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International Airline Support Group Inc – ‘10-K’ for 5/31/01

On:  Wednesday, 8/29/01   ·   For:  5/31/01   ·   Accession #:  859307-1-500010   ·   File #:  1-12893

Previous ‘10-K’:  ‘10-K/A’ on 6/7/01 for 5/31/00   ·   Next & Latest:  ‘10-K’ on 8/29/02 for 5/31/02

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  As Of                Filer                Filing    For·On·As Docs:Size

 8/29/01  Int’l Airline Support Group Inc   10-K        5/31/01    5:217K

Annual Report   —   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        10K Iasg                                              54    296K 
 5: EX-10       Employment Murnane                                    11±    50K 
 2: EX-10       Empolyment Dyer                                       11±    51K 
 4: EX-99       Auditor Consent                                        1      5K 
 3: EX-99       Miscellaneous Exhibit -- schedule2                     2      9K 


10-K   —   10K Iasg
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
4Item 1. Business
13Cautionary Statements
15Item 2. Properties
16Item 3. Legal Proceedings
"Item 4. Submission of Matters to A Vote of Security Holders
17Item 5. Market for the Registrant's Common Stock and Related Stockholder
18Item 6. Selected Financial Data
19Item 7. Management's Discussion and Analysis of Financial Condition and Results
22Item 7A. Quantitative and Qualitative Disclosures About Market Risk
"Item 8. Financial Statements and Supplementary Data
"Item 9. Changes and Disagreements With Accountants on Accounting And
23Item 10. Directors and Executive Officers of the Registrant
"Item 11. Executive Compensation
"Item 12. Security Ownership of Certain Beneficial Owners and Management
"Item 13. Certain Relationships and Related Transactions
24Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-Kitem
37Air 41 Joint Venture
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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended MAY 31, 2001 -------------- [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ____________________ to _______________________ Commission File Number 0-18352 ------- INTERNATIONAL AIRLINE SUPPORT GROUP, INC. ---------------------------------------------------- (Exact name of Registrant as specified in its charter) Delaware 59-2223025 -------- ---------- (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) ------------------------------ ------------------------------------ 1954 Airport Road, Suite 200, Atlanta, Georgia 30341 (Address of Principal Executive Offices) (Zip Code) ---------------------------------------- ---------- (770) 455-7575 ---------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of class Name of each exchange on which registered Common Stock, $.001 par value American Stock Exchange ----------------------------- ----------------------- Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] At August 7, 2001, the aggregate market value of common stock held by non-affiliates of the Registrant was approximately $1,728,924. The number of shares of the Registrant's Common Stock outstanding as of August 10, 2001 was 2,021,498. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement for the 2001 Annual Meeting of the Company's Stockholders are incorporated by reference in Parts III and IV.
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INTERNATIONAL AIRLINE SUPPORT GROUP INC. ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED MAY 31, 2001 TABLE OF CONTENTS ----------------- PAGE ---- PART I Item 1. Business 1 Item 2. Properties 12 Item 3. Legal Proceedings 13 Item 4. Submission of Matters to a Vote of Security Holders 13 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters 14 Item 6. Selected Financial Data 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 19 Item 8. Financial Statements and Supplementary Data 19 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 19 PART III Item 10. Directors and Executive Officers of the Registrant 20 Item 11. Executive Compensation 20 Item 12. Security Ownership of Certain Beneficial Owners and Management 20 Item 13. Certain Relationships and Related Transactions 20 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 21 SIGNATURES
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PART I ITEM 1. BUSINESS. ------- -------- THIS ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"), INCLUDING THE PLANS AND OBJECTIVES OF MANAGEMENT FOR THE BUSINESS, OPERATIONS AND FINANCIAL PERFORMANCE OF THE COMPANY. THE FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS SET FORTH IN THIS ANNUAL REPORT MAY INCLUDE OR RELATE TO, AMONG OTHER THINGS, (I) INCREASING THE COMPANY'S MARKET SHARE OF PARTS FOR CERTAIN COMMERCIAL JET AND COMMUTER AIRCRAFT, WHILE MAINTAINING ITS POSITION AS A LEADING REDISTRIBUTOR OF PARTS FOR MD-80 AND DC-9 AIRCRAFT, (II) POTENTIAL ACQUISITIONS OF ADDITIONAL INVENTORIES OF AIRCRAFT SPARE PARTS AND THE ACQUISITION OF OTHER COMPANIES, ASSETS OR PRODUCT LINES THAT WOULD COMPLEMENT OR EXPAND THE COMPANY'S EXISTING AIRCRAFT SPARE PARTS BUSINESS, (III) DEMAND AMONG THE COMPANY'S PRINCIPAL CUSTOMERS, INCLUDING CARGO CARRIERS AND REGIONAL COMMERCIAL AIRLINES, FOR THE COMPANY'S INVENTORY OF PARTS, (IV) THE DEMAND FOR DC-9 AIRCRAFT, WHICH WILL DETERMINE THE SUCCESS OF THE COMPANY'S JOINT VENTURE'S EFFORTS TO REMARKET ITS AIRCRAFT; (V) THE SIZE AND GROWTH RATE OF THE AIRCRAFT PARTS REDISTRIBUTION INDUSTRY AND THE AIRCRAFT AND ENGINE LEASING INDUSTRY, (VI) INCREASES OR CHANGES IN GOVERNMENT REGULATIONS REGARDING THE AVIATION INDUSTRY, (VII) COMPETITION FROM OTHER AIRCRAFT PARTS REDISTRIBUTORS, (VIII) THE EXPANSION OF THE COMPANY'S PRODUCT LINES, (IX) THE AVAILABILITY OF CAPITAL TO OPERATE EFFECTIVELY, (X) THE COMPANY'S ABILITY TO MANAGE ITS DEBT AND COMPLY WITH THE FINANCIAL COVENANTS IN ITS CREDIT FACILITY, AND (XI) OPERATION OF A PART 135 AIR CARRIER, IN WHICH THE COMPANY HAS A SIGNIFICANT INTEREST. SEE "CAUTIONARY STATEMENTS" HEREIN. THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN ARE BASED UPON CURRENT EXPECTATIONS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. THESE FORWARD-LOOKING STATEMENTS ARE BASED UPON ASSUMPTIONS THAT THE COMPANY WILL CONTINUE TO MANAGE ITS INVENTORY EFFECTIVELY, THAT COMPETITIVE CONDITIONS WITHIN THE AIRCRAFT PARTS REDISTRIBUTION INDUSTRY WILL NOT CHANGE MATERIALLY OR ADVERSELY, THAT DEMAND FOR AIRCRAFT SPARE PARTS WILL REMAIN STRONG, THAT THE COMPANY WILL BE ABLE TO ENTER INTO NEW LEASES OF AIRCRAFT AS EXISTING LEASES EXPIRE, THAT THE COMPANY'S JOINT VENTURE WILL BE ABLE TO REMARKET ITS AIRCRAFT AS THEY COME OFF LEASE ON FINANCIAL TERMS THAT WILL PERMIT THE JOINT VENTURE TO SERVICE ITS INDEBTEDNESS, THAT THE COMPANY WILL BE ABLE TO PURCHASE AIRCRAFT THAT ARE SUBJECT TO LEASES, THAT THE AIR CARRIER IN WHICH THE COMPANY HAS A SIGNIFICANT INTEREST WILL BE ABLE TO OPERATE PROFITABLY, THAT THE COMPANY WILL HAVE ACCESS TO SUFFICIENT CAPITAL AT COMPETITIVE RATES, THAT THE COMPANY WILL BE ABLE TO COMPLY WITH ITS DEBT COVENANTS AND THAT THERE WILL BE NO MATERIAL ADVERSE CHANGE IN THE COMPANY'S BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS AND FUTURE BUSINESS DECISIONS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT ACCURATELY AND MOST OF WHICH ARE BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, ANY OF THE ASSUMPTIONS COULD PROVE INACCURATE AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT THE RESULTS CONTEMPLATED IN SUCH FORWARD-LOOKING INFORMATION WILL BE REALIZED. IN ADDITION, AS DISCLOSED ABOVE, THE BUSINESS AND OPERATIONS OF THE COMPANY ARE SUBJECT TO SUBSTANTIAL RISKS THAT INCREASE THE UNCERTAINTY INHERENT IN SUCH FORWARD-LOOKING STATEMENTS. ANY OF THE OTHER FACTORS DISCLOSED ABOVE COULD CAUSE THE COMPANY'S REVENUES OR NET EARNINGS, OR GROWTH IN REVENUES OR NET EARNINGS, TO DIFFER MATERIALLY FROM PRIOR RESULTS. FURTHERMORE, A CHANGE IN THE MARKET FOR AIRCRAFT AND ENGINE PARTS COULD RESULT IN THE COMPANY'S INVENTORY BEING OVERVALUED AND COULD REQUIRE THE COMPANY TO WRITE DOWN ITS INVENTORY VALUATIONS IN ORDER TO BRING THEM IN LINE WITH THE REVISED FAIR MARKET VALUE. THERE IS NO ASSURANCE THAT A WRITE-DOWN WOULD NOT ADVERSELY AFFECT THE COMPANY'S BUSINESS, OPERATING RESULTS OR FINANCIAL CONDITION OR ITS ABILITY TO COMPLY WITH ITS DEBT COVENANTS. GROWTH IN ABSOLUTE AMOUNTS OF COST OF SALES AND GENERAL AND ADMINISTRATIVE EXPENSES OR THE OCCURRENCE OF EXTRAORDINARY EVENTS COULD CAUSE ACTUAL RESULTS TO VARY MATERIALLY FROM THE RESULTS CONTEMPLATED IN THE FORWARD-LOOKING STATEMENTS. BUDGETING AND OTHER MANAGEMENT DECISIONS ARE SUBJECTIVE IN MANY RESPECTS AND THUS SUSCEPTIBLE TO INTERPRETATIONS AND PERIODIC REVISIONS BASED ON ACTUAL EXPERIENCE AND BUSINESS DEVELOPMENTS, THE IMPACT OF WHICH MAY CAUSE THE COMPANY TO ALTER ITS MARKETING, CAPITAL EXPENDITURE OR OTHER BUDGETS, WHICH MAY IN TURN AFFECT THE COMPANY'S RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING INFORMATION INCLUDED HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL BE ACHIEVED. - 1 -
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GENERAL The Company is a leading redistributor of aftermarket aircraft spare parts used primarily for McDonnell Douglas MD-80 and DC-9 aircraft and commuter turboprop aircraft. Management believes that the Company has one of the most extensive inventories of aftermarket MD-80, DC-9 and Embraer EMB-120 Brasilia parts in the industry. In addition, the Company provides aircraft spare parts for Airbus, Boeing, Lockheed and other McDonnell Douglas and commuter turboprop aircraft. The aircraft spare parts distributed by the Company, including avionics, rotable and expendable airframe and engine parts, are sold to a wide variety of domestic and international air cargo carriers, major commercial and regional passenger airlines, maintenance and repair facilities and other redistributors. The wide variety of aircraft spare parts distributed by the Company are acquired through purchase or consignment of surplus or bulk inventories from airlines, purchases from other redistributors and disassembly of aircraft. In addition to being a provider of aircraft spare parts, the Company leverages its industry expertise to purchase, sell and lease aircraft and engines. The Company has periodically acquired, leased and sold a variety of narrow-body commercial jet aircraft, such as Boeing 727 and 737 and McDonnell Douglas MD-80 and DC-9 aircraft, as well as commuter turboprop aircraft, such as Embraer EMB-120 aircraft. The Company currently owns nine Embraer EMB-120 aircraft, five of which are leased and one of which is being disassembled for parts. The Company derives revenue from lease payments and seeks to sell spare parts to the lessee both for the leased aircraft as well as other aircraft in the lessee's fleet. Upon return of the aircraft, the Company either re-leases, sells or disassembles the aircraft for parts in order to achieve the highest utilization of the asset. The Company believes that its aircraft trading activities and its parts redistribution business complement one another. As access to capital in the aircraft parts redistribution industry becomes more difficult, the Company's ability to trade and to lease aircraft successfully could be adversely impacted. The Company also owns a 50% interest in a joint venture that owns 20 DC-9-41H aircraft. Sixteen of the aircraft are leased to Scandinavian Airlines System ("SAS"); one is leased to another European operator; and three are currently being held for lease. The joint venture expects to derive revenue from lease payments with respect to such aircraft and from the re-lease or sale of the aircraft following the expiration of the leases with SAS. The Company believes that its investment in this joint venture complements its parts redistribution and aircraft sales and leasing businesses by providing a high quality source of aircraft for further releasing, sales and/or parting out. While the joint venture is actively pursuing the marketing of the aircraft as they are returned off-lease, there can be no assurances that the aircraft will be successfully re-leased. The Company's other business activities include providing advisory services to air carriers on parts-inventory disposition and an equity interest in a regional airline. The Company's advisory services and the equity interest in the regional airline complement its parts sales and aircraft trading and leasing activities by enhancing the Company's reputation as an industry expert in commercial jet and turboprop parts and operations. The Company's strategy is to capitalize upon its position as a leading redistributor of MD-80, DC-9 and commuter turboprop aircraft spare parts and broaden its product lines to include other high-use aircraft as the world fleet grows. Key elements of the Company's strategy include: - Increase Sales to Cargo Carriers, Regional Commercial Airlines and Commuter Airlines - Broaden Product Line - Utilize Consignment Agreements to Acquire Inventory - Seek Additional Bulk Purchase Opportunities - Continued Commitment to Quality and Technological Innovation - Pursue Strategic Acquisitions - 2 -
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COMPANY HISTORY The Company was founded in 1982 in Miami, Florida. Initially the Company focused on parting out DC-8 aircraft and reselling the resulting spare parts. Based upon the Company's success in parting out DC-8 aircraft, in 1991 the Company began purchasing and parting out DC-9 and MD-80 aircraft. Beginning in 1992, the Company began purchasing and parting out Boeing 727 aircraft. Since its founding, the Company has acquired over 50 aircraft for parting out. The Company has also engaged in aircraft and engine trading throughout its history. Beginning in fiscal 1999, the Company broadened its product lines by acquiring significant parts inventories for McDonnell Douglas DC-10, Boeing 747 and Embraer EMB-120 aircraft. The Company also expanded its aircraft trading activities during fiscal 1999 and 2000, completing the purchase of eight and the sale of two EMB-120 aircraft. During fiscal 2000, the Company established a presence in Europe, establishing a sales office in France and a distribution center in the Netherlands. INDUSTRY OVERVIEW The Company believes that the annual worldwide market for aircraft spare parts is approximately $11 billion, of which approximately $1.3 billion represents sales of aircraft spare parts to the redistribution market. The Company does not expect growth in the aircraft spare parts redistribution market in the foreseeable future. The Company's customers include a wide variety of domestic and international air cargo carriers, major commercial, regional and commuter passenger airlines, maintenance and repair facilities and other redistributors. As a result, the Company's business can be impacted by the economic factors that affect the airline and air cargo industries. When such factors adversely affect the airline and air cargo industries, they tend to cause reduced demand for aircraft spare parts, downward pressure on the pricing for aircraft spare parts and increased credit risk associated with doing business with airlines and air cargo carriers. Additionally, factors such as the price of fuel affect the aircraft spare parts market for older aircraft, since older aircraft become less competitive with newer model aircraft as the price of fuel increases. Because of the current economic environment, a number of companies in the aircraft parts redistribution industry have encountered financial difficulties. Consequently, many of these companies have been forced to sell inventory at reduced prices in order to generate cash, while many others have simply gone out of business with their creditors liquidating their inventories. The net effect of both of these actions is to put significant pricing pressure on the Company's products. The Company is not immune to a decline in the aviation industry or the economic woes of some of our competitors and there can be no assurance that these factors will not have a material adverse effect on the Company's business, financial condition and results of operations. However, for the survivors in the aircraft spare parts redistribution industry, the Company sees the following opportunities: Reduction in Number of Approved Suppliers. Cost considerations cause many aircraft operators to reduce the size of their spare parts inventories, while efficiency and quality concerns may cause aircraft operators to maintain relationships with a more limited number of approved suppliers. Quality concerns are causing aircraft operators to demand that their suppliers be quality certified by organizations such as the Airline Suppliers Association ("ASA") or the International Standards Organization ("ISO") and at least one major commercial airline has begun to demand that its suppliers carry product liability insurance. In addition, as aircraft operators adopt just-in-time inventory procurement processes, inventory storage is increasingly handled by suppliers such as the Company. The Company believes that these trends will continue in the future and will benefit well-positioned aircraft parts suppliers such as the Company. Increased Inventory Consignment. Certain of the Company's customers adjust inventory levels on a periodic basis by disposing of excess aircraft spare parts. Traditionally, larger airlines have used internal sales agents to manage such dispositions. The Company believes that major airlines and other owners of aircraft spare parts, as well as financial institutions that have taken possession of spare parts used as collateral, in order to concentrate on their core businesses and to more effectively monetize their excess parts and inventories, are increasingly entering into long-term consignment agreements with redistributors. By consigning inventories through a redistributor such as the Company, customers are able to offer their aircraft spare parts to a larger number of prospective inventory buyers, allowing the customer to maximize the value of its inventory. Consignment also enables a consignee to offer for sale significant parts and inventory at minimal capital cost. Modernization of Commuter Fleets. Many of the larger regional commuter airlines are modernizing their fleets by retiring their turboprop aircraft and acquiring short-range commuter jet aircraft. As a result, the retired commuter turboprop aircraft and related spare parts inventories are available for purchase at favorable prices. The Company believes that smaller regional commuter airlines will upgrade their fleets by replacing the small turboprop aircraft they currently operate with larger, more efficient turboprop aircraft being retired by the larger regional commuter airlines. Accordingly, the Company believes that small regional commuter airlines are potential customers for the aircraft and related spare parts being retired by the larger regional commuter airlines. The Company also believes that there is a significant opportunity for the redeployment of certain types of the commuter turboprop aircraft as cargo aircraft. - 3 -
