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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 1-12380
AVIALL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 65-0433083
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2750 REGENT BOULEVARD
DFW AIRPORT, TEXAS 75261-9048
(Address of principal executive offices) (Zip Code)
(972) 586-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
The number of shares of common stock, par value $0.01 per share, outstanding at
May 2, 2003 was 19,747,837.
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1
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
AVIALL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2003 2002
-------------- --------------
Net sales $ 251,490 167,603
Cost of sales 209,150 130,511
-------------- --------------
Gross profit 42,340 37,092
Selling and administrative expenses 25,243 24,082
-------------- --------------
Operating income 17,097 13,010
Interest expense 5,863 5,590
-------------- --------------
Earnings before income taxes 11,234 7,420
Provision for income taxes 4,064 2,894
-------------- --------------
Net earnings 7,170 4,526
Less deemed dividend from beneficial conversion feature -- (20,533)
Less preferred stock dividends (1,109) (1,015)
-------------- --------------
Net earnings (loss) applicable to common shares $ 6,061 (17,022)
============== ==============
Basic net earnings (loss) per share $ 0.22 (0.93)
Weighted average common shares 19,385,713 18,383,036
============== ==============
Diluted net earnings (loss) per share $ 0.22 (0.93)
Weighted average common and potentially dilutive common shares 29,113,963 23,458,085
============== ==============
See accompanying notes to consolidated financial statements.
2
AVIALL, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 4,302 4,997
Receivables 101,677 95,222
Inventories 327,069 348,027
Prepaid expenses and other current assets 3,222 2,166
Deferred income taxes 23,266 23,266
------------ ------------
Total current assets 459,536 473,678
------------ ------------
Property and equipment 32,088 32,604
Goodwill 46,843 46,843
Intangible assets 47,928 49,567
Deferred income taxes 32,766 37,013
Other assets 12,077 12,759
------------ ------------
Total assets $ 631,238 652,464
============ ============
LIABILITIES, CONVERTIBLE REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 3,413 3,207
Revolving line of credit 138,608 140,301
Accounts payable 93,669 114,263
Accrued expenses 31,839 37,736
------------ ------------
Total current liabilities 267,529 295,507
------------ ------------
Long-term debt, net of unamortized discount of $9,181 and $9,652 at
March 31, 2003 and December 31, 2002, respectively 77,833 77,899
Other liabilities 5,577 6,086
Commitments and contingencies -- --
Convertible redeemable preferred stock (160,000 shares authorized;
50,409 shares and 49,301 shares issued and outstanding at March 31, 2003
and December 31, 2002, respectively) 45,478 44,370
Shareholders' equity:
Common stock ($0.01 par value, 80,000,000 shares authorized; 21,755,724
shares and 21,612,380 shares issued at March 31,
2003 and December 31, 2002, respectively) 217 216
Additional paid-in-capital 361,376 361,377
Accumulated deficit (93,665) (99,726)
Treasury stock, at cost (2,007,887 shares at March 31, 2003 and
December 31, 2002) (27,789) (27,789)
Unearned compensation - restricted stock (1,211) (1,369)
Accumulated other comprehensive loss (4,107) (4,107)
------------ ------------
Total shareholders' equity 234,821 228,602
------------ ------------
Total liabilities, convertible redeemable preferred stock and shareholders' equity $ 631,238 652,464
============ ============
See accompanying notes to consolidated financial statements.
