraft, working capital and the expansion and improvement of maintenance and support facilities. In addition, the Company has, and will continue to have, capital requirements for the requisite periodic and major overhaul maintenance checks for its fleet and for debt service. The Company also has seasonal working capital needs, because it generates higher revenue and cash flow in the fourth calendar quarter and lower revenue and cash flow in the first calendar quarter. The Company's cash requirements for maintenance and working capital (particularly its seasonal requirements) have increased substantially due to the acquisition of the Kalitta Companies. Funding requirements have historically been met through internally generated funds, bank borrowings and aircraft sales and from public and private offerings of equity and debt securities. From time to time, the Company has entered into sale/leaseback transactions to acquire aircraft and may do so in the future.
In connection with the acquisition of the Kalitta Companies, the Company sold 2,200,000 shares of Common Stock resulting in net proceeds to the Company of approximately $38.3 million. In addition, the
Company issued $340 million of 9.95% Senior Secured Notes, resulting in net proceeds to the Company of approximately $329.1 million. See "Item 1. Business -- The Common Stock Offering, the Note Offering, the Credit Facility and the Term Loan." The Notes provide for semi-annual interest payments of approximately $16.9 million on each May 15 and November 15 and mature in November 2004. The Notes are secured by a fleet of 30 aircraft, including nine Boeing 747s (two of which were purchased in February 1998), eight Lockheed L-1011s and 13 Boeing 727s. The Notes are guaranteed by all of the Company's subsidiaries, other than AIC.
The Company has a $45.9 million outstanding Term Loan. The Term Loan is due in quarterly installments of $2.25 million commencing in March 1999, with the balance of $12.15 million due upon maturity in September 2002. Interest on the Term Loan accrues at LIBOR plus 3% or a Base Rate plus 1.5%, subject to reduction. The Base Rate is the Prime Rate of Wells Fargo Bank, N.A. ("WFB") or the Federal Funds Rate plus 5%. The Term Loan is secured by accounts receivable, all spare parts (including rotables), inventory, intangibles and contract rights, cash, 16 Boeing 727s and related engines, the stock of each of the Company's subsidiaries and the Company's 60% interest in AIC. The Term Loan is guaranteed by all of the Company's subsidiaries, other than AIC.
In addition, to fund ongoing capital requirements, including possible acquisitions, the Company has entered into a Credit Facility with WFB, individually and as agent for various lenders. The Credit Facility provides the Company with up to $100 million in revolving loans (subject to a current borrowing base limitation of approximately $59.3 million) and is secured by the same collateral as the Term Loan. The Credit Facility initially bears interest at LIBOR plus 2.75% or a Base Rate 1.25%, subject to adjustment. The Base Rate is WFB's Prime Rate or the Federal Funds Rate plus 5%. Borrowings under the Credit Facility are subject to borrowing base limitations based on eligible inventory and accounts receivable. The Credit Facility matures in November 2002. As of March 31, 1998, the Company had a balance of approximately $15 million outstanding under the Credit Facility and available borrowings under the Credit Facility of approximately $44.3 million. Borrowings under the Credit Facility and Term Loan are subject to certain financial covenants. As of December 31, 1997, the Company was not in compliance with the funded debt to Adjusted EBITDA ratio. The Company has obtained a waiver as of December 31, 1997 with respect to this ratio.
Capital expenditures were $113.5 million and $28.7 million for 1997 and 1996, respectively. Capital expenditures for 1997 were primarily for the purchase of (i) 20 Boeing 727 aircraft (including 16 Boeing 727s acquired from the Kalitta Companies) (ii) cargo and noise abatement modifications for three Boeing 727 aircraft and one Boeing 747 aircraft, (iii) noise abatement equipment with respect to two Douglas DC-9 aircraft, (iv) leasehold improvements to three Boeing 727 aircraft, including a cargo conversion, (v) the Company's 40,000 square foot headquarters facility and related ground sublease at Dallas/Fort Worth International Airport, (vi) five major maintenance checks on Boeing 727s, (vii) overhauls on seven engines and acquisition of 11 JT8D engines and (viii) ground service equipment for use in the Company's 1997 Christmas contract with the U.S. Postal Service. Capital expenditures for 1996 were primarily for the purchase of (i) three Boeing 727 aircraft and (ii) cargo and noise abatement modifications for two Boeing 727 aircraft.
During 1998, the Company estimates that capital expenditures will aggregate approximately $155.5 million (approximately $39.6 million of which has already been incurred) and that it will make substantial capital expenditures thereafter. As of March 24, 1998, the Company has acquired two Boeing 747s for approximately $39.6 million and anticipates modifying these aircraft to cargo configuration and having other work performed at an aggregate cost of approximately $26 million. The acquisition of the Boeing 747s was funded with approximately $39.6 million of the net proceeds from the Note Offering. The cargo conversion will be funded with approximately $16.4 million of the net proceeds from the Note Offering and approximately $9.6 million of internally generated funds or borrowings under the Credit Facility. Additionally, the Company anticipates converting one Boeing 727 aircraft from passenger to freighter configuration during 1998 at a cost of approximately $5 million.
During 1998, the Company anticipates capital expenditures ranging from $27 million to $32 million for noise abatement modifications to Douglas DC-9 and Boeing 727 aircraft currently owned. The Company's
total capital expenditures for noise abatement modifications for its existing fleet of owned and leased aircraft is expected to be between $80 million and $90 million. The entire fleet must be Stage III compliant by the year 2000. In the event more aircraft are acquired, anticipated capital expenditures for noise abatement modifications could materially increase. See "Item 1. Business -- Government Regulation -- Noise Abatement Regulations."
Service Bulletins and Directives issued under the FAA's "Aging Aircraft" program or issued on an ad hoc basis cause certain of the Company's aircraft to be subject to extensive aircraft examinations and require certain of the Company's aircraft to undergo structural inspections and modifications to address problems of corrosion and structural fatigue among other things, at specified times. It is possible that additional Service Bulletins or Directives applicable to the Company's fleet could be issued in the future. The cost of compliance with such Directives and Service Bulletins cannot currently be estimated, but could be substantial. See "Item 1. Business -- Government Regulation -- Aging Aircraft Regulations; Potential Compliance Costs."
The Company operates a fleet of 29 Boeing 727s, all of which were previously converted from passenger configuration to cargo configuration by the installation of a large cargo door and numerous interior modifications related to the installation of cargo container handling systems. The FAA has issued a proposed Directive, which if adopted, would limit the cargo capacity of 28 of these Boeing 727s until certain modifications are made. The costs to make such modifications and the amount of revenue that could be lost cannot currently be estimated. However, the Company believes this Directive will not have a material adverse effect of the Company. See "Item 1. Business -- Aircraft Fleet."
The Company believes that available funds, bank borrowings and cash flows expected to be generated by operations will be sufficient to meet its anticipated cash needs for working capital, debt service and capital expenditures for at least the next 12 months. Thereafter, if cash generated by operations is insufficient to satisfy the Company's liquidity requirements, the Company may sell additional equity or debt securities or obtain additional credit facilities. However, there can be no assurance that the Company will be able to sell any additional equity or debt securities or obtain additional credit facilities. Notwithstanding the foregoing, the Company may sell additional equity or debt securities or obtain additional credit facilities at any time.
YEAR 2000
The Company believes that its computer systems are generally year 2000 compliant. The Company does not yet know whether the computer systems of the FAA or its customers, suppliers, vendors and air logistics service providers are generally year 2000 compliant. The Company has begun discussions with its significant suppliers, customers and financial institutions to ensure that those parties have appropriate plans to remediate year 2000 issues where their systems interface with the Company's systems or otherwise impact its operations and assess the extent to which its operations are vulnerable should those organizations fail to remediate properly their computer systems.
The Company's comprehensive year 2000 initiative is being managed by a team of internal staff and outside consultants reporting directly to the Company's Audit Committee. The team's activities are designed to ensure that there is no adverse effect on the Company's core business operations and that transactions with customers, suppliers and financial institutions are fully supported. While the Company believes its planning efforts will be adequate to address its year 2000 concerns, there can be no guarantee that the systems of other companies will be converted on a timely basis and will not have a material adverse effect on the Company. The cost of the Company's year 2000 initiatives is not expected to have a material adverse effect on the Company.