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COMPANY STRATEGY The Company's strategy is to capitalize upon its position as a leading redistributor of MD-80, DC-9 and commuter turboprop aircraft spare parts and to broaden its product lines to include other high-use aircraft as the world fleet grows. Key elements of the Company's strategy include: Increase Sales to Cargo Carriers, Regional Commercial Airlines and Commuter Airlines. Cargo carriers, regional commercial airlines and commuter airlines are among the Company's principal customers. Cargo carriers are important customers because the fleets of such operators typically consist of older aircraft of the type for which the Company maintains an extensive inventory of parts. Additionally, such customers typically do not maintain extensive inventories of spare parts. Regional commercial airlines are important customers because such airlines favor narrow-body aircraft, such as MD-80 and DC-9 aircraft, for which the Company is a primary source of spare parts. The smaller commuter airlines are important customers because their fleets consist primarily of the turboprop aircraft being retired by the larger commuter airlines. The Company has acquired an extensive inventory of aftermarket parts for several popular commuter turboprop aircraft types. The Company will direct its marketing activities to broadening its customer base of cargo, regional and commuter airlines in order to increase market share and leverage its core competencies. Broaden Product Line. Historically, the Company has been a leading distributor of MD-80 and DC-9 spare parts. The Company has expanded its product line to include aftermarket parts for Airbus A-300, McDonnell Douglas DC-10 and Boeing 747 aircraft and certain commuter aircraft including Embraer, Shorts, Saab, de Havilland, British Aerospace and ATR aircraft. In addition, the Company intends to expand further its product line to include parts for other aircraft that are likely to be converted to freighters, such as Boeing 767 and 757 aircraft. As fleets of these aircraft age and as air cargo carriers transition larger portions of their fleets to wide-body aircraft, the Company will seek to capitalize on the demand for parts resulting from the aging and continued use of these aircraft models. Several air cargo carriers currently utilize DC-10, 767, 747 and A-300 series aircraft, and the Company believes use of these models will continue to increase. The Company believes that a significant number of these aircraft types have been or will be converted to cargo use and that its relationship with cargo carriers will provide an advantage in supplying parts for these aircraft to such customers. The Company also believes that there is a significant opportunity for the redeployment of the Embraer EMB-120 and ATR aircraft as cargo aircraft, as commuter carriers convert their fleets to small jet aircraft. The Company has acquired service bulletin kits that will permit the conversion of 20 EMB-120 aircraft to either full cargo or quick-change configurations. The Company has converted three of the eight (non-partout) EMB-120 aircraft that it owns to full cargo configuration. The Company intends to convert its remaining EMB-120 aircraft if customer demand for the EMB-120 cargo variant justifies the conversion cost. Utilize Consignment Agreements to Acquire Inventory. In recent years, the Company acquired most of its aircraft parts inventory by purchasing large numbers of parts in bulk from aircraft operators. The Company has recently begun to acquire inventory by means of strategic consignment arrangements. Pursuant to a consignment arrangement, an aircraft operator or financial institution permits the Company to market and sell an inventory of aircraft parts. The Company receives a percentage of the sales price of a consigned part. Consignment arrangements allow the Company to obtain parts inventory on a favorable basis without committing its capital to purchasing inventory. The Company's margins on sales of consigned parts are, however, typically lower than margins realized on sales of parts acquired by other methods. The Company believes that its market presence, experience in evaluating parts inventories, sophisticated management information systems and capital strength will enable the Company to enter into additional consignment arrangements. - 4 -
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Seek Additional Bulk Purchase Opportunities. The Company will continue to seek opportunities to purchase large spare parts inventories in bulk. The Company cannot predict when such opportunities will arise and such opportunities are dependent on the Company's ability to successfully access capital. Bulk purchase opportunities arise when airlines, in order to reduce capital requirements, sell large amounts of inventory in a single transaction, when inventories of aircraft spare parts are sold in conjunction with corporate restructurings or reorganizations or when an aircraft operator realigns its aircraft fleet, reducing the number of or exiting a particular aircraft model. Bulk inventory purchases allow the Company to obtain large inventories of aircraft spare parts at a lower cost than can ordinarily be obtained by purchasing parts on an individual basis. Therefore, the Company typically realizes higher gross margins on sales of parts acquired by bulk purchases, as opposed to other methods. However, bulk inventory purchases require a commitment of the Company's capital. The Company believes that it has the ability, due to its market presence, experience in evaluating parts inventories, sophisticated management information systems and capital strength, to complete large bulk purchase opportunities to the extent such purchases are considered favorable. Continued Commitment to Quality and Technological Innovation. The Company emphasizes adherence to high quality standards during each stage of its operations (product acquisition, documentation, inventory control and delivery). In August 1997, the ASA, an FAA-recognized independent quality assurance organization, accredited the Company as an aftermarket supplier. In addition, the Company believes it was one of the first aftermarket redistributors to bar-code its inventory and it has created and sponsors an industry-wide Internet parts locator service for its customers, which heightens awareness of the Company, enhances its position in the industry and increases sales of parts. Pursue Strategic Acquisitions. The Company competes in a fragmented market in which numerous small companies serve distinct market niches. The Company believes that small aftermarket parts redistributors, many of which are family-owned or capital constrained, are unable to provide the extensive inventory and quality control measures necessary to comply with applicable regulatory and customer requirements, and will provide acquisition opportunities for the Company. Similarly, the Company believes that many small aircraft leasing companies are potential acquisition targets. Acquisitions are expected to increase the Company's customer base, expand its product line both with respect to aircraft in which the Company currently specializes and into new aircraft types, to strengthen its relationships with existing customers through availability of additional inventory and permit the Company to expand its aircraft trading opportunities. Any opportunity to pursue strategic acquisitions is dependent upon the Company's ability to successfully access capital. AIRCRAFT SPARE PARTS Aircraft spare parts can be categorized by their ongoing ability to be repaired and returned to service. The general categories are as follows: (i) rotable; (ii) repairable and (iii) expendable. A rotable is a part which is removed periodically as dictated by an operator's maintenance program or on an as-needed basis and is typically repaired or overhauled and re-used an indefinite number of times. An important subset of rotables is life limited parts. A life limited rotable has a designated number of allowable flight hours and/or cycles (one take-off and landing generally constitutes one cycle) after which it is rendered unusable. A repairable is similar to a rotable except that it can only be repaired a limited number of times before it must be discarded. An expendable is generally a part which is used and not thereafter repaired for further use. Aircraft spare parts' conditions are classified within the industry as (i) factory new, (ii) new surplus, (iii) overhauled, (iv) serviceable and (v) as removed. A factory new or new surplus part is one that has never been installed or used. Factory new parts are purchased from manufacturers or their authorized distributors. New surplus parts are purchased from excess stock of airlines, repair facilities or other redistributors. An overhauled part has been completely disassembled, inspected, repaired, reassembled and tested by a licensed repair facility. An aircraft spare part is classified serviceable if it is repaired by a licensed repair facility rather than completely disassembled as in an overhaul. A part may also be classified serviceable if it is removed by the operator from an aircraft or engine while operating under an approved maintenance program and is functional and meets any manufacturer or time and cycle restrictions applicable to the part. With appropriate documentation, a factory new, new surplus, overhauled or serviceable part designation indicates that the part can be immediately utilized on an aircraft. A part in as removed - 5 -
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condition requires functional testing, repair or overhaul by a licensed facility prior to being returned to service in an aircraft. The aircraft spare parts sold by the Company include avionics, rotable and expendable airframe and engine parts for commercial aircraft. Currently, the Company specializes in replacement parts for MD-80, DC-9 and commuter turboprop aircraft and management believes that the Company has one of the most extensive inventories of aftermarket MD-80, DC-9 and EMB-120 parts in the industry. Currently, the Company has approximately 230,000 inventory line items (an increase from approximately 85,000 line items at the end of fiscal 2000, primarily due to consignment inventories), many of which represent multiple unit quantities and relate to the MD-80, DC-9 and EMB-120 aircraft. Many of these parts, such as avionics and engine parts, can also be used by a wide variety of aircraft other than MD-80, DC-9 and EMB-120 aircraft. In addition to the Company's inventory of MD-80, DC-9 and EMB-120 parts, the Company's inventory also includes spare parts for Boeing 727, 737 and 747 aircraft, Lockheed L-1011 aircraft, McDonnell Douglas DC-8 and DC-10 aircraft, and Airbus, Shorts, Saab, de Havilland, British Aerospace and ATR aircraft and for the Pratt & Whitney JT8D engine series. OPERATIONS OF THE COMPANY The Company's core business is buying and selling aircraft spare parts. In addition, the Company engages in the sale and leasing of aircraft and engines, provides advisory services to air carriers and through a minority-owned subsidiary, operates a regional air cargo airline. Inventory Acquisition. The Company acquires parts inventory by means of strategic consignment arrangements, by purchasing individual parts from airlines, repair facilities or other redistributors, by purchasing excess inventory from aircraft operators or by purchasing aircraft for disassembly. The Company may also fill a customer order for a part not held in the Company's inventory by locating the part for the customer from another vendor, purchasing the part and then reselling the part to the customer. The Company obtains inventory on consignment from or purchases inventory in bulk from airlines that are eliminating certain portions of their spare parts inventory due to the retirement of an aircraft type from their fleets, implementing inventory reduction programs to reduce costs, downsizing their operations or ceasing to conduct business. Aircraft and Engine Sales and Leasing. The Company has determined that its spare parts sales opportunities are enhanced by providing existing and new customers with whole aircraft and engines through sale and lease transactions. Such transactions allow the Company to expand its customer base for spare parts and, through leasing, to reduce the cost basis in its aircraft and engines. The Company derives revenue from lease payments and seeks to sell spare parts to the lessee both for the leased aircraft as well as other aircraft in the lessee's fleet. Upon return of the aircraft, the Company either re-leases, sells or disassembles the aircraft for parts in order to achieve the highest utilization of the asset. The success of the Company's aircraft and engine sales and leasing is dependent on the Company's ability to successfully access capital. The Company currently owns nine Embraer EMB-120 aircraft, five of which are leased and one of which is being disassembled for parts. Three of the aircraft are leased to NSA, a regional airline in which the company has a significant investment. The Company's aircraft leases are operating leases rather than finance leases and expire between September 2003 and February 2004. Under an operating lease, the Company retains title to the aircraft or engine, thereby retaining the potential benefits and assuming the risk of the residual value of the aircraft or engine. Operating leases allow aircraft operators greater fleet and financial flexibility due to their shorter-term nature, the relatively small initial capital outlay necessary to obtain use of the aircraft or engine and off-balance sheet accounting treatment. The Company currently focuses on leasing commuter turboprop aircraft, particularly the EMB-120. During the second quarter of fiscal 1999, the Company entered into a joint venture (the "Air 41 Joint Venture") for the acquisition of 20 DC-9-41H aircraft from SAS. The aircraft were leased back to SAS and the leases had an average term of 39 months. The Company's original investment in the Air 41 Joint Venture was approximately $1.4 million. The aircraft were financed through the joint venture, utilizing non-recourse debt to the partners. The Company's Air 41 Joint Venture partner is AirCorp, Inc., a privately held company. The Company is exploring opportunities for the aircraft after the end of the term of the leases with SAS. In this regard, the Air 41 Joint Venture has engaged an aircraft portfolio management firm to remarket the aircraft. Such opportunities include releasing the aircraft to SAS, leasing the aircraft to one or more different lessees, selling the aircraft, parting out the aircraft, or directly - 6 -
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placing the aircraft into either passenger or cargo service. SAS currently leases sixteen of the aircraft and has returned four of the aircraft to the Air 41 Joint Venture. One of the returned aircraft is currently leased to another European operator, while the other three aircraft have not been re-leased or sold. Air Carrier Operations. During the fourth quarter of fiscal 2000, the Company acquired a small regional airline, North-South Airways, Inc. ("NSA"), that operated three piston light twin and two light turboprop Part 23 aircraft under an Air Carrier Certificate under Part 135 of the FAA regulations. The Company paid $125,000, plus certain contingent consideration, including assuming the debt relating to the aircraft, for the airline. The Company expanded NSA's fleet with the addition of cargo and passenger EMB-120 aircraft. NSA leases these new aircraft from the Company. During the second quarter of fiscal 2001, NSA sold additional shares of stock raising approximately $1,000,000. This sale of stock reduced the Company's ownership interest in NSA from 100% to approximately 35%. Accordingly, commencing September 1, 2000, the Company is accounting for its investment in NSA under the equity method. SALES AND MARKETING; CUSTOMERS The Company has developed a sales and marketing infrastructure which includes well-trained and knowledgeable sales personnel, computerized inventory management, listing of parts in electronic industry data bank catalogues and a home page on the Internet. Crucial to the successful marketing of the Company's inventory is the Company's ability to make timely delivery of spare parts in reliable condition. The Company believes aircraft operators are more sensitive to reliability and timeliness than price. During fiscal 2000 the Company established a presence in Europe by opening a sales office in Nantes, France, and a distribution center at Schipohl Airport in the Netherlands. The distribution center is managed for the Company by KLM Aerospace Logistics Group, which provides all shipping and logistics services necessary for the delivery of parts to the Company's European customers. In addition to directly marketing its inventory, the Company has created and sponsors an industry-wide internet parts locator service, which is found at http:\\www.ipls.com. The Company's internet service is a free service available to any potential customer and lists all of the inventory available for sale by the Company. In order to increase its value to potential customers, the Company's Internet service also lists the inventory of over 100 additional aftermarket parts redistributors, representing more than 1.2 million individual parts. Similarly, the Company lists its inventory in the Air Transport Association's computerized databank ("AIRS") and with the Inventory Locator Service ("ILS") proprietary computerized databank. Buyers of aircraft spare parts can access any of the databases described above, as well as other parts databases, to determine the companies which have the desired inventory available. Neither the Company's service, AIRS nor ILS list price information relating to particular parts. Market forces establish the price for aftermarket aircraft parts. No pricing service or price catalogue exists for aftermarket parts. Aftermarket aircraft parts prices are determined by referencing new parts catalogues with consideration given to existing supply and demand conditions. Often, aircraft operators will opt for quality aftermarket parts even when new parts are still in production. Aftermarket aircraft parts meet the same FAA standard as new parts, cost less than the same new parts and are often more readily available. The Company's customers include a wide variety of domestic and international air cargo carriers, major commercial, regional and commuter passenger airlines, maintenance and repair facilities and other redistributors. Management believes that its customer relationships are important to the Company's operational success. The Company maintains an adequate level of inventory in order to service its customers in a timely manner. Management believes that availability and timely delivery of quality spare parts are the primary factors considered by customers when making a spare parts purchase decision. Cargo carriers, regional commercial airlines and commuter airlines are among the Company's principal customers. Cargo carriers are important customers because the fleets of such operators typically consist of older aircraft of the type for which the Company maintains an extensive inventory of parts and because such customers typically do not maintain extensive inventories of spare parts. Regional commercial airlines are important customers because such airlines favor narrow-body aircraft, such as MD-80 and DC-9 aircraft, for which the Company is a primary source of spare parts. The smaller commuter - 7 -