3
AVIALL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------------
2003 2002
------------- -------------
OPERATING ACTIVITIES:
Net earnings $ 7,170 4,526
Depreciation and amortization 4,624 4,101
Deferred income taxes 4,261 2,656
Paid-in-kind interest 202 136
Compensation expense on restricted stock awards 158 95
Changes in:
Receivables (6,455) (36,586)
Inventories 20,958 (9,201)
Accounts payable 6,927 31,038
Accrued expenses (5,897) (19)
Other, net (1,530) (803)
------------- -------------
Net cash provided by (used for) operating activities 30,418 (4,057)
------------- -------------
INVESTING ACTIVITIES:
Capital expenditures (1,365) (992)
Purchase of distribution rights -- (1,732)
Sales of property, plant and equipment -- 120
------------- -------------
Net cash used for investing activities (1,365) (2,604)
------------- -------------
FINANCING ACTIVITIES:
Cash overdrafts (27,521) 106
Net change in revolving credit facility (1,578) 9,435
Debt repaid (648) (600)
Purchase of treasury stock -- (40)
Cash dividends paid on redeemable preferred stock (1) (2)
------------- -------------
Net cash (used for) provided by financing activities (29,748) 8,899
------------- -------------
Change in cash and cash equivalents (695) 2,238
Cash and cash equivalents, beginning of period 4,997 2,526
------------- -------------
Cash and cash equivalents, end of period $ 4,302 4,764
============= =============
CASH PAID FOR INTEREST AND INCOME TAXES:
Interest $ 4,831 1,753
Income taxes $ 250 384
NONCASH INVESTING AND FINANCING ACTIVITIES:
Dividends on redeemable preferred stock $ 1,108 21,546
Issuance of warrants $ -- 11,060
See accompanying notes to consolidated financial statements.
4
AVIALL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, these financial statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting only of normal recurring adjustments) considered necessary for a
fair presentation have been included. Operating results for the three month
period ended March 31, 2003 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2003. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Annual Report on Form 10-K for Aviall, Inc. for the year ended December 31,
2002.
NOTE 2 - STOCK-BASED COMPENSATION
We account for our stock-based compensation plans in accordance with
the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, or APB 25, "Accounting for Stock Issued to Employees," and
related interpretations. All options granted under our plans have an exercise
price equal to the market value of the underlying common stock on the date of
grant. Therefore, no compensation cost related to these plans is included in net
earnings. We also make the appropriate disclosures as required by Statement of
Financial Accounting Standards No. 123, or SFAS 123, "Accounting for Stock-Based
Compensation," and Statement of Financial Accounting Standards No. 148, or SFAS
148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FAS 123." Awards of restricted stock are valued at the market price
of our common stock on the date of grant and recorded as unearned compensation
within shareholders' equity. The unearned compensation is amortized to
compensation expense over the vesting period of the restricted stock.
The following table illustrates the effect on net earnings and earnings
per share, or EPS, if we had applied the fair-value recognition provisions of
SFAS 123 to stock-based employee compensation (in thousands, except share data):
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
------------ ------------
Net earnings, as reported $ 7,170 4,526
Deduct: Total stock-based employee compensation expense determined under
fair-value-based method for all awards, net of related tax effects (310) (310)
------------ ------------
Pro forma net earnings $ 6,860 4,216
============ ============
Earnings per share:
Basic - as reported $ 0.22 (0.93)
Basic - pro forma $ 0.21 (0.94)
Diluted - as reported $ 0.22 (0.93)
Diluted - pro forma $ 0.21 (0.94)
5
NOTE 3 - SEGMENT INFORMATION
The following tables present information by operating segment (in
thousands):
THREE MONTHS ENDED
MARCH 31,
----------------------------
NET SALES 2003 2002
--------- ------------ ------------
Aviall Services $ 244,477 161,026
ILS 7,013 6,577
------------ ------------
Total net sales $ 251,490 167,603
============ ============
PROFIT
------
Aviall Services $ 17,108 13,807
ILS 2,368 2,208
------------ ------------
Reportable segment profit 19,476 16,015
Corporate (2,379) (3,005)
Interest expense (5,863) (5,590)
------------ ------------
Earnings before income taxes $ 11,234 7,420
============ ============
NOTE 4 - EARNINGS PER SHARE