OTHER MATTERS
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), both effective for years beginning after December 15, 1997. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements and is not expected to have a significant impact on the Company. SFAS 131 establishes standards for the manner
that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. The Company will adopt the new requirements retroactively in 1998. Management has not completed its review of SFAS 131 and, therefore, has not yet determined the impact, if any, this statement will have on the Company's financial reporting.
SEASONALITY
Certain customers of the Company engage in seasonal businesses, especially the U.S. Postal Service and customers in the U.S. automotive industry. As a result, the Company's air logistics business has historically experienced its highest quarterly revenues and profitability during the fourth quarter of the calendar year due to the peak Christmas season activity of the U.S. Postal Service and during the period from June 1 to November 30 when production schedules of the U.S. automotive industry typically increase. Consequently, the Company experiences its lowest quarterly revenue and profitability during the first quarter of the calendar year.
QUARTERLY RESULTS OF OPERATIONS
The following tables reflect certain selected quarterly operating results, which have not been audited or reviewed. The information has been prepared on the same basis as the Consolidated Financial Statements appearing elsewhere herein and includes all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the information shown. The Company's results vary significantly from quarter to quarter and the operating results for any quarter are not necessarily indicative of the results that may be expected for any future period.
- --------------- (1) Except for the quarter ended December 31, 1997, earnings per share information for each of the quarters has been restated to comply with Statement of Financial Accounting Standards No. 128, "Earnings per Share."
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a rapidly changing environment that involves numerous risks, some of which are beyond the Company's control. The following discussion highlights some of these risks.
Substantial Leverage and Debt Service. The Company incurred substantial indebtedness through the issuance of the Notes and contemporaneously with the issuance thereof entered into the Credit Facility, which allows for revolving borrowings of up to $100 million, subject to a current borrowing base limitation of approximately $59.3 million. In addition, the Company entered into the Term Loan to refinance a $45.9 million loan which was incurred in September 1997 in connection with the acquisition of 16 Boeing 727s from the Kalitta Companies. At December 31, 1997, the Company's total indebtedness was approximately $404.6 million and its stockholders' equity was $174.9 million. At March 31, 1998, there was a balance of $15 million under the Credit Facility and a balance of approximately $45.9 million under the Term Loan. The Indenture pursuant to which the Notes were issued permits the Company to incur substantial amounts of additional indebtedness for certain specified purposes, including an unlimited amount to acquire aircraft and aircraft-related assets.
The degree to which the Company is leveraged could have important consequences, including (i) the Company's ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes may be impaired in the future; (ii) a substantial portion of the Company's cash flow from operations will be dedicated to the payment of principal and interest on its indebtedness, thereby reducing funds available to the Company for other purposes; and (iii) the Company's substantial leverage may place the Company at a competitive disadvantage, hinder its ability to adjust rapidly to changing market conditions and make it more vulnerable in the event of a downturn in general economic conditions or its business or in the event of a strike or other labor problems at one of its significant customers.
The Company's ability to make scheduled principal and interest payments or to refinance its indebtedness will depend on its future financial performance, which to a certain extent will be subject to economic, financial, competitive and other factors beyond its control. There can be no assurance that the Company's business will generate sufficient cash flow from operations to service its indebtedness and make necessary capital expenditures. If unable to do so, the Company may be required to refinance all or a portion of its indebtedness, to sell assets or to obtain additional financing. There can be no assurance that any such refinancing would be possible, that any assets could be sold (or, if sold, of the timing of such sales and the amount of proceeds realized therefrom) or that additional financing could be obtained, any of which could have a material adverse effect on the Company.
Recent Financial Performance of the Kalitta Companies. The Kalitta Companies on a combined basis posted net losses of $17,000 in 1996 and of $40.8 million during the period from January 1, 1997 to November 18, 1997 (the day immediately preceding the consummation of the Merger). The Company believes that the recent negative financial performance prior to the Merger can be attributed to a number of factors, including (i) the incurrence of abnormally high engine overhaul expenses due to FAA Directives, (ii) the loss of revenue resulting from the effective grounding of two Boeing 747s in January 1996 due to a series of Directives, (iii) the incurrence principally in 1997 of start-up costs associated with establishing the Kalitta Companies' wide-body passenger charter business, (iv) the incurrence of costs to add and maintain flight crews in anticipation of increased air freight carrier business which has not yet materialized in part due to delays in acquiring aircraft and (v) lower revenues from the U.S. Military. Since January 1, 1998, AIA, which accounts for a substantial proportion of the combined operating results of the Kalitta Companies, has continued to suffer losses. The Company is striving to implement changes to improve the operating performance of AIA and AIA's relationships with its customers. The Company expended approximately $800,000 towards Merger-related integration during the fourth quarter of 1997 and has budgeted another $1.5 million for Merger-related costs for 1998. The Company believes AIA's results of operations for the first quarter of 1998 will be better than AIA's results of operations for the first quarter of 1997. Generally, the Company believes that AIA's losses for the first quarter of 1998 are the result of problems related to crew scheduling, maintenance scheduling and parts logistics.
Risks of Business Integration. There can be no assurance that the Company will be able to successfully integrate the operations of Kitty Hawk and the Kalitta Companies or achieve the aims of the Merger. The benefits of the Merger require (i) the integration of administrative, finance, purchasing, dispatching, maintenance, sales and marketing organizations, (ii) the coordination of aircraft operations and (iii) the implementation of appropriate operational, financial and management systems and controls. This will require substantial ongoing attention from the Company's management. The failure to successfully integrate Kitty Hawk and the Kalitta Companies would have a material adverse effect on the Company.
Control by Messrs. Christopher and Kalitta. As of the date hereof, Mr. Christopher, the Company's Chairman and Chief Executive Officer, beneficially owns 5,948,436 shares, or approximately 35.5% of the outstanding Common Stock, and Mr. Kalitta, the Company's Vice Chairman, beneficially owns 4,099,150 shares, or approximately 24.4% of the outstanding Common Stock, of which 650,000 shares are held in escrow to secure Mr. Kalitta's indemnification obligations under the Merger Agreement. As a consequence, the success of the Company depends, in some part, upon the ability of Messrs. Christopher and Kalitta to work together. Prior to the Merger, Messrs. Christopher and Kalitta were competitors and had disagreements, one of which resulted in litigation between Kitty Hawk and the Kalitta Companies. See "Item 3. Legal Proceedings -- U.S. Postal Service Contract." Disagreements between Messrs. Christopher and Kalitta in the
future could delay or disrupt the Company's operations and have a material adverse effect on the Company. Messrs. Christopher and Kalitta have entered into a voting agreement that, among other things, provides that until November 2000, Messrs. Christopher and Kalitta will vote their shares of Common Stock in favor of director nominees selected by a Nominating Committee or in certain cases, the Board of Directors.
Cyclicality and Seasonality. The Company's services are provided to numerous industries and customers that experience significant fluctuations in demand based on economic conditions and other factors beyond the control of the Company. The demand for the Company's services could be materially adversely affected by downturns in the businesses of the Company's customers. The Company believes a significant percentage of its revenues will continue to be generated from services provided to the U.S. automotive industry, which has historically been a cyclical industry. A contraction in the U.S. automotive industry, a prolonged work stoppage or other significant labor dispute involving that industry, or a reduction in the use of air freight charters by that industry, could have a material adverse effect on the Company.
Certain customers of the Company engage in seasonal businesses, especially the U.S. Postal Service and customers in the U.S. automotive industry. As a result, the Company's air carrier business and air freight charter logistics business have historically experienced their highest quarterly revenues and profitability during the fourth quarter of the calendar year due to the peak Christmas season activity of the U.S. Postal Service and during the period from June 1 to November 30 when production schedules of the U.S. automotive industry typically increase. Consequently, the Company generally experiences its lowest quarterly revenue and profitability during the first quarter of the calendar year. In addition, the Company has provided charter carrier services to the U.S. Military during periods of heightened military activity, such as the Persian Gulf conflict, which has caused its results of operations to fluctuate.