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airlines are important customers because their fleets consist primarily of the turboprop aircraft being retired by the larger commuter airlines. The Company has acquired an extensive inventory of aftermarket parts for several popular commuter turboprop aircraft types In fiscal 2001, no customer accounted for more than 10% of the Company's total revenue. In fiscal 2000, one customer accounted for approximately 11% of the Company's parts sales. Excluding aircraft and engine sales, in fiscal 2000, no other customer accounted for more than 5% of the Company's total revenues. Each aircraft or engine sale is unique and the Company does not rely on previous customers for repeat business. Currently, the Company believes that it has no customer, the loss of which would have a material adverse effect on the Company's business, financial condition and results of operations. In a given period, a substantial portion of the Company's revenues may be attributable to the sale of one or more aircraft or engines. Such sales are unpredictable transactions dependent, in part, upon the Company's ability to purchase an aircraft or engine at an attractive price and resell it within a relatively brief period of time. The revenues from the sale of an aircraft or engine, the timing of inventory sales or a lease transaction during a given period may result in a customer being considered a major customer of the Company for that period. SAS was a significant customer of the Air 41 Joint Venture providing 93% and 100% of the lease revenue during fiscal 2001 and fiscal 2000, respectively. QUALITY ASSURANCE The Company adheres to stringent quality control standards and procedures in the purchase and sale of its products. In August 1997, the ASA accredited the Company's quality assurance system after the completion of an extensive facilities audit and numerous meetings with the Company's management. Parts procured from an accredited supplier convey assurance to the purchaser that the quality is as stated and the appropriate documentation is on file at the supplier's place of business. Furthermore, accreditation provides assurance that the supplier has implemented an appropriate quality assurance system and has demonstrated the ability to maintain that system. In addition, many of the Company's customers periodically audit the Company's operations to ensure compliance with such customer's quality standards. Because aircraft operators require a readily available and identifiable source of inventory meeting regulatory requirements, the Company has implemented a total quality assurance program. This program consists of numerous quality procedures, including the following: - Inspection procedures mandating that procured aircraft, engines and parts be traceable to a source approved by the Company; - Training and supervision of personnel to properly carry out the total quality assurance program; - On-going quality review board meetings conducted by senior management to oversee the total quality assurance program GOVERNMENT REGULATION The aviation industry is highly regulated in the United States by the FAA and in other countries by similar regulatory agencies. These regulations are designed to ensure that all aircraft, engines and aircraft components are continuously maintained in proper condition for the safe operation of aircraft. Before spare parts are installed on an aircraft, they must meet certain standards as to their condition and have appropriate documentation. Parts owned or acquired by the Company may not meet currently applicable standards, or standards may change in the future, causing parts already contained in the Company's inventory to be scrapped or modified. While most of the Company's non-airline operations are not currently regulated directly by the FAA, the independent facilities that repair and overhaul the Company's products and the aircraft operators that ultimately utilize the Company's products are subject to extensive regulation. Accordingly, the Company must consider the regulatory requirements of its customers and provide them with parts that comply with airworthiness standards established by the FAA, together with required - 8 -
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documentation which enables these customers to comply with other applicable regulatory requirements. The inspection, maintenance and repair procedures for the various types of aircraft, engines and aircraft components are prescribed by regulatory authorities and can be performed only by FAA-licensed repair facilities utilizing certified technicians. Compliance with applicable FAA and OEM standards are required prior to installation of a part on an aircraft. The Company only utilizes FAA-licensed repair facilities to repair and certify aircraft, engines and aircraft components. In September 1996, the FAA issued an advisory circular to support the implementation of a voluntary accreditation program for civil aircraft parts suppliers. This accreditation program establishes quality standards applicable to aftermarket suppliers, such as the Company, and designates FAA approved organizations such as the ASA to perform quality assurance audits for initial accreditation of aftermarket suppliers. Quality assurance audits are required on an on-going basis to maintain accreditation. In addition, many of the Company's customers periodically audit the Company's operations to ensure compliance with such customer's quality standards. The Company believes that ongoing quality assurance audits and strict adherence to its quality assurance system is essential to meeting the needs of its existing and future customers. In August 1997, the Company received accreditation from the ASA. The inability of the Company to supply its customers with spare parts on a timely basis, or any occurrence of the Company providing products which subsequently fail, may adversely affect the Company's relationships with its customers and have a material adverse effect on its business, financial condition and results of operations. The core operations of the Company may in the future be subject to FAA or other regulatory requirements. The Company closely monitors the FAA and industry trade groups in an attempt to understand how possible future regulations might impact the Company. There can also be no assurance that new and more stringent government regulations, if enacted, would not have a direct or indirect adverse effect on the Company. An important factor in the aircraft spare parts redistribution market relates to the documentation and traceability of an aircraft spare part. The Company requires all of its suppliers to provide adequate documentation as dictated by the Company's customers. The Company utilizes electronic data scanning and storage techniques to maintain complete copies of all documentation. Documentation required includes, where applicable, (i) a maintenance release from a certified FAA repair facility signed and dated by a licensed airframe and/or power plant mechanic or other certified inspector who repaired the aircraft spare part and an inspection to certify that the proper methods, materials and workmanship were used, (ii) a "tear-down" report detailing the discrepancies and corrective actions taken during the last shop repair, and (iii) an invoice or purchase order for an approved source. NSA has been subject to FAA regulation since the commencement of its business activities. Under the Federal Aviation Act of 1958, as amended, the FAA is concerned with safety and the regulation of flight operations generally, including equipment used, ground facilities, maintenance, communications and other matters. The FAA can suspend or revoke the authority of air carriers or their licensed personnel for failure to comply with its regulations and can ground aircraft if questions arise concerning airworthiness. NSA holds all operating, airworthiness and other FAA certificates that are currently required for the conduct of its business, although these certificates may be suspended or revoked for cause. PRODUCT LIABILITY The commercial aviation industry periodically experiences catastrophic losses. As a redistributor, the Company may be named as a defendant in a lawsuit as a result of such catastrophic loss if a part sold by the Company were installed in an incident-related aircraft. In this regard, the Company maintains product liability insurance in an amount the Company believes is sufficient. While the Company believes that it has liability insurance to protect it from such claims, and while no lawsuit has ever been filed against the Company based upon a product liability theory, no assurance can be given that claims will not arise in the future or that such insurance coverage will be adequate. However, an uninsured or partially insured claim, or a claim for which third-party indemnification is not available, could have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, there can be no assurance that insurance coverage can be maintained in the future at an acceptable cost. Any such liability not covered by insurance could have a material adverse effect on the financial condition of the Company. NSA has secured public liability and property damage insurance in excess of minimum amounts required by the United States Department of Transportation. The Company has also obtained all-risk hull insurance on Company-owned aircraft and maintains cargo liability insurance. - 9 -
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COMPETITION The aircraft spare parts redistribution market is highly competitive. The market consists of a limited number of well-capitalized companies selling a broad range of products and numerous small competitors serving distinct market niches. Certain of these competitors have substantially greater financial, marketing and other resources than the Company. The Company believes that current industry trends will benefit larger, well-capitalized companies. The Company believes that range and depth of inventories, quality and traceability of products, service and price are the key competitive factors in the industry. The principal companies with which the Company competes are AAR Corp., AGES, Kellstrom Industries Inc., and The Memphis Group Inc., all of which are significantly larger than the Company. Customers in need of aircraft parts have access, through on-line inventory catalogues, to a broad array of suppliers, including aircraft manufacturers, airlines and aircraft services companies, which may have the effect of increasing competition for, and lowering prices on, parts sales. NSA operates in highly competitive markets and competes with approximately 50 other contract cargo carriers in the United States. Accurate industry data is not available to indicate NSA's position within its marketplace, but management believes that NSA is currently one of the smaller contract carriers. NSA's competitors, however, typically utilize older generation and less efficient aircraft, and are not as well capitalized as the Company. Given the growth in the regional freight and passenger charter markets expected by management, access to capital will be critical to successfully compete in this industry. EMPLOYEES As of May 31, 2001, the Company had 29 employees. The Company is not a party to any collective bargaining agreement. The Company believes its relations with its employees are good. CAUTIONARY STATEMENTS This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the Exchange Act, including the plans and objectives of management for the business, operations and financial performance of the Company. The forward-looking statements and associated risks set forth in this Annual Report may include or relate to, among other things, the factors set forth below, together with other information set forth in this Annual Report. Reliance on Executive Officers. The continued success of the Company is dependent to a significant degree upon the services of its executive officers and upon the Company's ability to attract and retain qualified personnel experienced in the various phases of the Company's business. The ability of the Company to operate successfully could be jeopardized if one or more of its executive officers were unavailable and capable successors were not found. The Company does not maintain key man insurance on any of its executive officers. The Company has employment agreements with Alexius A. Dyer III, its Chairman of the Board, President and Chief Executive Officer, and George Murnane III, its Executive Vice President and Chief Operating Officer. The employment agreements between the Company and Messrs. Dyer and Murnane are individually terminable by each executive officer upon a change of control of the Company. Effects of the Economy on the Operations of the Company. The Company does not expect growth in the aircraft spare parts redistribution market in the foreseeable future. The Company's customers include a wide variety of domestic and international air cargo carriers, major commercial, regional and commuter passenger airlines, maintenance and repair facilities and other redistributors. As a result, the Company's business can be impacted by the economic factors that affect the airline and air cargo industries. When such factors adversely affect the airline and air cargo industries, they tend to cause downward pressure on the pricing for aircraft spare parts and increase the credit risk associated with doing business with airlines and air cargo carriers. Additionally, factors such as the price of fuel affect the aircraft spare parts market for older aircraft, since older aircraft become less competitive with newer model aircraft as the price of fuel increases. There can be no assurance that economic and other factors which might affect the airline and air cargo industries will not have a material adverse effect on the Company's business, financial condition and results of operations. - 10 -
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Risks Associated with Leases. The Company currently leases five Embraer EMB-120 aircraft to aircraft operators. The Company also owns a 50% interest in a joint venture that owns 20 DC-9-41H aircraft, 17 of which are leased. All of the Company's and joint venture's leases are operating leases, as opposed to finance leases. The success of an operating lease depends in part upon having the aircraft and engines returned in marketable condition as required by the lease of such aircraft and engines. In addition, the financial return from a leased aircraft or engine depends in part on the re-lease of the aircraft and/or engines on favorable terms on a timely basis, the ability to sell the aircraft or engines at favorable prices or realize sufficient value from the disassembly for parts of the aircraft or engines at the end of the lease term. Numerous factors, many of which are beyond the control of the Company or the joint venture, may have an impact on the Company's or joint venture's ability to re-lease or sell aircraft, engines and parts. These factors include general market conditions, regulatory changes (particularly those imposing environmental, maintenance and other requirements on the operation of aircraft and engines), changes in the supply or cost of aircraft and engines and technological development. Consequently, there can be no assurance that the Company's or joint venture's estimated residual value for aircraft or engines will be realized. If the Company or the joint venture is unable to re-lease, sell its aircraft or engines on favorable terms or realize sufficient value from the disassembly for parts of the aircraft or engines on a timely basis upon expiration of the related lease, its business, financial condition and results of operations may be adversely affected. In the event that a lessee defaults in the performance of its obligations, the Company or joint venture may be unable to enforce its remedies under a lease. The Company's or joint venture's inability to collect lease payments when due or to repossess aircraft or engines in the event of a default by a lessee could have an adverse effect on the Company's or joint venture's business, financial condition and results of operations. If the Company was to acquire an aircraft or engines and such acquisitions were not financed by additional borrowing, it could result in a reduction of the Company's liquidity. Risks Regarding the Company's Inventory. The Company acquires inventory by purchasing individual parts from airlines, repair facilities or other redistributors, by purchasing excess inventory from aircraft operators, or by purchasing aircraft for disassembly. The Company also obtains parts inventory on consignment from airlines. The Company's business is substantially dependent on its ability to acquire inventory by one of these methods because its net sales are directly influenced by the level and composition of inventory available for sale. Because the size and composition of the Company's inventory is critical to its results of operations and because there is no organized market to procure surplus inventory, the Company's operations are materially dependent on the success of management in identifying potential sources of inventory and obtaining a consignment of the inventory on acceptable terms or purchasing it at acceptable prices. There can be no assurance that inventory will be available on acceptable terms or at the times required by the Company. In addition, once acquired, the market value of the Company's inventory could be adversely affected by factors beyond the Company's control, such as the sudden availability of additional inventory, a sudden decline in demand for the Company's parts due to a decline in use of certain aircraft types, regulatory changes mandating uneconomic improvements to items in inventory, or a decision by an OEM to begin manufacturing new parts that would compete with aftermarket parts. Any of such factors could result in the Company's inventory being overvalued and could require the Company to write down its inventory valuations in order to bring them in line with the revised fair market value. The failure to identify and acquire inventory in a timely fashion on acceptable terms or a decline in the value of the Company's inventory would have a material adverse effect on the Company's business, financial condition and results of operations. Concentration on MD-80, DC-9 and turboprop Aircraft. The Company's net sales are concentrated in the aftermarket for MD-80, DC-9 and turboprop aircraft. Neither the DC-9 nor the MD-80 is still in production, as is the case for many of the turboprop aircraft for which the company sells parts. Any decline in the use of MD-80, DC-9 or turboprop aircraft by aircraft operators, the unscheduled removal from service of large numbers of these aircraft types or the grounding of such aircraft by governmental authorities for any reason could have a material adverse effect on the Company's business, financial condition and results of operations. In the event these aircraft are removed from service, demand for the Company's MD-80, DC-9 and turboprop parts could decline and the supply of spare parts may increase, which would have a material adverse effect on the Company's business, financial condition and results of operations. Broadening of Product Line. The Company has recently expanded its product line to include aftermarket parts for Airbus A-300, McDonnell Douglas DC-10, Boeing 747 aircraft and certain commuter turboprop aircraft including Embraer, Shorts, Saab, de Havilland, British Aerospace and ATR aircraft. In addition, the Company intends to broaden further its product line to include parts for other aircraft that are likely to be converted to freighters, such as Boeing 767 and 757 aircraft. The Company has limited experience with respect to the purchase - 11 -