A reconciliation of the numerator and denominator of the basic and
diluted net EPS calculations for net earnings follows:
THREE MONTHS ENDED
MARCH 31,
----------------------------
NUMERATOR (IN THOUSANDS) 2003 2002
------------ ------------
Net earnings $ 7,170 4,526
Preferred stock dividends (1,109) (21,548)
------------ ------------
Net earnings (loss) available for distribution 6,061 (17,022)
Undistributed earnings allocated to participating preferred stockholders (1,847) --
------------ ------------
Net earnings (loss) for purposes of computing basic net earnings (loss) per share 4,214 (17,022)
Preferred stock dividends 1,109 21,548
Undistributed earnings allocated to participating preferred stockholders 1,847 --
------------ ------------
Net earnings for purposes of computing diluted net EPS $ 7,170 4,526
============ ============
DENOMINATOR
Weighted average common shares outstanding for purposes of computing
basic net earnings (loss) per share 19,385,713 18,383,036
Effect of dilutive securities:
Stock options 90,752 86,882
Restricted stock rights 315,935 189,999
Warrants 821,391 330,109
Convertible redeemable preferred stock 8,500,172 4,468,059
------------ ------------
Weighted average common shares outstanding for purposes of computing
diluted net EPS 29,113,963 23,458,085
============ ============
For the three months ended March 31, 2003, basic EPS is computed by
allocating net earnings available for distribution to the common and
participating preferred shareholders using the "two-class" method prescribed by
Statement of Financial Accounting Standards No. 128, or SFAS 128, "Earnings per
Share." Net earnings are reduced by dividends to preferred and common
stockholders to arrive at net earnings available for distribution. Net earnings
available for distribution are then allocated between the common and
participating preferred stockholders based on the weighted average common and
preferred shares outstanding, on an as-converted basis. Diluted EPS is computed
using the if-converted method by dividing net earnings by the weighted average
number of common and dilutive potential common shares outstanding during the
period.
6
For the three months ended March 31, 2002, basic EPS is computed by
dividing net loss available for distribution by the weighted average number of
common shares outstanding during the period. Diluted EPS is computed by dividing
net earnings by the weighted average number of common and dilutive potential
common shares outstanding during the period.
Diluted EPS was not dilutive, or lower than basic, for the three month
periods ended March 31, 2003 and 2002. Therefore, diluted EPS for the three
month periods ended March 31, 2003 and 2002 is presented equal to basic EPS.
NOTE 5 - CONVERTIBLE PARTICIPATING REDEEMABLE PREFERRED STOCK
On March 15, 2002, our Series B Senior Convertible Participating
Preferred Stock, or Series B Redeemable Preferred Stock, was automatically
converted into 45,110 shares of Series D Senior Convertible Participating
Preferred Stock, or Series D Redeemable Preferred Stock, which as of March 15,
2002 was convertible into 7,777,584 shares of common stock. Upon conversion of
the Series B Redeemable Preferred Stock, we recorded a $20.5 million deemed
dividend reflecting the difference between the $8.44 closing market price of our
common stock on the New York Stock Exchange on March 15, 2002 and the $5.80
conversion price of the Series D Redeemable Preferred Stock negotiated in
December 2001, multiplied by the total number of shares of common stock into
which the Series D Redeemable Preferred Stock could have been converted on March
15, 2002.
Dividends on the Series D Redeemable Preferred Stock are payable
quarterly in additional shares of Series D Redeemable Preferred Stock on a
cumulative basis at an annual rate of 9.0%. On March 31, 2003, we issued an
additional 1,108 shares of Series D Redeemable Preferred Stock and recorded $1.1
million in payment of the quarterly dividend due March 31, 2003. As of March 31,
2003, there were 50,409 shares of Series D Redeemable Preferred Stock
outstanding, which were convertible into 8,691,204 shares of common stock.
Unless previously converted into common stock, we must redeem all
outstanding shares of Series D Redeemable Preferred Stock on June 21, 2008 for
$1,000 per share, plus accrued and unpaid dividends, if any.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion and analysis should be read in conjunction
with the information set forth under "Item 7: Management's Discussion and
Analysis of Financial Condition and Results of Operations" on pages 23 through
39 of our Annual Report on Form 10-K for the year ended December 31, 2002.