Availability of Facilities. The Company leases the majority of its facilities from third parties. If the Company continues to grow, it must be able to expand its current facilities or relocate to new ones.
The Company's scheduled air freight operations utilize a sorting space at the Hulman Regional Airport in Terre Haute, Indiana. This sorting space is licensed from Roadway Global Air for a term which expires in August 1998. Because of the growth in the amount of freight sorted at this facility, the lack of available expansion space and the limited airport facilities in Terre Haute, the Company plans to move this sorting operation to Fort Wayne, Indiana in the spring of 1999. The Company is currently negotiating a lease with the airport authority in Fort Wayne and an interim lease for its current space in Terre Haute. There can be no assurance that the Company will be able to complete either of these negotiations or do so on favorable terms. Moreover, the move to Fort Wayne is dependent on the issuance of bonds by the Fort-Wayne-Allen County Airport Authority (the "Fort Wayne Authority"). There can be no assurance that the Fort Wayne Authority will complete the bond issuance in a timely manner or at all. The failure of the Company to successfully obtain sufficient space to operate would have a material adverse effect on the Company.
The Company also leases its Oscoda, Michigan maintenance facilities under various subleases from the Oscoda-Wurtsmith Airport Authority (the "Wurtsmith Authority"). These subleases vary in duration from month-to-month to long-term (the last of which expires in December 2015) and are subject to earlier termination upon termination of the prime lease between the U.S. Government and the Wurtsmith Authority. The Company is highly dependent on its facilities in Oscoda. There can be no assurance that the Company will be successful in extending these subleases or do so on favorable terms or that the prime lease will not terminate prior to its stated expiration. Failure to extend one or more of the subleases or early termination of the prime lease would force the Company either to reduce substantially its maintenance capabilities or relocate the Oscoda maintenance operations, either of which could increase costs and reduce revenues. If the Company were forced to relocate these maintenance operations, there can be no assurance that the Company would be able to find alternative space on acceptable terms. In addition, the cost to move to another site would be significant. The occurrence of any of these events, or the failure in general of the Company to obtain facilities to conduct efficiently any of its operations, would have a material adverse effect on the Company.
Dependence on Aircraft Availability. The Company's revenues are dependent on the availability of its aircraft. In the event that one or more of the Company's aircraft are lost or out of service for an extended period of time, the Company may be forced to lease or purchase replacement aircraft or, if necessary, convert
an aircraft from passenger to freighter configuration. There can be no assurance that suitable replacement aircraft could be located on acceptable terms. The Company does not maintain business interruption insurance to cover this risk. Loss of revenue resulting from any such business interruption or costs to replace aircraft could have a material adverse effect on the Company.
Dependence on Key Personnel. The Company believes that its continued success depends and will continue to depend, on the services of Mr. Christopher, the founder of Kitty Hawk and Chairman of the Board of Directors and Chief Executive Officer of the Company, Tilmon J. Reeves, the President of the Company and Richard R. Wadsworth, the Senior Vice President -- Finance, Chief Financial Officer and Secretary of the Company. The loss of the services of any of Messrs. Christopher, Reeves or Wadsworth, particularly Mr. Christopher, could have a material adverse effect on the Company. Each of Messrs. Christopher, Reeves and Wadsworth have entered into employment agreements with the Company.
Employee Relations. The Company believes that it has good relations with its employees. Certain employee pilots and flight engineers of the Company (as successor to the Kalitta Companies) are members of the Teamsters Union and are employed pursuant to a Collective Bargaining Agreement. The Collective Bargaining Agreement became amendable on August 29, 1997, and the parties have commenced "interest-based" bargaining for a successor agreement. Although the parties have commenced "interest-based" bargaining, there can be no assurance that a new collective bargaining agreement can be reached or that negotiations will not result in work stoppages, a substantial increase in salaries or wages, changes in work rules or other changes adverse to the Company. The cockpit crews of the Company's other subsidiaries are not unionized. There can be no assurance that the Company's non-union cockpit crews will remain non-unionized. Unionization of the Company's non-union cockpit crews, work stoppages, increased wages or other labor related matters could have a material adverse effect on the Company. See "Item 1. Business -- Employees."
Dependence on Computer Systems. The Company utilizes a number of computer systems to schedule flights and personnel, track aircraft and freight, bill customers, pay expenses and monitor a variety of its activities, ranging from safety compliance to financial performance. The failure of the hardware or software that support these computer systems, or the loss of data contained in any of them, could significantly disrupt the Company's operations, which could have a material adverse effect on the Company. See "Item 1. Business -- Air Freight Charter Logistics Services -- Database, Information Software and Tracking Systems."
While the Company believes its computer systems are generally year 2000 compliant, the computer systems of the FAA and the Company's customers, suppliers, vendors and air logistics service providers may not be year 2000 compliant. Failure of the computer systems of the FAA or one or more of the Company's significant customers, suppliers, vendors or air logistics service providers to correctly record, manipulate or retrieve dates from the year 2000 and beyond could have a material adverse effect on the Company.
Restrictive Covenants. The Indenture restricts, among other things, the Company's ability to pay dividends or make certain other restricted payments, to incur additional indebtedness (except for amounts incurred for certain specified purposes), to encumber or sell assets, to enter into transactions with stockholders and affiliates, to guarantee indebtedness, to merge or consolidate with any other entity and to transfer or lease all or substantially all of its assets.
The Company's Credit Facility and Term Loan also contain restrictive financial and operating covenants with respect to liens, indebtedness, capital expenditures, investments, prepayments of debt, dividends and certain requirements to maintain financial ratios.
As of the date hereof, the Company is in compliance with the financial and other covenants in the Credit Facility and Term Loan. As of December 31, 1997, the Company was not in compliance with the funded debt to Adjusted EBITDA ratio. The Company has obtained a waiver as of December 31, 1997 with respect to this ratio. The ability of the Company to comply with such covenants, including financial maintenance covenants, in the future will depend on the Company's future financial performance. The Company's failure to comply with such covenants would constitute an event of default under the Credit Facility and Term Loan, which could result in (i) the acceleration of debt maturities, including under the Notes, the Credit Facility and the Term Loan, (ii) the loss of the Company's borrowing capacity and (iii) the foreclosure upon the Company's pledged assets securing such indebtedness. The declaration of an event of default under the Credit Facility and
Term Loan could result in a default by the Company under other loan agreements or leases that contain cross-default or cross-acceleration provisions. Under these circumstances, there can be no assurance that the Company would have sufficient funds or other resources to satisfy all of its obligations on a timely basis.
Government Regulation. The Company is subject to Title 49 of the United States Code (formerly the Federal Aviation Act of 1958, as amended), under which the DOT and the FAA exercise regulatory authority over air carriers. The DOT and the FAA have the authority to modify, amend, suspend or revoke the authority and licenses issued to the Company for failure to comply with the provisions of law or applicable regulations. In addition, the DOT and the FAA may impose civil or criminal penalties for violations of applicable rules and regulations. Such actions by the FAA or the DOT, if taken, could have a material adverse effect on the Company. The adoption of new laws, policies or regulations or changes in the interpretation or application of existing laws, policies or regulations, whether by the FAA, the DOT, the U.S. government or any foreign, state or local government, could have a material adverse effect on the Company.
Modification of Aircraft. The Company owns 34 aircraft and leases two aircraft (not including aircraft held for sale and aircraft currently being brought into compliance with Stage III noise control standards) that do not meet FAA Stage III noise abatement standards. All of these aircraft must be brought into compliance with these standards by January 1, 2000. The Company may retire or terminate the leases related to some of these aircraft instead of modifying them. If all 36 aircraft are brought into compliance, the Company estimates that the cost would be approximately $88 million, not including aircraft downtime. There can be no assurance regarding the actual cost or that the Company will have or be able to raise the necessary funds. See "Item 1. Business -- Government Regulation."