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and sale of spare parts for these aircraft models. There can be no assurance that the Company will have the same level of success in managing its parts inventories for such aircraft that it has had with parts for MD-80 and DC-9 aircraft. The failure to successfully broaden its product line could have a material adverse effect on the Company's ability to implement its growth strategy. Risks Associated with Acquisitions. One of the Company's strategies for growth is to pursue acquisitions of aftermarket redistributors, small aircraft leasing companies and regional air carriers. There can be no assurance that any such acquisitions will be completed on reasonable terms, if at all. Certain of the Company's competitors may also seek to acquire the same companies which the Company seeks to acquire. This may increase the price and related costs at which the Company could otherwise have acquired such companies, perhaps materially. The Company's inability to complete acquisitions on reasonable terms could limit the Company's ability to grow its business. Any opportunity to pursue strategic acquisitions is dependent upon the Company's ability to successfully access capital. The Company may expend significant funds to pursue and consummate acquisitions. Such use of funds would reduce the Company's working capital. In addition, the Company may fund acquisitions in whole or in part by issuing equity securities, and any such issuances, individually or in the aggregate, may be dilutive to holders of the Common Stock. Acquisitions also may result in the Company incurring additional debt and amortizing costs related to goodwill and other intangible assets, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. In order to consummate an acquisition, the Company would be required to receive the consent of the lender under its Credit Agreement. The Company may experience difficulties in assimilating the operations, services and personnel of acquired companies and may be unable to sustain or improve the historical revenue and earnings levels of acquired companies, any of which may materially adversely affect the Company's business, financial condition and results of operations. In addition, to the extent it becomes necessary for the Company to fund the working capital requirements of acquired companies, the Company's working capital available for its currently existing operations would decrease. Acquisitions involve a number of additional risks, including the diversion of management's attention from ongoing business operations and the potential loss of key employees of acquired companies. There can be no assurance that the Company can successfully implement its acquisition strategy. The failure to consummate acquisitions on reasonable terms or the inability to successfully integrate and manage acquired operations and personnel could have a material adverse impact on the Company's business, financial condition and results of operations. Risks Associated with Air Carrier Operations. NSA, an air carrier in which the Company has a significant investment, operates in an industry that typically experiences lower average margins than the Company's other operations. NSA's ability to operate profitably depends on its ability to control costs, many of which are beyond its control. Examples of costs that NSA is unable to control are fuel costs, which are affected by political and economic conditions throughout the world, and the costs of regulatory compliance. The Company believes that NSA's existing financial resources are sufficient to permit it to implement its business plan. However, if NSA requires additional capital resources to fund its operations, it may be unable to obtain them on favorable terms, if at all, or such funds could dilute the Company's interest in NSA unless the Company matches such investment. NSA's air carrier operations may also result in demands on the Company's management time and liquidity that may preclude the Company from pursuing more profitable parts sales opportunities. ITEM 2. PROPERTIES. ------- ---------- The Company's executive offices and operations are located at 1954 Airport Road, Suite 200, Atlanta, Georgia 30341, consisting of approximately 3,600 square feet of leased space pursuant to a lease expiring in May 2004. The Company leases approximately 29,500 square feet of warehouse facilities in Fort Lauderdale, Florida pursuant to a lease expiring in June 2002. All facilities are rented at competitive rates for their location and utility. The Company believes that its facilities are adequate for its needs for the foreseeable future. - 12 -
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ITEM 3. LEGAL PROCEEDINGS. ------- ------------------ The Company is not now a defendant in any material litigation or other legal proceeding. The Company may become a defendant in legal proceedings in the ordinary course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ------- ----------------------------------------------------------- None. - 13 -
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PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER ------- ------------------------------------------------------------------- MATTERS. ------- The Company's Common Stock, which has been publicly traded since April 2, 1990, is listed and traded on the American Stock Exchange under the symbol "YLF." The following table sets forth the high and low closing prices of the Common Stock as reported on the American Stock Exchange for each quarter in fiscal 2001 and 2000. 2001 Fiscal Year High Low ------------------ ---- --- First Quarter $ 2.875 $ 1.9375 Second Quarter 1.875 1.00 Third Quarter 1.30 0.75 Fourth Quarter 1.06 0.75 2000 Fiscal Year High Low ------------------ ---- --- First Quarter $ 4.625 $ 4.25 Second Quarter 4.4375 3.75 Third Quarter 3.75 3.125 Fourth Quarter 4.5 2.625 At August 24, 2001, there were 106 holders of record of the Company's Common Stock. The Company has never paid dividends on the Common Stock. The Company's secured credit facility prohibits the Company from paying dividends on the Common Stock as long as indebtedness issued pursuant to such facility remains outstanding. It is unlikely that the Company will pay dividends on the Common Stock in the foreseeable future. - 14 -
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ITEM 6. SELECTED FINANCIAL DATA. ------- ------------------------- The selected consolidated financial data presented below for, and as of the end of, each of the fiscal years in the five-year period ended May 31, 2001, have been derived from the Company's audited consolidated financial statements. The consolidated financial statements of the Company as of May 31, 2000 and 2001 and for the three-year period ended May 31, 2001 and the accountant's reports thereon are included in Item 8 of this Form 10-K. [Enlarge/Download Table] YEAR ENDED MAY 31, ------------------------------------------------------- 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) OPERATING DATA: ---------------- Net sales $20,123 $25,648 $24,344 $ 23,480 $ 18,299 Lease and service revenue 1,109 2,315 3,328 2,724 2,631 Lease revenue - related party - - - - 595 -------- --------- --------- -------- -------- Total revenue 21,232 27,963 27,672 26,204 21,525 Total operating expenses 17,423 23,186 24,406 24,247 20,705 Equity in net earnings of unconsolidated joint ventures -- -- 1,026 1,757 1,550 -------- --------- --------- -------- -------- Income from continuing operations 3,809 4,777 4,292 3,714 2,370 Interest expense, net 1,550 1,934 1,302 1,657 1,800 -------- --------- --------- -------- -------- Earnings before income taxes and extraordinary item 2,259 2,843 2,990 2,057 570 Provision (benefit) for income taxes -- (2,820) 1,036 800 227 Earnings before extraordinary item 2,259 5,663 1,954 1,257 343 Extraordinary loss on extinguishment of debt (531) -- -- -- -- -------- --------- --------- -------- -------- Net earnings $ 1,728 $ 5,663 $ 1,954 $ 1,257 $ 343 ======== ========= ========= ======== ======== PER SHARE DATA: ----------------- Earnings per common share - basic before effect of extraordinary item $ 1.37 $ 2.29 $ 0.77 $ 0.57 $ 0.16 Extraordinary item (0.32) -- -- -- -- Net earnings $ 1.05 $ 2.29 $ 0.77 $ 0.57 $ 0.16 ======= ========= ======== ======== ======= Weighted average shares outstanding used in basic calculation 1,646,629 2,471,025 2,550,940 2,189,539 2,168,937 Earnings per common share - diluted before effect of extraordinary item $1.25 $2.03 $0.72 $ 0.55 $ 0.16 Extraordinary item (0.29) -- -- -- -- Net earnings $0.96 $ 2.03 $0.72 $ 0.55 $ 0.16 ===== ======= ===== ========= ========== Weighted average shares outstanding used in diluted calculation 1,806,938 2,793,414 2,720,513 2,268,472 2,172,504 - 15 -
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[Enlarge/Download Table] AT MAY 31, 1997 1998 1999 2000 2001 ----------- --------- ---------- --------- --------- (IN THOUSANDS) BALANCE SHEET DATA: --------------------- Working capital $ 9,141 $ 10,228 $ 11,524 $ 13,444 $ 11,328 Total assets 21,287 23,636 23,976 35,183 35,805 Total debt 13,749 9,648 9,594 20,094 20,392 Stockholders' equity 4,660 10,808 11,263 12,468 12,662 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ------ ----------------------------------------------------------------------- OF OPERATIONS. -------------- OVERVIEW The Company is primarily engaged in the sale of aircraft, aircraft parts, leasing of aircraft and engines and related services. In addition, with the minority interest in NSA, the Company is engaged in the operation of a small regional airline. The Company's total revenue includes net parts sales revenue and lease and service revenue. Net sales revenue includes revenue from individual parts sales and revenue from aircraft and engine sales. Aircraft and engine sales are unpredictable transactions, dependent, in part, upon the Company's ability to purchase an aircraft or engine and resell it within a relatively brief period of time. In a given period, a substantial portion of the Company's revenue may be attributable to the sale of aircraft or engines. Cost of sales consists primarily of inventory, aircraft and engine costs and shipping charges. The cost of the inventory is determined on a specific identification basis and inventory is stated at the lower of cost or market. The Company's operating results are affected by many factors, including the timing of orders from large customers, the timing of aircraft and engine sales, the timing of expenditures to purchase parts inventory, aircraft and engines and the mix of parts contained in the Company's inventory. The Company does not obtain long-term purchase orders or commitments from its customers. Revenue from the sale of parts is recognized when products are shipped to the customer. Revenue from aircraft and engine sales is recognized when the Company has received consideration for the sale price, the risk of ownership has passed to the buyer, and collectibility is reasonably assured. Lease and service revenue are recognized on an accrual basis, unless collectibility is uncertain. RESULTS OF OPERATIONS FISCAL 2001 COMPARED WITH FISCAL 2000 Net sales decreased by 22.1% from $23.5 million in fiscal 2000 to $18.3 million in fiscal 2001. This decrease was primarily due to a decrease in parts sales and aircraft sales, which was partially offset by an increase in engine sales. The decline in parts sales is attributable to the weaker economy, pricing pressure from our competition, a higher percentage of turboprop part sales compared to jet part sales and a higher percentage of expendable part sales compared to rotable part sales. Turboprop parts on average tend to have lower selling prices than equivalent jet parts, while expendable parts also tend to sell for less than rotable parts. During fiscal 2001, the Company sold eleven engines and no aircraft as compared to fiscal 2000, during which the Company sold nine engines and three aircraft. Lease and service revenue increased 18.5% from $2.7 million in fiscal 2000 to $3.2 million in fiscal 2001, due primarily to more assets being on lease during fiscal 2001. Due primarily to the decrease in parts sales and aircraft sales, partially offset by the increase in engine sales and lease and service revenue, total revenue for fiscal 2001 decreased 17.9% to $21.5 million from $26.2 million for fiscal 2000. Cost of sales decreased 19.0% from $17.4 million in fiscal 2000 to $14.1 million in fiscal 2001. Cost of sales as a percentage of total revenue decreased from 66.2% in fiscal 2000 to 65.6% in fiscal 2001. The slight decrease in the cost of sales as a percentage of total revenue in fiscal 2001 compared to fiscal 2000 was due primarily to a higher percentage of total revenue being provided by lease and service revenue which traditionally carries a much lower cost of sales. The cost of sales on part sales increased from fiscal 2000 to fiscal 2001. As the Company enters into more consignment - 16 -
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agreements and sells more parts on consignment, the Company anticipates that it will incur higher cost of sales as a percentage of revenues. These higher cost of sales should be partially offset by lower inventory costs, including interest. Selling, general and administrative expenses decreased 3.5% from $5.8 million in fiscal 2000 to $5.6 million in fiscal 2001. This decrease was due primarily to lower commissions due to lower parts sales and lower professional fees, partially offset by higher health care and insurance costs and an increase in the Company's provision for doubtful accounts in fiscal 2001. Depreciation was $1,092,000 in fiscal 2000 compared to $1,028,000 in fiscal 2001. The net decrease from fiscal 2000 to fiscal 2001 was due primarily to a change in the leasing portfolio from engines to aircraft, as the Company depreciates aircraft over a longer period of time than engines. Equity in Net Earnings of Unconsolidated Joint Venture decreased 11.8% from $1,757,000 for fiscal 2000 compared to $1,550,000 during fiscal 2001. This decrease is primarily due to the losses from NSA, whose earnings are reflected under the equity method of accounting. Interest expense increased 17.2% from $1,708,000 in fiscal 2000 to $2,002,000 in fiscal 2001. The increase in interest expense resulted from a higher outstanding average balance as the Company, among other things, financed the purchase of aircraft held for lease, and, while rates have been decreasing, an average higher interest rate during fiscal 2001. Interest and other income for fiscal 2001 was $202,000 compared to other income of $51,000 in fiscal 2000. The Company's income tax expense in fiscal 2001 was $227,000 compared to $800,000 in fiscal 2000. Net earnings for fiscal 2001 were $343,000, or $0.16 per share - basic and $0.16 per share - diluted, compared to net earnings for fiscal 2000 of $1,257,000, or $0.57 per share - basic and $0.55 per share - diluted. In the third quarter of fiscal 1999, the Company began acquiring shares of its common stock in connection with a stock repurchase program announced in December 1998. During fiscal 2000, the Company repurchased 4,200 shares of its common stock at an average price of $4.39. During fiscal 2001, the Company repurchased 168,700 shares of its common stock at an average price of $0.875. FISCAL 2000 COMPARED WITH FISCAL 1999 Net sales decreased by 3.6% from $24.3 million in fiscal 1999 to $23.5 million in fiscal 2000. This decrease was primarily due to a decrease in parts sales, which was partially offset by an increase in aircraft and engine sales. During fiscal 2000, the Company sold nine engines as compared to fiscal 1999, during which the Company sold three engines. Lease and service revenue decreased 18.1% from $3.2 million in fiscal 1999 to $2.7 million in fiscal 2000, due primarily to fewer assets being on lease during fiscal 2000. Due primarily to the decrease in parts sales and lease and service revenue, partially offset by the increase in aircraft and engine sales, total revenue for fiscal 2000 decreased 5.3% to $26.2 million from $27.7 million for fiscal 1999. Cost of sales decreased 4.7% from $18.2 million in fiscal 1999 to $17.4 million in fiscal 2000. Cost of sales as a percentage of total revenue increased from 65.8% in fiscal 1999 to 66.2% in fiscal 2000. The slight increase in the cost of sales as a percentage of total revenue in fiscal 2000 compared to fiscal 1999 was due primarily to an increase in the cost of parts sold. As the Company enters into more consignment agreements and sells more parts on consignment, the Company anticipates that it will incur higher cost of sales as a percentage of revenues. These higher cost of sales should be partially offset by lower inventory costs, including interest. Selling, general and administrative expenses increased 14.7% from $5.1 million in fiscal 1999 to $5.8 million in fiscal 2000. This increase was due to higher expenses related to legal and professional fees; travel, entertainment, and marketing expenses; health care costs; and outside commissions as outside agents were involved in the sale of an aircraft and several engines, partially offset by lower compensation expenses. Another factor in the increase in selling, general and administrative expenses was a $173,000 increase in the Company's provision for doubtful accounts in fiscal 2000 as the Company recorded no provision for doubtful accounts in fiscal 1999. - 17 -