The following discussion and analysis present gross profit and selling
and administrative expenses as a percentage of our first quarter 2002 net sales
including approximately $40 million of Rolls-Royce T56, or RR T56, engine parts
sales made directly by Rolls-Royce to the U.S. military during the RR T56
transition program, which ended in June 2002. These percentage of sales ratios
are "non-GAAP financial measures" as defined in Item 10 of Regulation S-K of the
Securities Exchange Act of 1934, as amended. We received our full contractual
margin from Rolls-Royce on these sales and assumed responsibility for direct
shipments to the U.S. military on Rolls-Royce's behalf at the end of the second
quarter of 2002. In addition, our first quarter 2002 gross profit and selling
and administrative expenses reflect the margins and additional expenses
associated with our RR T56 contract. Because our 2002 gross profit and selling
and administrative expenses include the impact of the RR T56 contract, we
believe the presentation of gross profit and selling and administrative expenses
as a percentage of 2002 net sales including the approximately $40 million of RR
T56 sales made by Rolls-Royce provides a more appropriate reference point for
comparing the first quarter of 2002 to the first quarter of 2003 than
calculating these ratios strictly on a GAAP basis.
CRITICAL ACCOUNTING POLICIES
For a discussion of our critical accounting policies refer to "Item 7:
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies" included in our Annual Report on Form
10-K for the year ended December 31, 2002. There have been no material changes
to the critical accounting policies discussed in our Annual Report on Form 10-K
for the year ended December 31, 2002.
7
RESULTS OF OPERATIONS-THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS
ENDED MARCH 31, 2002
NET SALES. Net sales for Aviall Services were $244.5 million, an
increase of $83.5 million or 51.8%, from the $161.0 million recorded in the
first quarter of 2002. The increase was primarily due to higher sales under the
RR T56 contract that began in 2002, sales for the Honeywell agreements
implemented during 2001 and 2002, and better-than-expected general
aviation/corporate sales. The first quarter 2002 net sales amount does not
include approximately $40 million of RR T56 sales, valued at our contractual
prices, made directly by Rolls-Royce to the U.S. military during the RR T56
transition program, which ended in June 2002. We received full margin for these
sales and assumed responsibility for direct shipments to the U.S. military on
Rolls-Royce's behalf at the end of the second quarter of 2002. Excluding net
sales from the RR T56 product line, higher net sales year-over-year were
reported by all three of Aviall Services' major sectors: general
aviation/corporate; commercial airline; and government/military. In addition,
all geographic regions posted higher year-over-year sales, except for the Latin
America geographic region. Sales of products supplied by Rolls-Royce and
Honeywell were $165.1 million and $83.7 million in the first quarter of 2003 and
2002, respectively.
Net sales for Inventory Locator Service, or ILS, were $7.0 million or a
6.6% increase from the $6.6 million recorded in the first quarter of 2002. This
increase is the fifth consecutive quarter-over-quarter increase for ILS.
GROSS PROFIT. Gross profit of $42.3 million increased $5.2 million or
14.1% in the first quarter of 2003 compared to $37.1 million in the first
quarter of 2002. Gross profit as a percentage of net sales was 16.8% in the
first quarter of 2003 as compared to 22.1% in the first quarter of 2002. If the
full sales impact of the approximately $40 million of RR T56 sales made directly
by Rolls-Royce to the U.S. military were reflected in Aviall Services' net sales
for the first quarter of 2002, gross profit as a percentage of net sales would
have been 17.9%.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative
expenses increased $1.2 million to $25.2 million in the first quarter of 2003
but decreased as a percentage of net sales to 10.0% from 14.4% reported in the
first quarter of 2002. If the approximately $40 million of RR T56 sales made
directly by Rolls-Royce to the U.S. military were reflected in Aviall Services'
net sales in the first quarter of 2002, selling and administrative expenses as a
percentage of net sales would have been 11.6%. Included in the first quarter of
2003 amount is a $1.2 million provision for doubtful accounts in the commercial
airline sector.