Aging Aircraft Regulations; Potential Compliance Costs. All of the Company's aircraft are subject to Service Bulletins and Directives issued under the FAA's "Aging Aircraft" program or issued on an ad hoc basis. These Service Bulletins or Directives could cause certain of these aircraft to be subject to extensive aircraft examinations and require certain of these aircraft to undergo structural inspections and modifications to address problems of corrosion and structural fatigue at specified times. It is possible that additional Service Bulletins or Directives applicable to the types of aircraft included in the Company's fleet could be issued in the future. The cost of compliance with such Directives and Service Bulletins cannot currently be estimated, but could be substantial. See "Item 1. Business -- Aircraft Fleet" for a discussion of certain Directives which currently affect or which may affect certain of the Company's aircraft. It is possible that additional Directives may be issued, which could have a material adverse effect on the Company.
Competition. The market for air freight services is highly competitive. The Company's air freight carrier services are also subject to competition from other modes of transportation, including, but not limited to, railroads and trucking. Additional demand for air freight carrier services over the last few years has resulted in numerous new entrants in this business. The Company believes there are limited barriers to entry into this business and that increased demand may stimulate additional competition.
The market for air logistics also has been and is expected to remain highly competitive. The Company's principal competitors for on-demand air logistics services are other air logistics companies, air freight carriers which seek to book charters directly with customers and air freight companies that offer expedited service.
The Company's ability to attract and retain business also is affected by whether and to what extent its customers decide to coordinate their own transportation needs. With respect to the Company's ACMI contract charter business, the Company could be adversely affected by the decision of certain of its certificated customers to acquire additional aircraft or by its uncertificated customers to acquire and operate their own aircraft. In this regard, many of the Company's competitors and customers have substantially greater financial resources than the Company.
Environmental Matters. The Company's operations must comply with numerous environmental laws ordinances and regulations. Under current federal, state and local environmental laws ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of contamination from hazardous or toxic substances, or the failure to
remediate such contaminated property properly, may adversely affect the ability of the owner of the property to use such property as collateral for a loan or to sell such property. Environmental laws also may impose restrictions on the manner in which a property may be used or transferred or in which businesses may be operated and may impose remedial or compliance costs. The costs of defending against claims of liability or remediating contaminated property and the cost of complying with environmental laws could have a material adverse effect on the Company. See "Item 1. Business -- Environmental."
The Company is aware of the presence of environmental contamination on properties that the Company (as successor to the Kalitta Companies) leases or owns. The Company does not believe that the costs of responding to the known contamination should or will be borne solely by the Company, if at all. While the Company does not believe that the costs of responding to the presence of such contamination is likely to have a material adverse effect on the Company, there can be no assurance in this regard.
In part because of the highly industrialized nature of many of the locations at which the Company operates, there can be no assurance that the Company has discovered all environmental contamination for which it may be responsible.
Capital Intensive Nature of Aircraft Ownership. The Company's air carrier business is highly capital intensive. In order to further expand the Company's air carrier business, the Company intends to purchase used jet aircraft that typically require certain modifications, including reconfiguring the aircraft from passenger to cargo use and installing equipment to comply with noise abatement regulations. The market for used jet aircraft is volatile and can be negatively affected by limited supply, increased demand and other market factors and recently has experienced significant price increases. Therefore, there can be no assurance that the Company will be able to purchase and modify additional aircraft at favorable prices or that the Company will have or be able to obtain sufficient resources with which to make such purchases and modifications. The capital intensive nature of the Company's business could adversely impact the value of the Common Stock.
Operating Costs. The operation of the Company's air freight and passenger carrier business incurs considerable operational, maintenance, fuel and personnel costs. The Company's financial results can be adversely affected by unexpected engine or airframe repairs, compliance with maintenance Directives and regulations of the FAA and associated aircraft downtime. In addition, spare or replacement parts and components may not be readily available in the marketplace. Failure to obtain necessary parts or components in a timely manner or at favorable prices could have a material adverse effect on the Company.
Fuel is a significant cost of operating the Company's aircraft for on-demand services and the aircraft of third party providers of charter services. Both the cost and availability of fuel are subject to many economic and political factors and events occurring throughout the world and recently the cost of fuel has fluctuated markedly. The Company has no agreement with any fuel supplier assuring the availability or price stability of fuel and such agreements are generally not available in the industry. The Company generally passes on fuel cost increases to its customers under ACMI charter contracts, but under certain contracts and the Company's scheduled operations, the Company's ability to pass on increased fuel costs is limited. Accordingly, the future cost and availability of fuel to the Company cannot be predicted and substantial price increases in, or the unavailability of adequate supplies of, fuel may have a material adverse effect on the Company.
Volatility of Air Freight Services Market. The demand for air freight services is highly dependent on the strength of both the domestic and global economy. Although the air freight services industry has experienced strong growth over the last several years, general economic downturns could have a material adverse effect on the Company.
Utilization of Aircraft. The Company's operating results are highly dependent on its ability to effectively utilize its diverse fleet of aircraft. There can be no assurance, however, that operation of any of the various types of aircraft in the Company's fleet will prove to be profitable. The failure of the Company to keep its aircraft in revenue service or achieve an acceptable level of aircraft utilization could have a material adverse effect on the Company.
Risk of Accident; Insurance Coverage and Expenses. The Company's operations involve risks of potential liability against the Company in the event of aircraft accidents and, in the case of the Company's air
ambulance services, for medical malpractice. The Company is required by the DOT to carry liability insurance on each of its aircraft. The Company also carries medical liability insurance for its air ambulance business. Although the Company believes its current insurance coverage is adequate and consistent with current industry practice, there can be no assurance that the amount of such coverage will not be changed or that the Company will not bear substantial losses and lost revenues from accidents. Substantial claims resulting from an accident in excess of related insurance coverage could have a material adverse effect on the Company. In addition, any significant increase in the Company's current insurance expense could have a material adverse effect on the Company. Moreover, any aircraft accident, even if fully insured, could cause a public perception that some of the Company's aircraft are less safe or reliable than other aircraft, which could have a material adverse effect on the Company.
International Business Risk. The Company expects to continue to derive a substantial portion of its revenues from providing air freight carrier services to customers in South and Central America and the Pacific Rim. The risks of doing business in foreign countries include potential adverse changes in the diplomatic relations between foreign countries and the U.S., hostility from local populations directed at a U.S. flag carrier, government policies against foreign-owned businesses, adverse effects of currency exchange controls, restrictions on the withdrawal of foreign investment and earnings and the risk of insurrections that could result in losses against which the Company is not insured. The Company's international operations also are subject to economic uncertainties, including risks of renegotiation or modification of existing agreements or arrangements with exchange restrictions and changes in taxation. Any of these events could have a material adverse effect on the Company.
Nearly all of the Company's revenue is denominated in U.S. dollars. However, a meaningful portion of the Company's revenue is derived from customers whose revenue is denominated in foreign currencies. Therefore, any significant devaluation in such currencies relative to the U.S. dollar could have an adverse effect on such customer's ability to pay the Company or to continue to use its services, which could have a material adverse effect on the Company.
Contraband Risk. Although required to do so, customers may fail to inform the Company about hazardous or illegal cargo. If the Company fails to discover any undisclosed weapons, explosives, illegal drugs or other hazardous or illegal cargo or mislabels or otherwise ships hazardous materials, it may suffer possible aircraft damage or liability, as well as fines, penalties or flight bans, imposed by both the country of origin and of destination. Any of these events could have a material adverse effect on the Company.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to Item 8 is submitted as a separate section of this Form 10-K. See "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K."