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Depreciation was $1,147,000 in fiscal 1999 compared to $1,092,000 in fiscal 2000. The net decrease from fiscal 1999 to fiscal 2000 was due primarily to fewer assets being on lease during fiscal 2000. Equity in Net Earnings of Unconsolidated Joint Venture for fiscal 1999 was $1,026,000 compared to $1,757,000 during fiscal 2000. This increase was primarily due to a full year of earnings in fiscal 2000 versus nine months of earnings in fiscal 1999, a decrease in the interest expense of the Air 41 Joint Venture as the debt associated with the acquisition is reduced, and higher revenue from the re-lease of one of the aircraft. Interest expense increased 29.9% from $1,315,000 in fiscal 1999 to $1,708,000 in fiscal 2000. The increase in interest expense resulted from a higher outstanding average balance as the Company, among other things, financed the purchase of aircraft held for lease. Furthermore, interest rates increased during the period. Interest and other income for fiscal 2000 was $51,000 compared to other income of $13,000 in fiscal 1999. The Company's income tax expense in fiscal 2000 was $800,000 compared to $1,036,000 in fiscal 1999. Income taxes have been provided at the Company's estimated effective tax rate of approximately 39% for fiscal 2000 compared to 35% for fiscal 1999. Net earnings for fiscal 2000 were $1,257,000, or $0.57 per share - basic and $0.55 per share - diluted, compared to net earnings for fiscal 1999 of $1,954,000, or $0.77 per share - basic and $0.72 per share - diluted. In the third quarter of fiscal 1999, the Company began acquiring shares of its common stock in connection with a stock repurchase program announced in December 1998. During fiscal 1999, the Company repurchased 467,325 shares of its common stock at an average price of $4.16. During fiscal 2000, the Company repurchased 4,200 shares of its common stock at an average price of $4.39. LIQUIDITY AND CAPITAL RESOURCES The Credit Agreement originally entered into by the Company in October of 1996 provided for a $3 million term loan and up to an $11 million revolving credit. The Credit Agreement has been amended eleven times to create several new term loan facilities and to increase the revolving credit to $14 million (collectively referred to as the "Credit Facility"). In the most recent amendment, the maturity of the revolving credit facility and the term loan were extended to December 2005, as well as providing an increase in availability as a result of the new term loan. The interest rate that the Company is assessed is subject to fluctuation and may change based upon certain financial covenants. As of May 31, 2001, the interest rate under the Credit Facility was the lender's base rate minus 0.25% (6.75%). The Credit Facility is secured by substantially all of the assets of the Company and availability of amounts for borrowing is subject to certain limitations and restrictions. Such limitations and restrictions are discussed in the Company's Proxy Statement/Prospectus filed with the Securities and Exchange Commission on August 29, 1996 and in the Amendments to the Credit Facility filed on various dates as listed below in Item 6. Exhibits and Reports on Form 8-K. Net cash (used in) provided by operating activities for the fiscal years ended May 31, 2000 and 2001 amounted to ($971,000) and $3,115,000, respectively. The change from net cash used in operating activities for fiscal 2000 to net cash provided by operating activities for fiscal 2001 was due primarily to large expenditures for aircraft held in inventory during fiscal 2000. Net cash used in investing activities for fiscal 2000 and 2001 amounted to $8,685,000 and $3,745,000 respectively. For fiscal 2001, the primary use of funds for investing activities was capital expenditures for aircraft and engines of $6,088,000, partially offset by the sale of engines held for lease of $2,083,000. For fiscal 2000, the primary use of funds was the purchase of aircraft held for lease. Net cash (used in) provided by financing activities for fiscal 2000 and 2001 amounted to $9,484,000 and ($20,000), respectively. For fiscal 2001, the Company refinanced its term loan and revolver Credit Facility. The primary use of cash in financing activities was the purchase of treasury stock for $149,000 and the payment of deferred debt costs of $168,000. For fiscal 2000, net of payments, the Company borrowed an additional $9.5 million under the Credit Facility. - 18 -
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At May 31, 2001, the Company was permitted to borrow up to an additional $4.0 million pursuant to the Credit Facility, $2.8 million of which is only available for the purchase of inventory. The Company believes that its working capital and amounts available under the Credit Facility will be sufficient to meet the requirements of the Company for the foreseeable future. In fiscal 2001, NSA, a regional carrier in which the Company has an equity investment, incurred significant losses. Should these losses continue, NSA may require additional capital to fund its operations, which could dilute the company's ownership unless the Company invests additional funds. FLUCTUATIONS IN OPERATING RESULTS The Company's operating results, both on an annual and a quarterly basis, are affected by many factors, including the timing of large orders from customers, the timing of expenditures to purchase inventory in anticipation of future sales, the Company's ability to obtain inventory on consignment on acceptable terms, the mix of available aircraft spare parts contained at any time in the Company's inventory, the timing of aircraft or engine sales or leases, unanticipated aircraft or engine lease terminations, default by any lessees and many other factors largely outside the Company's control. Since the Company typically does not obtain long-term purchase orders or commitments from its customers, it must anticipate the future volume of orders based upon the historic purchasing patterns of its customers and discussions with customers as to their future requirements. Cancellations, reductions or delays in orders by a customer or group of customers could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, due to the value of a single aircraft or engine sale relative to the value of parts typically sold by the Company, any concentration of aircraft or engine sales in a particular quarter may obscure existing or developing trends in the Company's business, financial condition and results of operations. RECENT ACCOUNTING PRONOUNCEMENT In June 2001, the Financial Accounting Standards Board approved the issuance of SFAS No. 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangible Assets." The new standards require that all business combinations initiated after June 30, 2001 must be accounted for under the purchase method. In addition, all intangible assets acquired that are obtained through contractual or legal right, or are capable of being separately sold, transferred, licensed, rented or exchanged shall be recognized as an asset apart from goodwill. Goodwill and intangibles with indefinite lives will no longer be subject to amortization, but will be subject to an annual assessment for impairment by applying a fair value based test. As the Company has no goodwill or other intangibles generated as a result of a business combination, the adoption of these Standards is not expected to have an impact on the Company's operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK -------- ---------------------------------------------------------------- The Company's major market risk exposure is to changing interest rates. The Company's policy is to manage interest rate risk through the use of floating rate debt instruments. The Company has loans under a Credit Facility totaling approximately $20.4 million at May 31, 2001. The interest rate on the Credit Facility, which fluctuates based on certain financial ratios of the Company, was the lender's prime rate less .25% at May 31, 2001 (6.75%). An immediate increase of 10% in interest rates would increase the Company's annual interest expense by approximately $138,000. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------- ----------------------------------------------- Information with respect to this Item is contained in the Company's consolidated financial statements and financial statement schedules indicated in the Index on Page F-1 of this Annual Report on Form 10-K and is incorporated herein by reference. The financial statements of Air 41 LLC a Delaware limited liability company, in which the company owns an equity interest, are filed beginning on Page FA-1 of this Annual Report on Form 10-K pursuant to Regulation S-X, rule 3-09. Such financial statements are incorporated by Reference into this item. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ------- ------------------------------------------------------------------- FINANCIAL DISCLOSURE. ------ -------------- None. - 19 -
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PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. -------- -------------------------------------------------------- The information contained under the heading "Information as to Directors and Executive Officers" in the Company's definitive proxy statement for its 2001 Annual Meeting of stockholders (the "2001 Proxy Statement") is incorporated by reference herein. ITEM 11. EXECUTIVE COMPENSATION. -------- ----------------------- The information contained under the heading "Executive Compensation" in the 2001 Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. -------- -------------------------------------------------------------------- The information contained under the headings "Directors and Executive Officers" and "Principal Stockholders" in the 2001 Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -------- -------------------------------------------------- The information contained under the heading "Executive Compensation--Certain Transactions" in the 2001 Proxy Statement is incorporated by reference. - 20 -
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PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-KITEM -------- --------------------------------------------------------------------- 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. -- ----------------------------------------------------------------------- (a) Financial Statements of the Registrant Page or Method of Filing -------------------------------------------- ---------------------------- (1) Index to Consolidated Financial Statements F-1 (2) Report of Grant Thornton LLP F-2 (3) Consolidated Financial Statements and Notes to Consolidated Financial Statements of the Company, including Consolidated Balance Sheets as of May 31, 2001 and 2000 and related Consolidated Statements of Earnings, Consolidated Cash Flows and Consolidated Stockholders' Equity for each of the years in the three-year period ended May 31, 2001 F-3 (b) Financial Statements of AIR41 LLC Page or Method of Filing --------------------------------------- ---------------------------- (1) Index to Consolidated Financial Statements FA-1 (2) Report of Grant Thornton LLP FA-2 (3) Financial Statements and Notes to Financial Statements of the Company, including Consolidated Balance Sheets as of May 31, 2001 and 2000 and related Consolidated Statements of Earnings, Consolidated Cash Flows and Consolidated Stockholders' Equity for each of the years in the three-year period ended May 31, 2001 FA-3 (c) Financial Statements Schedules Page or Method of Filing ------------------------------------- ---------------------------- (1) Schedule II. Valuation and Qualifying Accounts S-1 Schedules not listed above and columns within certain Schedules have been omitted because of the absence of conditions under which they are required or because the required material information is included in the Consolidated Financial Statements or Notes to the Consolidated Financial Statements included herein. (c) Exhibits -------- [Enlarge/Download Table] EXHIBIT NUMBER DESCRIPTION PAGE NUMBER OR METHOD OF FILING 2.4 Credit Incorporated by reference to Exhibit 2.4 to Agreement Amendment No. 2 to the Company's Registration between BNY Statement on Form S-4 filed on August 29, 1996 (File Financial No. 333-08065). Corporation and the Registrant (the "Credit Agreement"). 2.5 First Amendment, Incorporated by Reference. Waiver and Agreement, dated as of March 24, 1997, between BNY Financial Corporation and the Registrant and related to the Credit Agreement. 2.6 Second Incorporated by Reference. Amendment and Agreement, dated as of September 9, 1997, between BNY Financial Corporation and the Registrant and related to the Credit Agreement. 2.7 Third Amendment and Incorporated by Reference. Agreement, dated as of October 15, 1997, between BNY Financial Corporation and the Registrant and related to the Credit Agreement. 2.8 Fourth Amendment and Incorporated by Reference. Agreement, dated as of February 2, 1998, between BNY Financial Corporation and the Registrant and related to the Credit Agreement. 2.9 Fifth Amendment, Incorporated by Reference. dated as of July 16, 1998, between BNY Financial Corporation and the Registrant and related to the Credit Agreement. 2.10 Sixth Amendment, Incorporated by Reference dated as of May 30, 1998, between BNY Financial Corporation and the Registrant and related to the Credit Agreement. 2.11 Seventh Amendment, Incorporated by Reference. dated as of October 28, 1998, between BNY Financial Corporation and the Registrant and related to the Credit Agreement. - 14 -
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EXHIBIT NUMBER DESCRIPTION PAGE NUMBER OR METHOD OF FILING 2.12 Eight Amendment and Agreement Incorporated by Reference. dated as of December 8, 1998, by and among BNY Financial Corporation and the Registrant and related to the Credit Agreement. 2.13 Ninth Amendment and Agreement Incorporated by Reference. dated as of July 1, 1999, by and between the Registered and BNY Factoring LLC, as successor in interest to BNY Financial Corporation and related to the Credit Agreement. 2.14 Tenth Amendment and Agreement Incorporated by Reference. dated as of November 17, 1999, by and between the Registered and GMAC Commercial Credit LLC, as successor in interest By merger to BNY Financial Corporation And related to the Credit Agreement. 2.15 Eleventh Amendment, Waiver and Incorporated by Reference. Agreement dated as of January 5, 2001, by and between the Registered and GMAC Commercial Credit LLC, as successor in interest By merger to BNY Financial Corporation And related to the Credit Agreement. 3.1 Amended and Incorporated by reference to Exhibit 3.1 to the Restated Company's Annual Report on Form 10-K for the fiscal Certificate year ended May 31, 1996 (the "1996 Form 10-K"). of Incorporation of the Registrant. 3.2 Restated and Incorporated by reference to Exhibit 3.2 to the 1996 Amended Form 10-K. Bylaws of the Registrant. 4.1 Specimen Incorporated by reference to Exhibit 4.1 to the 1996 Common Stock Form 10-K. Certificate. 10.1.1 Second Amended and Filed herewith Restated Employment Agreement dated July, 25 2001 between the Registrant and Alexius A. Dyer III. 10.2.1 Amended and Filed herewith Restated Employment Agreement dated July, 25 2001 between the Registrant and George Murnane III. 10.2.1 1996 Long- Incorporated by reference to Appendix B to the Proxy Term Statement/Prospectus included in the Company's Incentive and Registration Statement on Form S-4 (File Share Award No. 333-08065), filed on July 12, 1996. Plan. - 15 -
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EXHIBIT NUMBER DESCRIPTION PAGE NUMBER OR METHOD OF FILING 10.2.2 401(k) Plan. Incorporated by reference to Exhibit 10-H to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1992 (the "1992 Form 10-K"). 10.2.3 Bonus Plan. Incorporated by reference to Exhibit 10.2.4 to the 1992 Form 10-K. 10.2.4 Cafeteria Incorporated by reference to Exhibit 10.2.5 of the Plan. Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993. 10.2.5 Form of Incorporated by reference to Exhibit 10.2.5 to the Option 1996 Form 10-K. Certificate (Employee Non-Qualified Stock Option). 10.2.6 Form of Incorporated by reference to Exhibit 10.2.6 to the Option 1996 Form 10-K. Certificate (Director Non-Qualified Stock Option). 10.2.7 Form of Incorporated by reference to Exhibit 10.2.7 to the Option 1996 Form 10-K. Certificate (Incentive Stock Option). 10.14 Commission Incorporated by reference to Exhibit 10.14 to the Agreement 1996 Form 10-K. Dated December 1, 1995 between the Registrant and J.M. Associates, Inc. 10.15 Operating Incorporated by reference to Exhibit 10.14 to the Air41 LLC, Exhibit 10.15 to the 1999 Form 10-K dated as of September 9, 1998, by and between AirCorp, Inc. and the Company 10.16 Office Lease Incorporated by reference to Exhibit 10.17 to the Agreement 1997 Form 10-K. dated January 31, 1997 between the Registrant and Globe Corporate Center, as amended. 10.17 Lease Incorporated by reference to Exhibit 10.18 to the Agreement 1997 Form 10-K. dated March 31, 1997 between the Registrant and Port 95- 4, Ltd. 10.18 Securities Purchase Incorporated by reference to Exhibit 10.18 to the Agreement, dated September, Company's Quarterly report ending November 30, 2000. 18, 2000, among Diamond Aviation, Inc., the Registrant And the purchasers named therein. 10.19 Stockholders Agreement, dated Incorporated by reference to Exhibit 10.18 to the September 18, 2000, among Company's Quarterly report ending November 30, 2000. Diamond Aviation, Inc., and The stockholders therof. 23 Consent of Auditors Filed herewith.