INTEREST EXPENSE. Interest expense increased $0.3 million to $5.9
million in the first quarter of 2003 from $5.6 million in the first quarter of
2002. Noncash interest expense included in the $5.9 million amounted to $1.3
million. This increase was primarily due to higher borrowings in 2003.
INCOME TAX EXPENSE. Income tax expense for the first quarter of 2003
was $4.1 million, and our effective tax rate was 36.2%. Our first quarter 2002
income tax expense was $2.9 million, and our effective tax rate was 39.0%. The
reduction in the effective tax rate year-over-year resulted primarily from the
impact of increased earnings in foreign taxing jurisdictions in 2003 as compared
to 2002.
NET EARNINGS. Net earnings for the first quarter of 2003 were $7.2
million, an increase of 58.4% compared to the $4.5 million reported in the first
quarter of 2002.
DEEMED DIVIDEND. The deemed dividend of $20.5 million in March 2002
resulted from the conversion of all of our outstanding Series B Redeemable
Preferred Stock into 45,110 shares of Series D Redeemable Preferred Stock on
March 15, 2002. The deemed dividend reflects the difference between the $8.44
closing market price of our common stock on the New York Stock Exchange on March
15, 2002 and the $5.80 conversion price of the Series D Redeemable Preferred
Stock negotiated in December 2001, multiplied by the total number of shares of
common stock into which the Series D Redeemable Preferred Stock could have been
converted on March 15, 2002.
PREFERRED STOCK DIVIDEND. The noncash preferred stock dividend of $1.1
million in March 2003 and $1.0 million in March 2002 resulted from the issuance
of 1,108 shares of Series D Redeemable Preferred Stock and 1,013 shares of
Series D Redeemable Preferred Stock, respectively, as payment of the quarterly
payable-in-kind dividend on the Series D Redeemable Preferred Stock due March
31, 2003 and March 31, 2002.
8
INCOME TAXES
Cash tax payments made for federal, state and foreign income taxes were
$0.2 million for the three months ended March 31, 2003 compared to $0.4 million
for the same period in 2002. Our cash income tax expense is primarily related to
foreign taxes on our foreign operations. Our cash income tax expense continues
to be substantially lower than the U.S. federal statutory rate through the use
of our U.S. federal net operating loss carryforwards. As of December 31, 2002,
our estimated U.S. federal net operating loss carryforward was approximately
$115.4 million, which substantially expires between 2009 and 2011.
We periodically assess the likelihood of realizing our deferred tax
assets and adjust the related valuation allowance based on the amount of
deferred tax assets that we believe is more likely than not to be realized.
While we believe we will generate sufficient future U.S. federal taxable income
to utilize our U.S. net operating loss carryforwards before expiration, we also
believe that we may not generate sufficient future taxable income in primarily
state and foreign tax jurisdictions to utilize all of our net operating loss
carryforwards before their expiration. To fully utilize our $60.3 million net
deferred tax asset as of December 2002, we must generate $160.6 million of U.S.
federal taxable income, based on current U.S. federal tax rates. We generated
U.S. federal taxable income of $28.1 million, $13.8 million and $12.0 million in
2002, 2001 and 2000, respectively. We will continue to monitor and assess the
likelihood of realizing our deferred tax assets. Future changes in the valuation
allowance may occur.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW. Net cash flow provided by and (used for) operations was
$30.4 million in the first three months of 2003 compared to $(4.1) million in
the first three months of 2002. The increase in cash flow in 2003 resulted from
reduced inventory levels as compared to December 31, 2002. Inventory levels as
of December 31, 2002 were unusually high due to inventory purchasing at year-end
to take advantage of pricing prior to Rolls-Royce's 2003 price increases. Aviall
Services inventory turns decreased slightly from 2.8 turns in December 2002 to
2.6 turns in March 2003 due to slightly lower-than-expected sales volumes for
some product lines. Additionally, the days' sales outstanding for Aviall's
receivables improved from 41 days in December 2002 to 35 days in March 2003
resulting largely from the higher mix of RR T56 contract sales which have
comparatively short receivable terms. Capital expenditures were $1.4 million in
the first three months of 2003 compared to $1.0 million in the first three
months of 2002. We expect capital expenditures, including noncash capital
expenditures, to be approximately $12.0 million in the aggregate for 2003. Net
cash flow (used for) and provided by financing activities was $(29.7) million in
the first three months of 2003 compared to $8.9 million in the first three
months of 2002.