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors required by Item 10 is incorporated by reference from the Company's definitive proxy statement for its 1998 Annual Meeting of Stockholders to be held on May 29, 1998. The information regarding executive officers required by Item 10 is submitted as a separate section of this Form 10-K. See "Item 4A. Executive Officers of the Registrant."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the Company's definitive proxy statement for its 1998 Annual Meeting of Stockholders to be held on May 29, 1998.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference from the Company's definitive proxy statement for its 1998 Annual Meeting of Stockholders to be held on May 29, 1998.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from the Company's definitive proxy statement for its 1998 Annual Meeting of Stockholders to be held on May 29, 1998.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)1. FINANCIAL STATEMENTS
The following financial statements are filed as a part of this report:
(A)2. FINANCIAL STATEMENT SCHEDULES
No financial statement schedules are filed as part of this Annual Report on Form 10-K because the required information is included in the financial statements, including the notes thereto, or circumstances requiring the inclusion of such schedules are not present.
(A)3. EXHIBITS
The following exhibits are filed herewith or are incorporated by reference to exhibits previously filed with the Securities and Exchange Commission.
- ---------------
* Filed herewith.
** This exhibit is a management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K
On October 2, 1997, the Company filed a Current Report on Form 8-K to report its acquisition of 16 Boeing 727s from the Kalitta Companies (Item 2). No financial statements were filed with this Form 8-K. On November 7, 1997, the Company filed Amendment No. 1 to this Form 8-K to file the historical and pro forma financial statements required by Item 7(a) and (b) of Form 8-K.
On December 4, 1997, the Company filed a Current Report on Form 8-K to report its acquisition of the Kalitta Companies from Mr. Kalitta (Item 2). This Form 8-K included the historical and pro forma financial statements required by Item 7(a) and (b) of Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 the 27th day of March, 1998.
KITTY HAWK, INC.
By: /s/ RICHARD R. WADSWORTH ---------------------------------- Richard R. Wadsworth Senior Vice President -- Finance, Chief Financial Officer and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 27th day of March, 1998.
KITTY HAWK, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
Stockholders Kitty Hawk, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Kitty Hawk, Inc. and subsidiaries as of December 31, 1996 and 1997 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the two years in the period ended August 31, 1996, for the year ended December 31, 1997 and for the four months ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kitty Hawk, Inc. and subsidiaries at December 31, 1996 and 1997 and the consolidated results of their operations and their cash flows for each of the two years in the period ended August 31, 1996, for the year ended December 31, 1997 and for the four months ended December 31, 1996, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Dallas, Texas March 4, 1998
KITTY HAWK, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
See accompanying notes.
KITTY HAWK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes.
KITTY HAWK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
KITTY HAWK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
KITTY HAWK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Kitty Hawk, Inc. and its subsidiaries (the "Company") provide air freight services through two related businesses: (i) an air freight carrier and (ii) an air logistics service provider. The air freight carrier provides ACMI scheduled services (includes supplying the aircraft, crew, maintenance, and insurance for the customer), passenger and freight charter services, an overnight freight service and third party maintenance operations. The air logistics service provider arranges the delivery of time sensitive freight utilizing third parties as well as its own fleet.
In November 1997, the Company acquired the Kalitta Companies (see Note 2). The results of operations of the Kalitta Companies are included in the accompanying financial statements from November 19, 1997 to December 31, 1997.
On December 4, 1996, the Company elected to change its fiscal year end to December 31. Operating results for the four month period ended December 31, 1996 and 1995 are not necessarily indicative of the results that may be expected for a calendar year. Operating results for the four month period ended December 31, 1995 (unaudited) include all adjustments management believes are necessary for a fair presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, which include Kitty Hawk Charters, Inc., Kitty Hawk Aircargo, Inc., Aircraft Leasing, Inc., American International Airways, Inc. ("AIA") (including a 60% limited partnership interest in American International Cargo ("AIC")), Kalitta Flying Service, Inc. ("KFS"), Flight One Logistics, Inc. ("FOL"), O.K. Turbines, Inc. ("OKT"), and American International Travel, Inc. ("AIT"). All significant intercompany accounts and transactions have been eliminated in consolidation. See Note 2.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and held in banks, money market funds, and other investments with original maturities of three months or less.
Restricted Cash and Short-Term Investments
At December 31, 1997, restricted cash and short-term investments equaled approximately $58.6 million. Of this amount, $56 million represents a portion of the proceeds from the Notes (see Note 4) reserved for the acquisition and subsequent modification of two Boeing 747 aircraft, which were acquired in February 1998 at a cost of approximately $39.6 million. The balance of $2.6 million of restricted cash and short-term investments represents passenger cash deposits held in escrow until charter services are provided.
Financial Instruments
The fair value of the 9.95% Senior Secured Notes is approximately $347.7 million based on the quoted price at December 31, 1997. Based on floating interest rates provided therein, management believes the
KITTY HAWK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
recorded value of the remaining financial instruments included in the financial statements approximates fair value.
Inventory and Aircraft Supplies
Inventory and aircraft supplies consist of aircraft parts and supplies and are stated at the lower of cost (using the first-in, first-out or average cost convention) or market.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, with estimated residual values of up to 10% for aircraft and core values of up to $300,000 for engines. Estimated useful lives are as follows:
Expenditures for additions, improvements, aircraft modifications, engine overhauls and major maintenance costs are capitalized. Routine maintenance and repairs are charged to expense when incurred. Costs of periodic airframe maintenance (C-checks) are accrued. Major maintenance and engine overhauls are depreciated on a straight line basis to the next scheduled major maintenance or overhaul date.
Revenue Recognition
Revenues are recognized as services are provided.
Deferred Income Taxes
Deferred income taxes are recognized using the liability method and reflect the tax impact of temporary differences between the recorded amounts of assets and liabilities for financial reporting purposes and such amounts as measured by existing tax laws and regulations.
Concentration of Credit Risk
The Company's air freight carrier business operates worldwide with approximately 9.3% of 1997 revenues earned outside of North America (including 3.5% of 1997 revenues from operations within Asia). The air logistics service provider principally operates in North America. Credit is extended based on an evaluation of a customer's financial condition and, except in the case of passenger charters, does not require a deposit or collateral. The Company's allowance for doubtful accounts is based on current market conditions and continuous evaluation of the customer's credit worthiness and has consistently been within management's expectations.
Stock-Based Compensation
The Company accounts for stock-based compensation utilizing Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." In October 1995, the Financial Accounting
KITTY HAWK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). Under the provisions of SFAS No. 123, the Company has elected to continue to apply the provisions of APB Opinion No. 25 to its stock-based compensation arrangements and provide supplementary financial statement disclosures as required under SFAS No. 123.
Basic and Diluted Earnings per Share
In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS 128") "Earnings per Share." SFAS 128 replaced the calculation of primary and fully diluted earnings per share presentation with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of stock options. Diluted earnings per share is similar to fully diluted earnings per share. The adoption of SFAS 128 had no effect on previously reported amounts.
Reclassifications
Certain amounts from prior years have been reclassified to conform to the current year presentation.
Pending Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), both effective for years beginning after December 15, 1997. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements and is not expected to have a significant impact on the Company. SFAS 131 establishes standards for the manner that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Management has not completed its review of SFAS 131 and, therefore, has not yet determined the impact, if any, this statement will have on the Company's financial reporting.
2. ACQUISITION OF THE KALITTA COMPANIES
On November 19, 1997, the Company acquired by merger all of the outstanding common stock of AIA, KFS, FOL, OKT and AIT (collectively, the "Kalitta Companies") in exchange for 4,099,150 shares of the Company's common stock valued by an independent appraisal at approximately $60.3 million and $20 million in cash. The transaction has been accounted for as a purchase and accordingly the results of operations for the year ended December 31, 1997 include the results of operations of the Kalitta Companies from November 19, 1997 through December 31, 1997. The purchase price allocation related to the acquisition of the Kalitta Companies is based on available information and management's best estimates and is subject to change as information becomes available.
In accordance with the merger agreement, $3 million in cash and 650,000 shares of the Company's common stock issued to the former owner of the Kalitta Companies are being held in escrow to secure certain indemnity obligations. Generally the Company cannot bring any indemnification claims after May 19, 2000, except the Company may make indemnity claims for certain environmental matters until May 19, 2001.