(b) Reports on Form 8-K ---------------------- The Company did not file a Current Report on Form 8-K during the last quarter of the fiscal year covered by this Annual Report. - 24 -
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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized this 28th day of August, 2001. International Airline Support Group, Inc., a Delaware corporation By: /s/ A.A. Dyer III ---------------------------- Alexius A. Dyer III Chairman of the Board, Chief Executive Officer and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated. SIGNATURE TITLE DATE --------- ----- ---- /s/ A.A. Dyer III Chairman of the Board, Chief Executive Officer and ---------------------- President and Director Alexius A. Dyer III (Principal Executive Officer) August 28, 2001 ---------------------- ------------------------------- ----------------- /s/ George Murnane III --------------------------- George Murnane III Executive Vice President, Chief Operating Officer and -------------------- ------------------------------------------------------- Director August 28, 2001 -------- ----------------- /s/ James M. Isaacson Chief Financial Officer, Treasurer -------------------------- James M. Isaacson and Secretary (Principal Financial Officer and Principal --------------------------------------------------------- Accounting Officer) August 28, 2001 -------------------- ----------------- /s/ F. Dixon McElwee, Jr. ------------------------------- F. Dixon McElwee, Jr. Director August 28, 2001 ------------------------ -------- ----------------- /s/ Ronald R. Fogleman --------------------------- Ronald R. Fogleman Director August 28, 2001 -------------------- -------- ----------------- /s/ E. James Mueller ------------------------- E. James Mueller Director August 28, 2001 -------------------- -------- ----------------- FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES MAY 31, 2001, 2000 AND 1999
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Stockholders International Airline Support Group, Inc. We have audited the accompanying consolidated balance sheets of International Airline Support Group, Inc. and Subsidiaries as of May 31, 2001 and 2000, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years ended May 31, 2001. 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 auditing standards generally accepted in the United States of America. 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 International Airline Support Group, Inc. and Subsidiary as of May 31, 2001 and 2000 and the consolidated results of its operations and its consolidated cash flows for each of the three years ended May 31, 2001, in conformity with accounting principles generally accepted in the United States of America. We have also audited Schedule II of International Airline Support Group, Inc. and Subsidiaries for each of the three years ended May 31, 2001. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein. /s/ Grant Thornton LLP Miami, Florida August 2, 2001
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The accompanying notes are an integral part of these statements. F-4 INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS [Download Table] May 31, --------------------------- 2001 2000 ----------- ----------- Current assets Cash and cash equivalents $ 70,290 $ 721,111 Accounts receivable, net of allowance for doubtful accounts of $301,424 in 2001 and $172,722 in 2000 2,558,176 2,647,215 Inventories, including aircraft and engines available for sale 12,471,871 12,807,512 Deferred tax benefit 1,088,953 1,053,888 Other current assets 198,449 583,626 Current portion of note receivable - related party 78,454 - --------- --------- Total current assets 16,466,193 17,813,352 Property and equipment Aircraft in operations - 1,114,919 Aircraft and engines held for lease 13,973,285 12,832,298 Leasehold improvements 166,991 176,594 Machinery and equipment 1,089,341 1,074,576 --------- --------- 15,229,617 15,198,387 Less accumulated depreciation 2,643,867 2,263,110 --------- --------- Property and equipment, net 12,585,750 12,935,277 --------- --------- Other assets Investment in joint ventures 5,559,057 3,860,136 Notes receivable - related party 725,714 - Deferred debt costs, net 232,373 228,066 Deferred tax benefit 83,745 345,883 Deposits and other assets 152,440 - ------- --------- 6,753,329 4,434,085 --------- --------- $ 35,805,272 $ 35,182,714 = ========== = ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current maturities of long-term obligations $ 2,387,642 $ 1,748,642 Accounts payable 1,965,179 1,359,998 Accrued liabilities 785,867 1,261,147 ------- --------- Total current liabilities 5,138,688 4,369,787 Long-term obligations, less current maturities 18,004,574 18,345,079 Commitments and contingencies - - Stockholders' equity Preferred stock - $.001 par value; authorized 2,000,000 shares; no shares outstanding in 2001 and 2000, respectively - - Common stock - $.001 par value; authorized 20,000,000 shares; issued and outstanding 2,661,723 and 2,661,723 shares in 2001 and 2000, respectively 2,661 2,661 Additional paid-in capital 13,902,909 13,902,909 Retained earnings 871,230 527,769 Common stock in treasury, at cost - 640,225 and 471,525 shares in 2001 and 2000, respectively (2,114,790) (1,965,491) ---------- ---------- Total stockholders' equity 12,662,010 12,467,848 $ 35,805,272 $ 35,182,714 = ========== = ========== The accompanying notes are an integral part of these statements. F-3
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INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS [Enlarge/Download Table] Years Ended May 31, --------------------------------------------- 2001 2000 1999 ----------- ---------- ---------- Revenues Net sales $ 18,299,222 $ 23,479,801 $ 24,344,083 Lease and service revenue 2,630,435 2,724,365 3,327,859 Lease revenue - related party 595,000 - - ----------- ----------- ---------- Total revenues 21,524,657 26,204,166 27,671,942 Cost of sales 14,110,335 17,350,142 18,196,982 Selling, general and administrative expenses 5,566,428 5,805,426 5,062,525 Depreciation - property and equipment 93,898 61,629 38,567 Depreciation - aircraft and engines held for lease 934,241 1,030,187 1,108,345 ----------- ----------- ---------- Total costs 20,704,902 24,247,384 24,406,419 Equity in net earnings of unconsolidated joint ventures 1,550,496 1,757,114 1,026,359 --------- --------- --------- Income from operations 2,370,251 3,713,896 4,291,882 Interest expense 2,001,886 1,707,998 1,314,503 Interest and other income (202,169) (51,185) (13,082) -------- ------- ------- Earnings before income taxes 570,534 2,057,083 2,990,461 Provision for income taxes 227,073 800,490 1,036,145 ------- ------- --------- Net earnings $ 343,461 $ 1,256,593 $ 1,954,316 ========= ========== =========== Per share data: Earnings per common share - basic $ .16 $ .57 $ .77 Weighted average shares outstanding used in basic calculation 2,168,937 2,189,539 2,550,940 ========= ========= ========= Earnings per common share - diluted $ .16 $ .55 $ .72 Weighted average shares outstanding used in diluted calculation 2,172,504 2,268,472 2,720,513 ========= ========= ========= The accompanying notes are an integral part of these statements F-4
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INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY [Enlarge/Download Table] Unrealized Retained Common Common Stock Additional Loss on Earnings Stock in Number of Par Paid-In Equity (Accumulated Treasury, Shares Value Capital Security Deficit) at Cost Total ------ -------------- ------------- ------------ ------------ --------- ----------- Balance at June 1, 1998 2,562,667 $ 2,562 $ 13,511,610 $ (22,545) $ (2,683,140) $ - $ 10,808,487 Exercise of stock options 93,056 93 288,394 - - - 288,487 Tax benefit from exercise of stock options - - 136,085 - - - 136,085 Repurchase of common stock - - - - - (1,946,780) (1,946,780) Sale of equity security - - - 22,545 - - 22,545 Net earnings - - - - 1,954,316 - 1,954,316 --------- -------------- ----------- ------------ ------------ --------- ----------- Balance at May 31, 1999 2,655,723 2,655 13,936,089 - (728,824) (1,946,780) 11,263,140 Exercise of stock options 6,000 6 19,557 - - - 19,563 Repurchase of stock options - - (52,737) - - - (52,737) Repurchase of common stock - - - - - (18,711) (18,711) Net earnings - - - - 1,256,593 - 1,256,593 --------- -------------- ----------- ------------ ------------ --------- ----------- Balance at May 31, 2000 2,661,723 2,661 13,902,909 - 527,769 (1,965,491) 12,467,848 Repurchase of common stock - - - - - (149,299) (149,299) Net earnings - - - - 343,461 - 343,461 --------- -------------- ----------- ------------ ------------ --------- ----------- Balance at May 31, 2001 2,661,723 $ 2,661 $ 13,902,909 $ - $ 871,230 $ (2,114,790) $ 12,662,010 ========= =========== ========== ============ ============ ============ =========== The accompanying notes are an integral part of this statement. F-5
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INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS [Enlarge/Download Table] Years Ended May 31, -------------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Cash flows from operating activities: Net earnings $ 343,461 $ 1,256,593 $ 1,954,316 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities, net of effects of deconsolidation of North-South: Depreciation and amortization 1,193,024 1,423,653 1,299,728 Gain on sale of aircraft and engines held for lease (254,443) (108,611) (865,276) Unrealized loss on equity securities - - 22,545 Equity in net earnings of joint ventures (1,550,496) (1,757,114) (1,026,359) Stock option tax benefits - - 136,085 Decrease in deferred tax benefit 227,073 800,490 762,669 Provision for bad debt 202,169 172,893 - Provision for slow moving inventory 143,290 107,518 376,000 Changes in assets and liabilities: Accounts receivable (356,350) (81,396) (1,632,740) Inventories 2,658,029 (1,783,971) 237,865 Other current assets 372,427 (449,352) 60,324 Other assets (152,440) 66,155 68,378 Accounts payable and accrued liabilities 289,379 (617,418) (60,778) --------- --------- ---------- Net cash provided by (used in) operating activities 3,115,123 (970,560) 1,332,757 Cash flows from investing activities: Distributions received from joint ventures 334,000 360,000 240,000 Cash acquired in acquisition - 4,754 - Cash relinquished upon deconsolidation of North-South (18,922) - - Capital expenditures, including aircraft and engines held for lease (6,087,766) (10,011,392) (3,786,356) Sale of investments - - 92,194 Investment in joint ventures (203,095) (89,450) (1,587,213) Proceeds from sale of aircraft and engines held for lease 2,083,000 1,176,000 5,875,000 Purchase stock of Diamond Aviation - (125,000) - Payments received on notes receivable 146,835 - - --------- --------- ---------- Net cash (used in) provided by investing activities (3,745,948) (8,685,088) 833,625 Cash flows from financing activities: Net (payments) borrowings under revolving line of credit (3,056,764) 3,866,961 2,047,754 Borrowings under term loans 6,151,172 7,300,000 2,576,000 Payments under term loans (2,795,913) (1,630,600) (4,677,963) Purchase of treasury stock (149,299) (18,711) (1,946,780) Repurchase of stock options - (52,737) - Proceeds from the exercise of stock options - 19,563 288,487 Payment of deferred debt costs (169,192) - - --------- --------- ---------- Net cash (used in) provided by financing activities (19,996) 9,484,476 (1,712,502) ------- --------- ---------- Net (decrease) increase in cash and cash equivalents (650,821) (171,172) 453,880 Cash and cash equivalents at beginning of year 721,111 892,283 438,403 --------- --------- ---------- Cash and cash equivalents at end of year $ 70,290 $ 721,111 $ 892,283 = ========= = ========= = ========= Supplemental disclosures of cash flow information Cash paid during the year for: Interest $ 1,791,728 $ 1,501,503 $ 1,161,687 = ========= = ========= = ========= Income taxes $ - $ 20,000 $ 58,298 = ========= = ========= = ========= (continued) F-7
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INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED Non-cash investing and financing activities: In April 2000, the Company purchased all of the outstanding stock of North-South Airways, Inc. (North-South), formerly Diamond Aviation, for approximately $125,000 in cash and approximately $880,000 in assumed debt. In conjunction with this acquisition, the Company recorded the following assets and liabilities: Cash $ 4,754 Accounts receivable $ 73,788 Aircraft in operations $ 1,114,919 Accounts payable and accrued expenses $ (114,758) Debt $ (1,078,703) In September 2000, North-South sold additional shares of stock raising approximately $1,000,000. This sale of stock reduced the Company's ownership interest commencing September 1, 2000 in North-South from 100% to approximately 35%. Accordingly, commencing September 1, 2000, the Company is accounting for its investment in North-South under the equity method. As of May 31, 2001, the Company had notes receivable in the principal amount of $804,168 relating to loans provided to North-South, which are secured by certain aircraft operated by the airline. In the prior fiscal year, these notes receivable were eliminated in consolidation. In fiscal 2001, the Company reclassified certain aircraft held for lease to aircraft available for sale with a net book value of $2,465,678. The accompanying notes are an integral part of these statements. F-8
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INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED MAY 31, 2001, 2000 AND 1999 NOTE A - DESCRIPTION OF COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES International Airline Support Group, Inc. and Subsidiaries (the "Company") is primarily engaged in the sale of aircraft, engines, aircraft parts, leasing of aircraft and engines and related services. Since its inception in 1982, the Company has become a primary source of replacement parts for widely operated aircraft models such as the McDonnell Douglas MD-80 and DC-9, and Embraer EMB-120. a) Basis of Presentation ----------------------- The consolidated statements include the accounts of International Airline Support Group and its wholly-owned subsidiaries. The related entities are collectively referred to as the ("Company"). All material intercompany transactions and balances have been eliminated in the consolidation. In September 2000, North-South Airways (North-South) sold additional shares of stock raising approximately $1,000,000. This sale of stock reduced the Company's ownership interest in North-South from 100% to approximately 35%. Accordingly, commencing September 1, 2000, the Company is accounting for its investment in North-South under the equity method. b) Cash and Cash Equivalents ---------------------------- The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents. c) Inventories ----------- Inventories are stated at the lower of cost or market. The cost of aircraft, engines and aircraft parts is determined on a specific identification basis. d) Property and Equipment ------------------------ Property and equipment are stated at cost, less accumulated depreciation. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets, less their estimated salvage values, to operations over their estimated life utilizing straight-line and accelerated methods. The estimated lives of the depreciable assets range from 3 to 12 years. Overhaul costs on aircraft held for lease are capitalized and depreciated over the estimated service life of the overhaul. For income tax purposes, accelerated methods of depreciation are generally used. Deferred income taxes are provided for the difference between depreciation expense for tax and financial reporting purposes. The Company does not provide for depreciation expense on aircraft and engines classified as available for sale. e) Deferred Debt Costs --------------------- The deferred debt costs relate to the costs associated with obtaining the Senior Secured Revolving Credit Loan Facility and the Senior Secured Term Loans. These costs are being amortized using the interest method over the life of the respective debt issue. Accumulated amortization at May 31, 2001 and 2000, was $688,968 and $524,083, respectively. (continued)
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NOTE A - DESCRIPTION OF COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued f) Earnings Per Share -------------------- Basic net earnings per share equals net earnings divided by the weighted average shares outstanding during the year. The computation of diluted net earnings per share includes dilutive common stock equivalents in the weighted average shares outstanding. The reconciliation between the computations is as follows: [Download Table] Basic Basic Diluted Diluted Net Earnings Shares EPS Shares EPS -------------- ---------- --------- --------- ----------- 2001 $ 343,461 2,168,937 $ .16 2,172,504 $ .16 2000 $ 1,256,593 2,189,539 $ .57 2,268,472 $ .55 1999 $ 1,954,316 2,550,940 $ .77 2,720,513 $ .72 Included in diluted shares are common stock equivalents relating to options of 3,567, 78,933, and 169,573 for 2001, 2000 and 1999, respectively. Stock options to purchase 529,947 shares of the Company's common stock at prices ranging from $2.75 to $3.31 , which were outstanding during fiscal 2001, were not included in the computation of diluted EPS because the options' exercise prices were greater than the annual average market price of the Company's common stock and thus their inclusion would be anti-dilutive. g) Revenue Recognition -------------------- Revenue from the sale of parts is recognized when products are shipped to the customer. Net sales is comprised of gross sales less provisions for estimated customer returns and discounts. Revenue from aircraft and engine sales is recognized when the Company has received consideration for the sales price, the risk of ownership has passed to the buyer, and collectibility is reasonably assured. Lease and service revenue are recognized on an accrual basis, unless collectibility is uncertain. Included in net sales is revenue from exchange transactions. This revenue is generated from fees paid by the company's customers for the exchange of parts, and is recognized when the Company has fulfilled all of its obligations under the exchange agreement. h) Employee Benefit Plan ----------------------- In fiscal 1992, the Company established a contributory 401(K) plan. The plan is a defined contribution plan covering all eligible employees of the Company, to which the Company makes certain discretionary matching contributions based upon the level of its employees' contributions. The amount charged to earnings in fiscal 2001, 2000 and 1999 was insignificant. The Company does not provide any health or other benefits to retirees. i) Fair Value of Financial Instruments --------------------------------------- The carrying value of cash and cash equivalents, trade receivables, and accounts payable approximate fair value due to the short-term maturities of these instruments. The carrying value of the debt under the Senior Facility approximates fair value as it is floating rate debt. The carrying value of the notes receivable - related party approximates fair value as the interest rates on the notes approximate the current market rates. (continued)
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NOTE A - DESCRIPTION OF COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued j) Income Taxes ------------- Income taxes are provided based on earnings reported for tax return purposes in addition to a provision for deferred income taxes. Deferred income taxes are provided in order to reflect the tax consequences in future years of differences between the financial statement and tax basis of assets and liabilities at each year end. The Company provides a valuation allowance against its deferred tax assets when it believes that it is more likely than not that the asset will not be realized. k) Management Estimates --------------------- The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods. Actual results could differ from those estimates. l) New Accounting Pronouncement ------------------------------ In June 2001, the Financial Accounting Standards Board approved the issuance of SFAS No. 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangible Assets." The new standards require that all business combinations initiated after June 30, 2001 must be accounted for under the purchase method. In addition, all intangible assets acquired that are obtained through contractual or legal right, or are capable of being separately sold, transferred, licensed, rented or exchanged shall be recognized as an asset apart from goodwill. Goodwill and intangibles with indefinite lives will no longer be subject to amortization, but will be subject to an annual assessment for impairment by applying a fair value based test. As the Company has no goodwill or other intangibles generated as a result of a business combination, the adoption of these Standards is not expected to have an impact on the Company's operations. m) Business Segment and Geographic Area Information ----------------------------------------------------- The Company sells aircraft and aircraft parts, and leases aircraft to foreign and domestic customers. Most of the Company's sales take place on an unsecured basis, and a majority of the sales are to aircraft operators. The Company's revenues are derived primarily from customers located in the United States and all of the Company's long-lived assets are located in the United States. One customer accounted for 12% of the Company's sales in fiscal 2000 and another customer accounted for 11% of the Company's sales in fiscal 2000. No customers accounted for more than 10% of the Company's sales in fiscal 2001 or fiscal 1999. n) Accounting for Stock Based Compensation ------------------------------------------- The Company accounts for stock options issued to non-employees, under SFAS 123, "Accounting for Stock Based Compensation." The exercise price of all options granted by the Company equals the market price at the date of grant. The Company's employee stock option plan is accounted for using the intrinsic value method under APB 25. The Company provides disclosure of certain pro forma information as if the fair value-based method had been applied in measuring compensation expense (see Note H). o) Reclassifications ----------------- Certain prior period amounts have been reclassified to conform with the current year presentation.