In summary, our cash used for operating activities improved by $34.5
million to $30.4 million during the three month period ended March 31, 2003
compared to the same period in 2002. This was after investing $21.4 million in
working capital, defined as receivables, inventories and accounts payable, in
2003 compared to $(14.8) million in 2002. In 2003, we used this cash, as well as
$0.7 million of available cash, to invest in $1.4 million of net capital
expenditures, pay down $2.2 million of debt and decrease our cash overdraft
position by $27.5 million. In 2002, we invested $0.9 million in net capital
expenditures. The combined deficit in the first three months of 2002 of $6.7
million for both operating and investing activities was funded by drawing $8.8
million on our debt facility and increasing our cash overdraft position by $0.1
million, which also increased our cash on hand by $2.2 million.
We believe our cash flow from operations and available credit under our
credit facilities are sufficient to meet our anticipated normal working capital
and operating needs for at least the next twelve months.
CONVERTIBLE PARTICIPATING REDEEMABLE PREFERRED STOCK. The Series D
Redeemable Preferred Stock carries a cumulative dividend at an annual rate of
9.0%. Dividends paid on or prior to December 31, 2005 will be paid in shares of
Series D Redeemable Preferred Stock. Thereafter, dividends are payable in cash,
to the extent funds are legally available for payment of cash dividends. If we
fail to pay cash dividends after December 31, 2005, we will be required to pay
dividends in shares of Series D Redeemable Preferred Stock. During March 2003,
we issued an additional 1,108 shares of Series D Redeemable Preferred Stock in
payment of the quarterly dividend due March 31, 2003. As of March 31, 2003,
there were 50,409 shares of Series D Redeemable Preferred Stock outstanding,
which were convertible into 8,691,204 shares of common stock. Without the prior
consent of the holders of our Series D Redeemable Preferred Stock, we are
prohibited from, among other things, incurring certain types of additional debt,
making specified payments and capital expenditures, consolidating, merging with
or acquiring another business, or selling certain of our assets. Unless
previously converted into common stock, we must redeem all outstanding shares of
Series D Redeemable Preferred Stock on June 21, 2008 for $1,000 per share plus
accrued and unpaid dividends, if any.
9
SENIOR UNSECURED DEBT. The senior unsecured notes, or the Senior Notes,
bear interest at 14.0% per annum and mature on December 21, 2007, unless
previously redeemed at our option. Of the 14.0% interest rate on the Senior
Notes, 13.0% is payable in cash and 1.0% is payable in additional Senior Notes.
On March 31, 2003, we made a cash interest payment of $2.6 million, and the
outstanding principal amount on the Senior Notes increased by $0.2 million to
$81.0 million from the $80.8 million at December 31, 2002. On March 15, 2002, we
issued to our senior unsecured noteholders warrants exercisable for an aggregate
of 1,750,000 shares of our common stock, subject to adjustment for antidilution
events, at an exercise price of $0.01 per share. We valued the warrants using an
option pricing model and recorded an $11.1 million discount on the Senior Notes,
which is being amortized over the term of the Senior Notes. As of March 31,
2003, the unamortized discount was $9.2 million. After the issuance of the
warrants, the effective interest rate on the Senior Notes is 15.3%. As of March
31, 2003, we have issued 927,500 shares of common stock to certain noteholders
pursuant to the exercise of their warrants.