In September 1997, as an interim step to the acquisition of the Kalitta Companies, the Company acquired sixteen Boeing 727s from AIA for approximately $51 million cash. Of the $51 million, $45.9 million was financed with a note payable under the Company's existing credit facility. This note payable was subsequently refinanced upon the consummation of the acquisition of the Kalitta Companies. See Note 4.
KITTY HAWK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
4. LONG-TERM DEBT AND REVOLVING CREDIT FACILITY
Long-term debt and Revolving Credit Facility consist of the following:
Maturities of long-term debt at December 31, 1997 are as follows:
KITTY HAWK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the acquisition of the Kalitta Companies in November 1997, the Company privately placed $340 million of 9.95% Senior Secured Notes due 2004 (the "Notes") pursuant to Rule 144A of the Securities Act of 1933. Net proceeds to the Company were $329.1 million. Costs incurred in issuing the Notes are being amortized over seven years. The net proceeds of the Notes, along with the net proceeds of the November 1997 common stock offering (see Note 8), were used to refinance approximately $33 million of existing Kitty Hawk debt and to pay off approximately $250 million of the Kalitta Companies' pre-Merger debt as part of the acquisition of the Kalitta Companies, provide for $56 million of cash to acquire and modify two Boeing 747s, provide for $20 million of cash to acquire the Kalitta Companies, with the balance used for working capital and expenses incurred in connection with the acquisition.
Interest on the Notes is due on May 15 and November 15. The Notes are secured by a fleet of aircraft including nine Boeing 747s (including one in cargo modification), eight Lockheed L1011s and 13 Boeing 727s. At December 31, 1997 the carrying value of the aircraft securing the Notes is approximately $338 million. Each of the Company's subsidiaries are guarantors on the Notes, exclusive of the 60% limited partnership interest in AIC. In March 1998, the Company concluded an exchange offer for the Notes thereby exchanging the Notes for new 9.95% Senior Secured Notes due 2004 (the "New Notes"). The form and terms of the New Notes are identical to the Notes, except the New Notes are registered under the Securities Act of 1933 and therefore do not bear a legend restricting their transfer.
The Notes and the New Notes provide for certain covenants which limit the amount of indebtedness of the Company and its subsidiaries, restrict the payment of dividends, restrict the selling of subsidiary stock and provide for an interest coverage ratio. As of December 31, 1997, the Company was in compliance with all applicable covenants.
The New Notes are due in full in November 2004. However, at any time after November 15, 2001, the Company at its option may redeem the Notes based on a percentage of the principal balance plus accrued and unpaid interest. The redemption rates are: during the 12 month period beginning November 15, 2001, 104.975%, during the 12 month period beginning November 15, 2002, 102.488%, and during the 12 month period beginning November 15, 2003, 100%. Additionally, any time prior to November 15, 2000, the Company may redeem up to 35% of the original principal amount of the New Notes with the proceeds of one or more public offerings at a redemption price of 109.95% plus accrued and unpaid interest, provided that at least $150 million of aggregate principal amount of the New Notes remains outstanding after each redemption.
On November 19, 1997, the Company entered into a credit agreement (the "Credit Agreement") with a bank which provides for a $45.9 million Term Loan (the "Term Loan") and a $100 million Revolving Credit Facility (the "Revolver"). The proceeds of the Term Loan were used to fully refinance a note previously entered into in September 1997, the proceeds of which were used to acquire sixteen Boeing 727s from AIA prior to the acquisition of the Kalitta Companies (see Note 2). The Term Loan is due in sixteen quarterly principal installments of $2.25 million beginning in March 1999 with the balance due upon maturity in November 2002. The Term Loan bears interest at the Company's option at either prime plus 0% to 1.5% or LIBOR plus 0% to 3% (margins above prime and LIBOR are based on certain financial covenant performance as defined in the Credit Agreement). The applicable rate at December 31, 1997 was 8.97%.
Borrowings under the Revolver provide the Company with cash availability for working capital and general corporate purposes. Advances under the Revolver bear interest at the Company's option at either prime plus 0% to 1.25% or LIBOR plus 0% to 2.75% (margins above prime and LIBOR are based on certain financial covenant performance as defined in the Credit Agreement). The applicable rate at December 31, 1997 was 9.75%. At December 31, 1997, $10 million was outstanding under the Revolver which was subsequently paid off during January 1998. All principal balances outstanding under the Revolver are due in full upon maturity in November 2002. Balances drawn on the revolver are subject to certain borrowing base provisions as defined. In January 1998, the borrowing base provisions were amended to include additional eligible receivables and inventory. Available borrowings, as amended, were approximately $44.3 million.
KITTY HAWK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The balances outstanding under the Credit Agreement are secured by the sixteen Boeing 727s acquired from AIA (see Note 2) with a carrying value of approximately $55 million at December 31, 1997, cash, accounts receivable, rotable parts, inventory, intangibles and contract rights of the Company, and the stock of each of the Company's subsidiaries, including the Company's 60% interest in AIC. Each of the Company's subsidiaries are guarantors on the Credit Agreement, exclusive of AIC. Fees incurred in connection with the Credit Agreement of approximately $2.65 million are being amortized over a period of five years. The Credit Agreement allows for up to $20 million of outstanding letters of credit, subject to the borrowing base provisions, as defined. As of December 31, 1997, the Company had approximately $5.2 million of unused letters of credit available. Borrowings under the Credit Agreement are subject to certain financial covenants, including a funded debt to EBITDA ratio, a minimum net worth balance and cash flow coverage ratio.
The Company made cash interest payments of $1,088,928, $1,765,523, $3,129,864 and $664,164 during fiscal years ended 1995, 1996, the year ended December 31, 1997 and for the four months ended December 31, 1996, respectively.
5. INCOME TAXES
The provision for income taxes consists of the following:
The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to income before income taxes are as follows:
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The components of the net deferred tax liabilities recognized on the accompanying balance sheets are as follows:
At December 31, 1997, the Company's net deferred tax liability has increased from December 31, 1996 primarily as a result of the acquisition of the Kalitta Companies. The acquisition resulted in approximately $70.7 million of net deferred tax liabilities being recorded for the difference between the book basis and tax basis of the assets acquired and the liabilities assumed.
The Company made cash income tax payments of $4,552,371, $2,078,673, $3,629,043 and $571,420 during fiscal years 1995, 1996, the year ended December 31, 1997 and for the four months ended December 31, 1996, respectively.
6. COMMITMENTS AND CONTINGENCIES
In December 1996, the Company sold at cost two recently acquired and modified Boeing 727 aircraft to a third party and entered into an operating lease agreement for such aircraft commencing January 1, 1997, ending December 31, 1997, with monthly lease payments of approximately $252,000, with five successive one year renewal options. The Company has an option to purchase the aircraft at the end of each year, and guarantees to the lessor certain minimum sale values if the Company elects not to renew the lease or exercise its purchase option. On January 1, 1998, the Company elected to renew the lease for another year. Lease expense during fiscal year 1997 was approximately $3.03 million.
The Company also leases a Boeing 727 aircraft in cargo configuration under a seven year operating lease at a monthly rate of $50,000, which expires in 2003. Lease expense during 1997 was $450,000.
The Company's acquisition of the Kalitta Companies resulted in the Company leasing office buildings, hangars, cargo storage, and related facilities under noncancelable operating leases which expire on various dates through 2011. In addition, the Company periodically leases aircraft and other equipment under month-to-month lease agreements. Total rent expense incurred by the Kalitta Companies included in the 1997 results of operations was approximately $809,000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Minimum annual rentals at December 31, 1997 are as follows:
The Company currently licenses its sorting space for its overnight freight service at the Hulman Regional Airport in Terre Haute, Indiana from Roadway Global Air for a term which will expire in August 1998. Because of the growth in the volume of freight shipped in its domestic scheduled service, the lack of available expansion space and the limited airport facilities in Terre Haute, the Company plans to move this sorting center to Fort Wayne, Indiana in the spring of 1999. The Company has entered into discussions with the Hulman Regional Airport Authority to obtain an interim lease of its current space in Terre Haute until it is able to move to Fort Wayne. There is no assurance that the Company will be able to obtain an interim lease of its current space at Terre Haute.