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NOTE B - INVESTMENT IN NORTH-SOUTH AIRWAYS In April 2000, the Company purchased all of the outstanding stock of North-South Airways, Inc. (North-South), formerly Diamond Aviation, a small regional airline located in Statesboro, Georgia that operates under an Air Carrier Certificate under Part 135 of the regulations of the Federal Aviation Administration. The Company purchased North-South for approximately $125,000 in cash and approximately $880,000 in assumed debt. The acquisition has been accounted for as a purchase and accordingly, the assets and liabilities have been recorded at their estimated fair values at the date of acquisition. No goodwill was recorded as a result of this acquisition. The results of operations of North-South are included in the accompanying consolidated statement of earnings as of the date of the acquisition. In September 2000, North-South sold additional shares of stock raising approximately $1,000,000. This sale of stock reduced the Company's ownership interest in North-South from 100% to approximately 35%. Accordingly, commencing September 2000, the Company is accounting for its investment in North-South under the equity method, and the accounts of North-South are not included in the consolidated statements as of May 31, 2001. NOTE C - INVESTMENT IN JOINT VENTURES AIR41 Joint Venture --------------------- On September 16, 1998, the Company entered into a joint venture (the "AIR41 Joint Venture") for the acquisition of 20 DC-9-41H aircraft from Scandinavian Airlines System ("SAS"). The aircraft were leased back to SAS and the leases had an average term of 39 months. The Company's original investment in the AIR41 Joint Venture was $1.4 million, which represents a 50% ownership interest. The Company's AIR41 Joint Venture partner is AirCorp, Inc., a privately held company. The aircraft purchases were financed through the joint venture, utilizing non-recourse debt to the partners. The AIR41 Joint Venture debt is secured by the AIR41 aircraft. In connection with this financing, the Company had to post a $1.5 million letter of credit. As of May 31, 2001, the letter of credit outstanding is, $1.15 million. The Company and its joint venture partner are collectively guarantors on the AIR41 Joint Venture's obligation as the lessor of the aircraft. The AIR41 Joint Venture is accounted for under the equity method. The owners of the AIR41 Joint Venture pay all expenses on behalf of the AIR41 Joint Venture, which represent primarily aircraft maintenance and improvements. The payment of these expenses is accounted for as capital contributions. The joint venture partners are exploring opportunities for the aircraft after the end of the term of the leases with SAS. Such opportunities include releasing the aircraft with SAS, leasing the aircraft to one or more different lessee(s), selling the aircraft, parting out the aircraft, or directly placing the aircraft into either passenger or cargo service. In fiscal 2001, three aircraft came off of lease and one was then leased to another unrelated party. In fiscal 2002, six additional aircraft are scheduled to come off of lease. Currently, the AIR41 Joint Venture has no further commitment related to the disposition of these aircraft upon the termination of the leases, although, it is actively marketing these aircraft. A future impairment in the value of these aircraft and/or the inability of the AIR41 Joint Venture to sell at favorable terms or re-lease these aircraft after they come off lease, could have a significant negative impact on the value of the Company's investment. If the Company is unable to re-lease the aircraft, the AIR41 Joint Venture's lender may provide notice of default and then would have the ability to foreclose on all of the aircraft held by the AIR41 Joint Venture. This event could have a significant negative impact on the value of the Company's investment. In fiscal 2001 and 2000, 93% and 100% of the AIR41 Joint Venture revenue was derived from SAS. (continued)
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NOTE C - INVESTMENT IN JOINT VENTURES North-South Airways -------------------- In April 2000, the Company purchased all of the outstanding stock of North-South Airways, Inc. (North-South), a small regional airline that operates under an Air Carrier Certificate under Part 135 of the regulations of the Federal Aviation Administration. In September 2000, North-South sold additional shares of stock raising approximately $1,000,000. This sale of stock reduced the Company's ownership interest in North-South from 100% to approximately 35%. Accordingly, commencing September 2000, the Company is accounting for its investment in North-South under the equity method. A condensed summary of the companies two joint venture operations follows: 2001 2000 ------------ ------------- Current assets $ 874,008 $ 120,860 Non-current assets 68,880,311 72,899,986 ---------- ---------- Total assets $ 69,754,319 $ 73,020,846 = ========== = ========== Current liabilities $ 18,856,938 $ 23,257,194 Non-current liabilities 39,256,148 40,978,361 ---------- ----------- Total liabilities $ 58,113,086 $ 64,235,555 = ========== = ========== Revenues $ 15,740,127 $ 14,528,175 = ========== = ========== Net earnings $ 2,689,251 $ 3,506,556 = ========= = ========= All revenues of the joint ventures were derived from entities other than members of the consolidated group. Included in the Company's consolidated retained earnings is approximately $4,442,000 and $2,783,000 relating to the Company's share in the net earnings of the joint ventures as of May 31, 2001 and 2000 respectively. NOTE D - INVENTORIES Inventories at May 31, 2001 and 2000 consisted of the following: 2001 2000 ------------- ------------- Aircraft parts $ 6,644,053 $ 7,382,143 Aircraft and engines available for sale 5,827,818 5,425,369 $ 12,471,871 $ 12,807,512 = ========== = ==========
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NOTE E - LONG-TERM OBLIGATIONS Long-term obligations at May 31, 2001 and 2000 consisted of the following: 2001 2000 ------------ ------------ Senior Secured Revolving Credit Loans $ 7,952,726 $ 11,009,490 Term loans 12,439,490 9,084,231 ---------- --------- 20,392,216 20,093,721 Less: Current maturities 2,387,642 1,748,642 --------- --------- $ 18,004,574 $ 18,345,079 = ========== = ========== In October 1996, the Company entered into a Credit Agreement with the Bank of New York, which provided for a $3 million term loan (Term Loan-A) and up to an $11 million revolving credit. The Credit Facility is secured by substantially all of the assets of the Company and availability of amounts for borrowing is subject to certain limitations and restrictions such as accounts receivable and inventory levels. The interest rate on the Credit Facility which fluctuates based on certain financial ratios of the Company, was the lenders prime rate less .25% (6.75% at May 31, 2001). The revolving line of credit was increased to $13 million in March 1997 and to $14 million in fiscal 1998. As of May 31, 2001, the available line of credit is approximately $1.2 million and approximately $4 million is available for the purchase of inventory. The credit agreement includes certain covenants which provide, among other things, restrictions relating to the maintenance of consolidated net worth and other financial ratios, as well as a restriction on the payment of dividends. During fiscal 2000, the Credit Agreement was amended twice to create an additional term loan facility (term loans E) in the amount of $7.3 million, due August 1, 2003, to finance the purchase of three aircraft. During fiscal 2001, the Company entered into a loan with another financial institution to borrow $1.7 million to finance a purchase an aircraft. The principal on the loan is due in 84 monthly payments of $22,071 commencing January 2001. The interest rate on the loan is fixed at 9.02% per annum. The loan is collateralized by the aircraft. During fiscal 2001, the Credit Agreement was amended whereas the outstanding term loans were consolidated into one single term loan facility and the termination date was extended to December 31, 2005. The scheduled maturities of long-term obligations in each of the next five years until maturity subsequent to May 31, 2001 are as follows: 2002 - $2,387,642, 2003 - $2,224,080, 2004 - $2,236,066, 2005 - $2,249,179, 2006 - $10,301,001, and thereafter - $994,248. NOTE F - COMMITMENTS AND CONTINGENCIES Leases ------ The Company leases warehouse facilities, office space, as well as certain equipment under long-term operating lease agreements. Rental expense under these leases for the years ended May 31, 2001, 2000 and 1999 was approximately $269,000, $279,000 and $286,900, respectively. At May 31, 2001, the future minimum payments on non-cancellable operating leases are as follows: 2002 - $274,061, 2003 - $51,043, and 2004 - $52,244. (continued)
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NOTE F - COMMITMENTS AND CONTINGENCIES - Continued Leases - Continued ------ The Company currently leases aircraft and engines to customers under long-term operating lease agreements. In addition to minimum base rentals, the lease agreements often require additional rent based upon aircraft and engine usage. The net investment in aircraft and engines held for or leased to customers was approximately $12,321,202 and $11,513,000 at May 31, 2001 and 2000, respectively, net of accumulated depreciation of $1,652,082 and $1,319,298, respectively. At May 31, 2001, the future rental income under the long-term operating leases are approximately as follows: 2002 - $2,100,000, 2003 - $2,100,000, and 2004 - $795,000. NOTE G - INCOME TAXES The provision for income taxes for the years ended May 31, 2001, 2000 and 1999 is as follows: 2001 2000 1999 ---------- ---------- ---------- Current provision: Federal $ - $ - $ 76,138 State - - - ------- ------- ------- - - - - - 76,138 Deferred provision 227,073 800,490 960,007 ------- ------- ------- $ 227,073 $ 800,490 $ 1,036,145 ========= ========== ============ The tax effect of the Company's temporary differences and carryforwards is as follows: 2001 2000 ----------- ----------- Deferred tax assets- current: Bad debt reserve $ 108,000 $ 62,000 Inventory capitalization 197,000 358,000 Accrued payroll 95,000 86,000 Accrued vacation 35,000 14,000 Reserve for inventory 654,000 534,000 ------- ------- $ 1,089,000 $ 1,054,000 = ========= = ========= Deferred tax (liabilities) benefits - non-current: AIR41 Joint Venture $ (281,000) $ (281,000) Depreciation and amortization (4,139,000) (3,879,000) Net operating loss carryforward - federal 3,846,000 3,923,000 Net operating loss carryforward - state 426,000 388,000 Minimum tax credit - federal 264,000 222,000 Other, net (32,000) (27,000) ------- ------- $ 84,000 $ 346,000 = ====== = ======= The Company's policy is to record a valuation allowance against its deferred tax assets if the Company believes that it is more likely than not that it will not recognize the deferred tax benefits. Based on the Company's recent earnings history and management's estimate of future profits, the Company believes that it is more likely than not that its future profits will be sufficient to realize these benefits. (continued)
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NOTE G - INCOME TAXES - Continued The following table summarizes the differences between the Company's effective tax rate and the statutory federal rate as follows: 2001 2000 1999 ------- ------- ------- Statutory federal rate 34.0% 34.0% 34.0% Equity in net loss of unconsolidated joint venture 3.9 - - Tax expense(benefit) from net Operating loss carryforward - .7 - State income taxes 1.9 - 1.7 Other - 4.2 (1.1) ------- ------- ------ Effective tax rate 39.8% 38.9% 34.6% ====== ====== ====== The Company has net operating loss carryforwards for federal tax purposes of approximately $11.3 million. The net operating losses expire as follows: 2010 - $3,800,000, 2012 - $491,000 and 2020 - $7,020,000. The Company also has a federal minimum tax credit carryover of approximately $264,000 which may be utilized in future years to the extent that the regular tax liability exceeds the alternative minimum tax. Certain provisions of the tax law may limit the net operating loss and credit carryforwards available for use in any given year in the event of a significant change in ownership interest. NOTE H - STOCK OPTIONS Under the terms of the Company's 1996 Stock Option Plan (the "Plan"), the Company has 967,782 shares of common stock reserved. As of May 31, 2001, 245,207 shares are available to be issued under the Plan. The exercise price of all options granted by the Company to the employees equals the market price at the date of the grant. No compensation expense has been recognized. The options, other than those issued to the executive officers, vest immediately and expire 10 years from the date of the grant. On December 3, 1998, the Company's Board of Directors approved and ratified the repricing of certain unexercised employee stock options granted under the Company's stock option plans. As a result, options granted to purchase 131,173 shares of the Company's common stock were repriced from $4.50 - $6.94 per share to $3.31 per share. The 131,173 shares are reflected in both the granted and cancelled captions in the accompanying table for fiscal year ending May 31, 1999. The pro forma effect on earnings from this repricing is included in the pro forma net earnings shown below. Had compensation expense for the issuance of stock options under the Plan been determined based on the fair value of the options at the grant dates consistent with the method of SFAS 123, the Company's net earnings and earnings per share would have been changed to the pro forma amounts below. 2001 2000 1999 ----------- ----------- ----------- Net earnings As reported $ 343,461 $ 1,256,593 $ 1,954,316 Pro forma $ 317,361 $ 1,222,093 $ 1,743,076 Basic earnings per share As reported $ .16 $ .57 $ .77 Pro forma $ .15 $ .56 $ .68 Diluted earnings per share As reported $ .16 $ .55 $ .72 Pro forma $ .15 $ .54 $ .64 (continued)
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NOTE H - STOCK OPTIONS - Continued The above pro forma disclosures may not be representative of the effects on reported net earnings for future years as certain options vest over several years and the Company may continue to grant options to employees. The fair value of each option grant is estimated on the date of grant using the binomial option-pricing model with the following weighted-average assumptions used for grants in fiscal 2001, 2000 and 1999, respectively: dividend yield of 0.0 percent for all years; expected volatility of 95 percent, 40 percent and 40 percent; risk-free interest rates of 6 percent; 6.50 percent and 5.50 percent; and expected holding periods of 4 years. A summary of the status of the Company's fixed stock options as of May 31, 2001, 2000 and 1999, and changes during the years ending on those dates is as follows: [Enlarge/Download Table] May 31, 2001 May 31, 2000 May 31, 1999 Weighted - Weighted - Weighted - Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------- --------- ---------- ---------- ------- ------------- Outstanding at beginning of year 529,947 $ 3.13 593,154 $ 3.12 563,210 $ 3.42 Granted 30,000 1.25 25,000 3.44 254,173 3.31 Exercised - - (6,000) 3.26 (93,056) 3.10 Cancelled - - (82,207) 3.10 (131,173) 4.78 Outstanding at -------- ---------- --------- ------- -------- --------- end of year 559,947 $ 3.03 529,947 $ 3.13 593,154 $ 3.12 ======== ========= ========= ======= ======== ========= Options exercisable at end of year 559,947 447,185 437,174 Weighted-average fair value of options granted during the year $ 0.87 $ 1.38 $ 1.28 The following information applies to options outstanding at May 31, 2001: Options Outstanding Options Exercisable -------------------- -------------------- Weighted - Average Remaining Weighted - Weighted - Ranges of Contractual Average Average Exercise Prices Shares Life Exercise Price Shares Exercise Price ------------------ ----------- -------------- -------------- --------- ---------------- $ 1.25 30,000 9.5 years $ 1.25 30,000 $ 1.25 $2.75 - $3.44 529,947 6.35 years 3.13 529,947 3.13 ------- ------- $1.25 - $3.44 559,947 559,947 ======= =======
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NOTE I - STOCK REPURCHASE In the third quarter of 1999, the Company began acquiring shares of its common stock in connection with a stock repurchase program approved by the Board of Directors in December 1998. During fiscal 2001, fiscal 2000 and the six months ended May 31, 1999, the Company repurchased 168,700, 4,200 and 467,325 shares, respectively of its common stock for a total expenditure of $149,299, $18,711 and $1,946,780, respectively. The Company does not currently have a formal plan in place to purchase any additional shares; however, the Company is authorized by the Board to make further purchases if deemed to be in the best interests of the Company. Any such purchases must be also approved by the Company's lender. NOTE J - RELATED PARTY TRANSACTIONS Under the commission agreement entered into with the Company during fiscal 1994, an outside director is entitled to 3-4% of revenues generated from sales to customers brought in by the director. The Company paid the outside director approximately $60,000, $60,000 and $96,000 for the years ended May 31, 2001, 2000 and 1999. This agreement can be canceled by either party at any time. The Company paid an individual who was a director of the Company through fiscal 2000, $86,000 during fiscal 1999 for services rendered to the Company in connection with the identification and evaluation of acquisition opportunities. An executive of the Company's partner in the AIR41 Joint Venture was also an executive of one of the Company's significant customers until the fourth quarter of fiscal 2000. Total sales to this significant customer were $826,000 million and $1.6 million in fiscal 2000 and 1999, respectively. As of May 31, 2000, the accounts receivable from this significant customer was approximately $157,000, respectively. During fiscal 1999, the Company purchased three engines from the Company's joint venture partner for $3,120,000. The Company makes advances to the AIR41 Joint Venture on behalf of the Company's partner in the AIR41 Joint Venture. As of May 31, 2001 and 2000, the outstanding advances were $156,568 and $95,075, respectively, which are included in accounts receivable. The notes receivable - related party represents amounts due from North-South. The notes receivable are collateralized by certain of North-South's aircraft and accrue interest at a rate of 9.5% per annum. The future principal payments on the notes receivable are as follows: 2002 - $78,454, 2003 - $77,357, 2004 - $576,244, and 2005 - $72,113. The Company is currently leasing three aircraft to North-South. Total lease and service income recognized by the Company related to these leases was approximately $595,000 in fiscal 2001. In addition, during fiscal 2001, the Company sold inventory to North-South representing sales of approximately $248,000. The Company performs certain services on behalf of North-South. Accordingly, the Company charges North-South $5,000 per month for these services, which is reflected as an offset to selling, general and administrative expenses. As of May 31, 2001, the amount due from North-South was $79,862, which is included in accounts receivable as of May 31, 2001. An executive officer and board member of the Company are members of the Board of Directors of one of the Company's customers. The Company both purchases and sells inventory to this customer. Total sales to this customer were $77,450, $80,000 and $33,847 in fiscal 2001, 2000 and 1999, respectively. As of May 31, 2001 and 2000, the accounts receivable from this customer was approximately $18,000 and $20,000, respectively. Total purchases from this customer were approximately $1.1 million, $1.6 million and $1.2 million in fiscal 2001, 2000 and 1999, respectively. In fiscal 1999, the Company received $250,000 of consulting income from this customer. As of May 31, 2001 and 2000, the Company has a payable to this customer of approximately $330,000 and $104,000, respectively.