Pursuant to the terms of the Senior Notes, without the prior consent of
the holders of the Senior Notes, we are prohibited from, among other things,
incurring certain types of additional debt, making specified payments and
capital expenditures, consolidating, merging with or acquiring another business,
or selling certain of our assets.
We have the option to redeem the Senior Notes at 104% of the principal
amount outstanding and at lesser premiums after 2003. A decision to refinance
the Senior Notes will depend on several factors, including the availability of
replacement financing sources, the cost of replacement debt or the occurrence of
a significant event such as the award of another major distribution rights
contract, which might exceed our borrowing base capacity. If we decide to
refinance the Senior Notes, the costs of such a refinancing would include the
prepayment premium on the Senior Notes. In addition, all unamortized deferred
costs related to the Senior Notes, which includes the debt discount and original
debt issuance costs, would be required to be written off. In April 2002, the
FASB issued Statement of Financial Accounting Standards No. 145, or SFAS 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections." With the adoption of SFAS 145, these
unamortized costs, along with the prepayment premium, would be included in
earnings from continuing operations instead of being treated as an extraordinary
item net of tax. The EPS estimates provided in our Annual Report on Form 10-K
for the year ended December 31, 2002 do not include any charges which may arise
from refinancing the Senior Notes.
Additionally, we continually review opportunities for acquiring other
compatible businesses or operations. If a strategic acquisition candidate meets
our quantitative and qualitative thresholds, it is possible that such a
strategic acquisition candidate might require us to refinance both our senior
secured debt and the Senior Notes.
SENIOR SECURED DEBT. Our senior secured credit facility, or the Credit
Facility, consists of a $200.0 million revolving credit and letter of credit
facility due as a balloon payment in 2006, with availability determined by
reference to a borrowing base calculated using our eligible accounts receivable
and inventory and after deducting reserves required by the lenders. As of March
31, 2003, we had $138.6 million outstanding on the Credit Facility and issued
letters of credit for $1.0 million. We had $60.4 million available for
additional borrowings under the Credit Facility and our borrowing base was
$201.0 million as of March 31, 2003. Borrowings under the Credit Facility bear
interest, at our option, based upon either: a Eurodollar Rate plus an applicable
margin ranging from 2.5% to 3.0% depending upon our financial ratios, or a Base
Rate plus an applicable margin ranging from 1.5% to 2.0% depending upon the same
financial ratios. We utilize both of these interest rate options. As of March
31, 2003, the average interest rate on the Credit Facility was 4.26%. A
commitment fee of 0.5% is payable quarterly on the unused portion of the Credit
Facility. Obligations under the Credit Facility are collateralized by
substantially all of our domestic assets and 65.0% of the stock of each of our
foreign subsidiaries. The Credit Facility also contains default clauses that
permit the acceleration of all amounts due following the maturity of an event of
default at the discretion of the lenders, and lock-box provisions that apply our
cash collections to outstanding borrowings. Based on the terms of our Credit
Facility and pursuant to EITF Issue No. 95-22, "Balance Sheet Classification of
Revolving Credit Agreement Obligations Involving Lock-Box Arrangements," we have
classified amounts outstanding under the Credit Facility as current.
We also maintain a revolving credit facility in Canada. The Canadian
$6.0 million credit facility was renewed in April 2003 for a one year term, and
had an outstanding balance at March 31, 2003 equivalent to U.S. $0.6 million.
10
DEBT COVENANTS. The Credit Facility contains various restrictive
operating and financial covenants, including several that are based on earnings
before interest, taxes, depreciation, amortization, extraordinary gains or
losses, and one-time items, or Adjusted EBITDA. For the three months ended March
31, 2003, our Adjusted EBITDA was $20.2 million.