The Company has firm purchase commitments to acquire hushkits for ten of its Boeing 727 aircraft for a total purchase price of up to $22.1 million.
Airline operators must comply with Federal Aviation Administration noise regulations primarily promulgated under the Airport Noise and Capacity Act of 1990 (the "Noise Regulations"). Currently, the Company is in compliance with the Noise Regulations. The Company owns 73 aircraft and leases 5 aircraft which are affected by the Noise Regulations of which 41 are currently in compliance with Stage III noise control standards of the Noise Regulations or are currently being modified to be in compliance with such standards by January 1, 2000. Any aircraft not in compliance may not be operated in the United States until it complies with such standards. European countries have similar regulations. The estimated cost of modifications to bring the Company's entire fleet into compliance is estimated to be between $80 million and $90 million including the modification to the Boeing 727 aircraft noted above.
The Company may elect not to modify certain aircraft to meet the standards because the estimated cost may exceed the economic benefits of such modifications. If the Company elects not to modify these aircraft, they must be removed from its fleet in the United States before January 1, 2000.
In February 1998, the Company purchased two Boeing 747s for approximately $39.6 million with the exchange of restricted cash. See Note 1. Upon delivery, the Company entered into a contract with a third party to modify the aircraft to cargo configuration at an approximate total cost of $26 million. Modification is expected to commence in June and August with completion scheduled in September and November, respectively. Until such time, the aircraft will be used in the passenger charter services operations. These two aircraft were pledged to secure a portion of the Notes.
The Company is aware of the presence of environmental contamination on properties that the Company acquired in connection with its acquisition of the Kalitta Companies. Pursuant to the merger agreement, the former owner of the Kalitta Companies, has agreed, subject to certain limitations, to indemnify the Company until May 19, 2001 against any losses arising with respect to environmental liabilities related to contamination at any of the Kalitta Companies facilities. In the opinion of management, none of the costs of responding to the presence of any such contamination that may be borne by the Company will have a material adverse affect on the Company's financial position or results of operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Service Bulletins and Directives issued under the FAA's "Aging Aircraft" program or issued on an ad hoc basis cause certain of the Company's aircraft to be subject to extensive aircraft examinations and require certain of the Company's aircraft to undergo structural inspections and modifications to address problems of corrosion and structural fatigue, among other things, at specified times. It is possible that additional Service Bulletins or Directives applicable to the Company's fleet could be issued in the future. The cost of compliance with such Directives and Service Bulletins cannot currently be estimated, but could be substantial.
The Company operates a fleet of 31 Boeing 727s, all of which were previously converted from passenger configuration to cargo configuration by the installation of a large cargo door and numerous interior modifications related to the installation of cargo container handling systems. The FAA has issued a proposed Directive, which if adopted, would limit the cargo capacity of 30 of these Boeing 727s until certain modifications are made. The costs to make such modifications and the amount of revenue that could be lost cannot currently be estimated. However, the Company believes this Directive will not have a material adverse effect on the Company.
7. LEGAL PROCEEDINGS
The United States Postal Service ("USPS") selected the Company's air freight carrier in September 1992 as the successful bidder on a contract for a multi-city network of air transportation services supporting the USPS Express Mail system. Two unsuccessful bidders sued the USPS to enjoin the award. The Company intervened. This litigation (the "ANET Litigation") was settled in April 1993 by agreements under which the USPS terminated the Company's contract for convenience and awarded the contract to the incumbent contractor, Emery Worldwide Airlines, Inc. ("Emery").
In March 1995, the Company was served with a complaint in a qui tam lawsuit filed on behalf of the U.S. Government by a third-party plaintiff seeking to share a recovery under the Federal False Claims Act (the "Act"). The suit, filed in May 1994, was filed under seal in accordance with the Act, to enable the U.S. Government to review the claim before its disclosure to the defendants. The U.S. Government declined to pursue the claim, but the third-party plaintiff chose to continue. The suit claimed that the Company and another defendant fraudulently failed to disclose to the USPS, both in the Company's successful bid and in the settlement of the ANET Litigation, that some of the aircraft the Company proposed to purchase and use to perform the contract were aging aircraft with high use, and claimed that the Company and Emery similarly fraudulently conspired in connection with the settlement of the ANET Litigation. The suit sought to recover treble the $10 million settlement payment made by the USPS in settling the ANET Litigation, plus the third party plaintiff's costs and fees.
The Company moved to dismiss the suit with prejudice on grounds that it was barred by the Act. The Company also sought to recover its attorneys' fees from the plaintiff and to obtain sanctions against the plaintiff's attorneys. The Company believes the suit was clearly frivolous because, among other things, the Company in the ANET bid identified each aircraft by serial number, age, hours and cycles, and made available use and maintenance records for each aircraft as required by the request for proposal, and that the USPS reviewed and inspected the aircraft, data and records and found them acceptable. In May 1996, the court dismissed the suit and awarded the Company its attorneys' fees and costs. The plaintiff has asked the court to reconsider its ruling. The Company does not expect the outcome of this matter to have a material adverse effect upon the Company's financial condition or results of operations.
In January 1996, the FAA issued a series of Airworthiness Directives (the "Directives") on certain Boeing 747 aircraft which were modified for freight hauling by GATX-Airlog Company, a subsidiary of General American Transportation Corp. ("GATX"). The Directives, which became effective on January 30, 1996, were issued because of concerns relating to the integrity of the cargo door and surrounding floor area in the event the aircraft were operated at their maximum cargo capacity of approximately 220,000 pounds. In spite of the fact that the aircraft affected by the Directives have flown over 83,000 hours without incident, the
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Directives require certain modifications to be made to the aircraft. Absent such modifications, the Directives limit the cargo capacity of these aircraft to 120,000 lbs., a limit which restricts the Company's ability to profitably operate the aircraft.
One of each of the Company's Boeing 747-200 and Boeing 747-100 freighters are affected by the Directives and have been out of service since January 1996. GATX has proposed a solution to the problem identified by one of the Directives which has been approved by the FAA. An appropriate means to test the proposed solution, however, has not yet been identified. Currently, the Company anticipates modifying one aircraft to be in compliance with a portion of the Directive for which the FAA has approved a solution by the second half of 1998, which will allow the Company to operate it with a reduced cargo capacity of 160,000 lbs. The Company is awaiting engineering solutions to address the remaining Directives. If the cost necessary to fully implement these solutions and return both the Boeing 747-100 and -200 to maximum cargo capacity is uneconomical, the Company may either operate one or both of the aircraft at limited loads or use one or both for spare parts. The Company is currently involved in litigation against GATX to recover the cost to repair these aircraft as well as revenues lost as a consequence of the aircraft downtime. Any amounts which are recovered from the litigation are first to be applied to reimburse the Company for its legal costs and then to correct the mechanical problems associated with the Boeing 747s. Any additional amounts will be allocated 10% to the Company and 90% to the former owner of the Kalitta Companies. In the event the amounts recovered by the Company, if any, are insufficient to reimburse the Company for its legal costs incurred in connection with this litigation, the former owner of the Kalitta Companies will reimburse the Company for the unreimbursed portion of its legal costs incurred after November 19, 1997.
Additionally, in the normal course of business, the Company is a party to matters of litigation, none of which, in the opinion of management, will have a material adverse effect on the Company's financial condition or the results of operations.
8. STOCKHOLDERS' EQUITY
In October 1994 the Company granted non-qualified options to two executives to purchase a total of 337,848 shares of common stock at $7.81 per share.
During the fiscal year ended August 31, 1996, the Company canceled 245,708 of the options outstanding and granted to an executive a non-qualified option to purchase 390,707 shares of common stock at $0.01 per share. The new option had a term of nine years and was fully vested. In June 1996, the Company canceled the remaining 92,140 options outstanding and granted to another executive a non-qualified option to purchase 153,567 shares of common stock at $0.01 per share. The new option had a term of nine years and was fully vested. On June 26, 1996, the executives fully exercised their options. Based on an independent appraisal commissioned by the Company, the fair value of the options of $4,230,954 is reflected as a charge to earnings in the accompanying statement of income for the year ended August 31, 1996. No additional options have been issued. Accordingly, no supplemental disclosures under SFAS No. 123 are necessary.