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NOTE K - ACCRUED LIABILITIES Accrued liabilities at May 31, 2001 and 2000 consisted of the following items: 2001 2000 ----------- ----------- Customer deposits $ 158,612 $ 189,554 Accrued payroll 377,760 555,101 Accrued property taxes 118,499 88,795 Other 130,996 427,697 ------- ------- $ 785,867 $ 1,261,147 = ======= = ========= NOTE L - EMPLOYMENT AGREEMENTS In October 1996, the Company entered into employment agreements with two of its executive officers with a term of five years. Subsequent to May 31, 2001, the agreements were extended through October 2005. The agreements provide the officers with a certain minimum annual salary plus bonus. The agreements provide the officers with an option to terminate their agreements and receive a lump sum payment equal to the officer's average annual compensation paid by the Company for the most recent two years upon a change in control of the Company. NOTE M - QUARTERLY FINANCIAL INFORMATION (UNAUDITED) [Enlarge/Download Table] First Second Third Fourth Year Quarter Quarter Quarter Quarter Total ----------- ---------- --------- --------- --------- --------- (In Thousands, Except for Per Share Information) 2001 ---- Revenues $ 6,770 $ 4,675 $ 5,221 $ 4,859 $ 21,525 Operating income 623 727 476 544 2,370 Net earnings available for common shareholders 70 117 30 126 343 Earnings per share - basic .03 .05 .01 .06 .16* Earnings per share - diluted .03 .05 .01 .06 .16* 2000 ---- Revenues $ 8,999 $ 6,207 $ 5,359 $ 5,639 $ 26,204 Operating income 1,297 1,118 622 677 3,714 Net earnings available for common shareholders 597 454 116 90 1,257 Earnings per share - basic .27 .21 .05 .04 .57 Earnings per share - diluted .25 .20 .05 .04 .55* * Difference of $.01 when adding the quarters is due to use of the average quarterly stock prices in the quarterly earnings per share - diluted calculations, while the full year earnings per share - diluted calculation uses the average yearly stock price. FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS AIR 41 LLC May 31, 2001 and 2000
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C O N T E N T S Page REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 1 FINANCIAL STATEMENTS BALANCE SHEETS 2 STATEMENTS OF EARNINGS 3 STATEMENT OF MEMBERS' CAPITAL 4 STATEMENTS OF CASH FLOWS 5 NOTES TO FINANCIAL STATEMENTS 6 - 10
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors AIR 41 LLC We have audited the accompanying balance sheets of AIR 41 LLC (the "Company") as of May 31, 2001 and 2000, and the related statements of earnings, members' capital and cash flows for the years then ended. 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 auditing standards generally accepted in the United States of America. 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 financial position of AIR 41 LLC as of May 31, 2001 and 2000 and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ Grant Thornton LLP Miami, Florida August 2, 2001
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AIR 41 LLC BALANCE SHEETS May 31, ASSETS [Download Table] 2001 2000 ----------- ----------- Aircraft, net $ 67,692,589 $ 71,573,610 Deferred debt costs, net of accumulated amortization of $413,821 and $225,848 as of May 31, 2001 and 2000, respectively 137,244 222,739 Other assets 75,000 - ----------- ----------- Total assets $ 67,904,833 $ 71,796,349 = =========== = =========== LIABILITIES AND MEMBERS' CAPITAL Current liabilities Accounts payable and accrued expenses $ 172,204 $ 262,955 Deferred revenue 600,000 600,000 Current portion of long-term debt 33,149,983 22,234,761 ----------- ----------- Total current liabilities 33,922,187 23,097,716 Long-term debt, net of current portion 22,948,658 40,978,361 Commitment and contingencies - - Members' capital 3,635,584 3,353,327 Retained earnings 7,398,404 4,366,945 ----------- ----------- Total members' capital 11,033,988 7,720,272 ----------- ----------- Total liabilities and members' capital $ 67,904,833 $ 71,796,349 = =========== = =========== The accompanying notes are an integral part of these statements. FA-2
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AIR 41 LLC STATEMENTS OF EARNINGS Years Ended May 31, [Enlarge/Download Table] 2001 2000 1999 ----------- ----------- ----------- Rental revenue $ 13,949,000 $ 14,475,000 $ 10,200,000 Expenses Interest expense 5,348,029 5,770,912 4,522,184 Depreciation and amortization expense 4,901,512 5,189,861 3,625,098 ----------- ----------- ----------- 10,249,541 10,960,773 8,147,282 ----------- ----------- ----------- Net earnings $ 3,699,459 $ 3,514,227 $ 2,052,718 = =========== = =========== = =========== The accompanying notes are an integral part of these statements. FA-3
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AIR 41 LLC STATEMENT OF MEMBERS' CAPITAL Years Ended May 31, 2001 and 2000 [Download Table] Members' Retained Capital Earnings Total ----------- ----------- ----------- Balance at May 31, 1999 $ 3,174,426 $ 1,572,718 $ 4,747,144 Capital contributions 178,901 - 178,901 Net earnings - 3,514,227 3,514,227 Distributions - (720,000) (720,000) ----------- ----------- ----------- Balance at May 31, 2000 3,353,327 4,366,945 7,720,272 Capital contributions 282,257 - 282,257 Net earnings - 3,699,459 3,699,459 Distributions - (668,000) (668,000) ----------- ----------- ----------- Balance at May 31, 2001 $ 3,635,584 $ 7,398,404 $ 11,033,988 = =========== = =========== = =========== The accompanying notes are an integral part of these statements. FA-4
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AIR 41 LLC STATEMENTS OF CASH FLOWS Years Ended May 31, [Download Table] 2001 2000 ----------- ----------- Net cash flows from operating activities: Net earnings $ 3,699,459 $ 3,514,227 Adjustments to reconcile net earnings to cash provided by operating activities: Depreciation and amortization 4,901,512 5,189,861 Changes in assets and liabilities: Other assets (75,000) - Accounts payable and accrued expenses (90,751) (20,715) ----------- ----------- Net cash provided by operating activities 8,435,220 8,683,373 Cash flows from investing activities: Additions to aircraft (832,518) (162,721) ----------- ----------- Net cash used in investing activities (832,518) (162,721) Cash flows from financing activities: Principal payments on long-term debt (7,926,491) (7,918,179) Proceeds from long-term debt 812,010 - Capital contributions 282,257 178,901 Distributions (668,000) (720,000) Payment of debt costs (102,478) (61,374) ----------- ----------- Net cash used in financing activities (7,602,702) (8,520,652) ----------- ----------- Net change in cash and cash equivalents - - Cash and cash equivalents at beginning of period - - ----------- ----------- Cash and cash equivalents at end of period $ - $ - = =========== = =========== Supplemental disclosure of cash flow information: Cash paid during the year for: Interest $ 5,317,279 $ 5,813,845 = =========== = =========== Taxes $ - $ - = =========== = =========== The accompanying notes are an integral part of these statements. FA-5
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AIR 41 LLC NOTES TO FINANCIAL STATEMENTS May 31, 2001 and 2000 NOTE A - SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation --------------------- The statements include the accounts of AIR 41 LLC (the "Company") which is equally owned by International Airline Support Group ("IASG") and Aircorp, Inc. Nature of Operations -------------------- The Company is the owner and lessor of twenty McDonnell Douglas aircraft. The aircraft are leased primarily to Scandinavian Airline Systems ("SAS"), a company based in Sweden. As of May 31, 2001, sixteen of the twenty aircraft are leased to SAS which represents approximately 93% of the rental revenue for the year ended May 31, 2001. Cash Flow --------- All monthly rental income from operations is paid directly to the Company's lender. The lender applies the portion of the rental income to the respective monthly principal and interest due on the Company's debt and the remaining portion is distributed back to the members of the Company. Accordingly, the Company does not retain any cash. Aircraft and Depreciation The aircraft is recorded at cost less accumulated depreciation. Depreciation is computed using the straight-line method over an estimated economic life of twelve years with an estimated salvage value equal to 25% of the original asset cost. Major improvements to aircraft are capitalized when incurred and depreciated over the useful life of the improvement. The Company evaluates the carrying value of the aircraft based upon changes in market and other physical and economic conditions and will record write- downs to recognize a loss in the value of the aircraft when management believes that, based on expected future cash flows, the recoverability of the Company's investment has been impaired. The Company does not record depreciation expense during the period the aircraft are not in service. Operating Leases The aircraft leases are accounted for as operating leases and have an average original term of 39 months. Lease rental revenues are recognized in equal installments over the terms of the related leases. (continued) FA-6
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NOTE A - SIGNIFICANT ACCOUNTING POLICIES - Continued Operating Leases - Continued Currently, the Company has no further commitment related to the disposition of these aircraft upon the termination of the leases, although, the Company is actively marketing these aircraft. A future impairment in the value of these aircraft and/or the inability of the Company to sell or re-lease these aircraft, after they come off lease, could have a significant negative impact on the Company's operations. Deferred Debt Costs ------------------- Deferred debt costs represent costs incurred related to the loan with Finova Capital Corporation. These costs are amortized using the effective interest rate method. Income Taxes ------------ Income taxes on earnings are payable personally by the members pursuant to an election under section 701 of the Internal Revenue Code and the Company is not taxed as a Corporation. Accordingly, no provision has been made for federal income taxes in these financial statements. Revenue Recognition ------------------- Rental income is recognized on a straight-line basis over the term of each lease and when collection is reasonably assured. Deferred Revenue ---------------- Lease revenues received in advance, but not yet earned, are deferred and recognized as rental revenue when earned. Use of Estimates In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that effect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates. FA-7
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NOTE B - AIRCRAFT Net Investment in Aircraft -------------------------- The Company's net investment in aircraft as of May 31, consisted of the following: 2001 2000 ----------- ----------- Aircraft at cost $ 80,947,795 $ 80,115,277 Less: Accumulated depreciation (13,255,206) (8,541,667) ----------- ----------- Aircraft, net $ 67,692,589 $ 71,573,610 = ========== = ========== The above aircraft balance of $80,947,795 at May 31, 2001 represents seventeen aircraft on lease and three aircraft available for lease. NOTE C - FUTURE MINIMUM RENTAL INCOME The following is a schedule by year of future minimum rental income under the leases as of May 31, 2001: Year Amount ------ ---------- 2002 $ 10,644,000 2003 4,884,000 - --------- Total $ 15,528,000 = ========== In September 1998, the Company entered into a lease agreement with Scandinavian Airline Systems ("SAS") to lease twenty McDonnell Douglas DC-9-41 aircraft. The monthly lease payments are $60,000 per aircraft and the average original lease term was 39 months. The operational responsibility for the aircraft rests with the lessee, and at its cost must maintain, service, repair and overhaul the aircraft so as to keep the aircraft in good repair condition and appearance and airworthy in all respects and to the same standard as lessee maintains, services, repairs and overhauls other commercial jet aircraft which it owns or leases. However, the Company is responsible for the cost related to any Airworthiness Directives over a certain amount, as defined in the Lease Agreement. Title to the aircraft remains with the lessor throughout the lease period, however, the lessee is responsible for the insurance on the aircraft. IASG and Aircorp, Inc. collectively have guaranteed the Company's obligation as the lessor of the aircraft. FA-8
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NOTE D - DEBT Long-term obligations at May 31, consisted of the following: 2001 2000 ----------- ----------- Note payable $ 56,098,641 $ 63,213,122 Less: Current maturities 33,149,983 22,234,761 ----------- ----------- $ 22,948,658 $ 40,978,361 = ========== = ========== In September 1998, the Company entered into a loan agreement with Finova Capital Corporation in the amount of $76 million. In connection with this financing, each of the Company's members posted a $1.5 million letter of credit. The annual interest rate on the loan is fixed at 8.63% and the loan is collateralized by the twenty aircraft as well as the interest in the SAS leases (see Note B). During the original terms of the leases, the Company is required to repay principal and interest on the debt based on 95% of the rental income received from the lease of the aircraft. Once an aircraft lease expires, the remaining principal on the aircraft is due to Finova Capital Corporation. If the aircraft is re-leased, the repayment terms of the debt on the aircraft is modified in accordance with the new lease terms. If the aircraft is sold, the remaining principal due on the aircraft is repaid in full with the proceeds from the aircraft sale. In fiscal 2001, Finova Capital Corporation financed maintenance to certain of the aircraft totaling approximately $812,000, which has been added to the total outstanding principal on the loan. In fiscal 2002, six aircraft are due to come off lease. Accordingly, the remaining principal due on these six aircraft as of May 31, 2001 is classified as part of current portion of long-term debt on the accompanying May 31, 2001 Balance Sheet. If any of these six aircraft are re-leased, the repayment terms of the debt on the re-leased aircraft will be modified so that the principal will be due over the term of the new lease. This loan represents non-recourse debt to IASG and Aircorp, Inc. Currently, the Company has no further commitment related to the disposition of these aircraft upon the termination of these leases, although it is actively marketing these aircraft. A future impairment in the value of the aircraft or should the Company be unable to re-lease the aircraft, the Company may be forced to sell the aircraft at unfavorable terms. In addition, if the Company is unable to re-lease the aircraft, the Company's lender may provide notice of default and then would have the ability to foreclose on all the aircraft. Either of these events could have a significant negative impact on the Company's operations. The following is a schedule of the future principal payments as of May 31, 2001: 2002 $ 33,149,983 2003 22,948,658 ---------- $ 56,098,641 ================ NOTE E - RELATED PARTY TRANSACTIONS Funding of Expenses The members pay all expenses on behalf of the Company, which represent primarily aircraft maintenance and improvements. The payment of these expenses is accounted for by the Company as capital contributions. Allocation of Expenses Certain management and accounting expenses of the Company are absorbed by IASG and have not been allocated to the Company. These expenses are deemed to be insignificant. Aircraft Lease In fiscal 2001 and 2000, the Company leased one of its aircraft to an entity controlled by the owner of Aircorp, Inc., a member of the Company. Total rental income from this related party was $850,000 and $75,000 for the years ended May 31, 2001 and 2000, respectively. AIR 41 LLC FA-9

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