9. RELATED PARTY TRANSACTIONS
The Company leased its primary office and maintenance space in Dallas, Texas under an operating lease from a party who was a member of the Company's Board of Directors until August 1997. Rent expense under this lease was $252,595, $254,934, $21,000 and $84,305 for fiscal years 1995, 1996, the year ended December 31, 1997 and for the four months ended December 31, 1996, respectively. Under the lease agreement, the Company had the option to purchase the office facilities and the landlord's interest in the associated ground lease at any time prior to March 1, 1997 for consideration of $2,200,000, less $5,000 for each monthly rental payment made after March 1, 1993. Effective February 1997, the Company exercised its option and purchased the facility for $1.76 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As a result of the acquisition of the Kalitta Companies, one of the Company's vendors became a related party as the vendor is owned by a relative of the former owner of the Kalitta Companies. The Kalitta Companies also lease certain aircraft to this vendor as well as provide ground handling services in certain locations. Additionally, the Company uses this related company for subcharter flight and lift capacity for the Company's overnight scheduled cargo service. Total revenues earned during 1997 (subsequent to the acquisition of the Kalitta Companies) from this related company were approximately $379,000 with related accounts receivable of approximately $813,000. Subsequent to the acquisition of the Kalitta Companies, the Company incurred approximately $1.8 million of expenses with this related party and owed approximately $200,000 to this related party at December 31, 1997.
The Company leases an office facility through May 2007 from a company which is owned by the former owner of the Kalitta Companies and two of his relatives. The annual rent on this facility is $713,000.
The Company has entered into an agreement to sponsor the racing activities of a racing team owned by the former owner of the Kalitta Companies. The agreement provides for annual payments of up to $2 million for two years.
10. EMPLOYEE COMPENSATION PLANS AND ARRANGEMENTS
The Company has a retirement savings plan under Section 401(k) of the Internal Revenue Code which covers substantially all employees meeting minimum service requirements. Under the plan, voluntary contributions are made by employees and the Company provides matching contributions based upon the employees' contribution. The Company incurred $121,217, $159,967, $268,230 and $56,378 in matching contributions related to this plan during fiscal years 1995, 1996, the year ended December 31, 1997 and for the four months ended December 31, 1996, respectively. The Kalitta Companies have two separate 401(k) employee savings plans, covering substantially all employees. Company contributions are discretionary and were $40,000 in 1997.
The Company has adopted:
- An Omnibus Securities Plan (the "Plan") under which 300,000 shares of its common stock are reserved for issuance to its employees and members of the board of directors. The Plan is administered by the Company's Compensation Committee which may grant stock based and non-stock based compensation to the Plan participants. In March 1998, 6,840 total shares of common stock were issued to current and former members of the Board of Directors for services performed during 1996 and 1997 leaving 293,160 shares available under the plan.
- An Annual Incentive Compensation Plan (the "Compensation Plan") under which the Compensation Committee awards semiannual bonuses to employees of the Company. The aggregate amount of bonuses available for award is limited to 10% of the Company's income before income taxes and the bonuses to be paid under the Compensation Plan. The Company may elect to pay the full amount of the bonuses in common stock, which is limited to total stock distributions of 200,000 shares of common stock. As of December 31, 1996, 198,193 shares were available for distribution under the Compensation Plan.
- An Employee Stock Purchase Plan under which up to 100,000 shares of the Company's common stock are reserved for purchase by Company employees. In January 1998, 9,084 shares were issued under the plan, leaving 90,916 shares available under the plan.
11. SIGNIFICANT CUSTOMERS
The Company provided air logistics services to one customer which accounted for approximately 47%, 41%, 18% and 16% of its total revenues in fiscal years 1995, 1996, the year ended December 31, 1997 and for
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the four months ended December 31, 1996, respectively. The contract for these services is effective through May 31, 2000; however, such contract may be canceled by either party with 30 days notice. Another customer accounted for approximately 10%, 15%, 18% and 44% of the Company's total revenues in fiscal years 1995, 1996, the year ended December 31, 1997 and for the four months ended December 31, 1996, respectively. Related accounts receivable from this customer at December 31, 1996 and 1997 were approximately $27,086,000 and $44,468,000, respectively. The Company provided air freight carrier services to one customer which accounted for approximately 18% and 12% of its total revenues in the year ended December 31, 1997 and for the four months ended December 31, 1996.
12. EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per share:
The weighted average number of common shares outstanding during the years ended August 31, 1995 and 1996 include the effect of options to purchase 390,707 and 153,567 shares of the Company's common stock at $0.01 granted to certain executives in December 1995 and June 1996, respectively, in accordance with Securities and Exchange Commission Staff Accounting Bulletin 98.
On June 28, 1996 the Company approved a 1.2285391-for-1 stock split effected as a stock dividend. All references to common stock and per share data have been restated to give effect to the split.
13. COLLECTIVE BARGAINING AGREEMENTS
Approximately 15% of the Company's employees, consisting of pilots and flight engineers, (as successor to the Kalitta Companies) are members of the Teamsters Union and are employed pursuant to a Collective Bargaining Agreement. The Collective Bargaining Agreement became amendable on August 29, 1997, but remains in effect while the parties are in negotiations for a successor collective bargaining agreement. Pilots and flight engineers subject to the agreement are guaranteed pay based upon a minimum of 60 block hours per month. The agreement requires that all flight crew personnel must meet minimum qualifications and includes typical seniority, furlough, grievance, group health insurance, sick leave and vacation provisions. The seniority provisions require that the most senior flight crews have the opportunity to operate larger aircraft or move to new crew positions as aircraft or crew positions become available by reason of flight crew attrition or aircraft acquisitions. As a consequence, the contract obligates to Company to incur costs to retrain crews as they advance in seniority and progress to new aircraft or crew positions. In addition, the Company may incur costs to train flight crews to fill positions vacated by more senior flight crews. The Collective Bargaining Agreement provides that so long as the agreement is in effect, the Teamsters Union will not authorize a strike and the Company (as successor to the Kalitta Companies) will not lockout union employees. Although the Company and the Teamsters Union have commenced "interest-based" bargaining, there can be no assurance that a new Collective Bargaining Agreement can be reached or that negotiations will not result in work stoppages, substantial increases in salaries or wages, changes in work rules or other changes adverse to the Company.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
The following sets forth the unaudited pro forma consolidated statement of operations for each of the four quarters in the year ended December 31, 1997 and for the years ended December 31, 1996 and 1997, in each case giving effect to the acquisition of the Kalitta Companies, the issuance of the Notes, Term Loan, and the acquisition of the sixteen Boeing 727s from the Kalitta Companies as if each of the transactions had been consummated at the beginning of 1996 and 1997 for each of the respective years. This information is presented for illustrative purposes only and does not purport to present the results of operations of the Company had these transactions occurred on the dates indicated, nor are they necessarily indicative of the consolidated results of operations which may be expected to occur in the future.
No pro forma adjustments have been applied to reflect (i) revenues or operating costs expected to be generated from the Boeing 747s recently purchased and being modified with approximately $56 million of the net proceeds from the Notes or (ii) operating efficiencies or cost savings (other than approximately $1.5 million of insurance savings) expected to result from the Merger. In addition, pro forma results have not been adjusted to eliminate abnormally high engine maintenance expenses, costs incurred to add and maintain flight crews in anticipation of increased air freight carrier business which has not yet materialized in part due to delays in acquiring aircraft and start-up costs associated with establishing the Kalitta Companies' wide-body passenger charter business.
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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(1) Adjusted EBITDA is calculated as income (loss) before minority interest, income taxes, interest expense and depreciation and amortization. Adjusted EBITDA excludes approximately $4,231 from stock options granted to executives in 1996.
INDEX TO EXHIBITS
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* Filed herewith.
** This exhibit is a management contract or compensatory plan or arrangement.