The following table presents a reconciliation of our Adjusted EBITDA to
earnings from continuing operations for 2003 (in thousands):
THREE MONTHS ENDED
MARCH 31, 2003
------------------
Earnings from continuing operations $ 7,170
------------
Plus:
Income tax expense 4,064
Interest expense 5,863
Depreciation and amortization expense 3,449
Minus:
Noncash (gains) losses (328)
------------
Adjusted EBITDA $ 20,218
============
The Adjusted EBITDA calculation above is prepared in accordance with
the terms of the Credit Facility. The noncash gains and losses, which are
included in the Adjusted EBITDA calculation in accordance with the terms of the
Credit Facility, may occur again in the future. Depreciation and amortization
expense above excludes debt issue cost and debt discount amortization. Adjusted
EBITDA is presented solely to provide information on our debt covenants and
should not be considered an alternative to operating results or cash flows
calculated in accordance with generally accepted accounting principles.
Beginning December 31, 2002, we must comply with a maximum leverage
ratio covenant that measures the ratio of our outstanding debt to our Adjusted
EBITDA for the trailing four quarters. This maximum leverage ratio covenant was
initially set at 4.25 to 1 on December 31, 2002, and it will periodically
decline until it reaches 2.50 to 1 for December 31, 2004 and all periods
thereafter. As of March 31, 2003, the required ratio was 4.00 to 1. In addition,
beginning December 31, 2002, we must also comply with a minimum interest
coverage ratio covenant that measures the ratio of our Adjusted EBITDA for the
trailing four quarters to our interest expense during the trailing four
quarters. The minimum interest coverage ratio covenant was initially set at 2.50
to 1 on December 31, 2002 and will periodically increase until it reaches 3.50
to 1 for December 31, 2004 and all periods thereafter. As of March 31, 2003, the
required ratio was 2.50 to 1. Furthermore, we must maintain a tangible net worth
at or above certain levels. At December 31, 2002, we were required to have a
minimum tangible net worth of $160.9 million. Our tangible net worth covenant
will periodically increase until it reaches $315.3 million on December 31, 2006,
at which time it will expire. As of March 31, 2003, the required tangible net
worth was $169.1 million. Finally, we must limit our capital expenditures to no
more than $14.0 million for 2003, which includes allowed carryover spending from
2002, and $11.0 million for each of 2004, 2005 and 2006.
The Senior Notes also contain various restrictive financial covenants,
several of which are less restrictive than those relating to the Credit
Facility. Beginning December 31, 2002, we must comply with a maximum leverage
ratio covenant that measures the ratio of our outstanding debt to our Adjusted
EBITDA for the trailing four quarters. This maximum leverage ratio covenant was
initially set at 4.75 to 1 on December 31, 2002, and it will periodically
decline until it reaches 3.00 to 1 for December 31, 2004 and all periods
thereafter. As of March 31, 2003, the required ratio was 4.50 to 1. In addition,
beginning December 31, 2002, we must also comply with a minimum interest
coverage ratio covenant that measures the ratio of our Adjusted EBITDA for the
trailing four quarters to our interest expense during the trailing four
quarters. The minimum interest coverage ratio covenant was initially set at 2.00
to 1 on December 31, 2002 and will periodically increase until it reaches 3.00
to 1 for December 31, 2004 and all periods thereafter. As of March 31, 2003, the
required ratio was 2.00 to 1. Furthermore, we must maintain a tangible net worth
at or above certain levels. At December 31, 2002, we were required to have a
minimum tangible net worth of $155.0 million. Our tangible net worth covenant
will periodically increase until it reaches $285.0 million on December 31, 2006,
at which time it will expire. As of March 31, 2003, the required tangible net
worth was $162.5 million. Finally, we must limit our capital expenditures to no
more than $15.1 million for 2003, which includes allowed carryover spending from
2002, and $12.1 million for each of 2004, 2005 and 2006.
11
We are currently, and expect to remain, in compliance for at least the
next twelve months in all material respects with the covenants in the Credit
Facility and the Senior Notes.
CONTRACTUAL OBLIGATIONS. There have been no material changes in our
contractual obligations as set forth in "Item 7: Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" of our Annual Report on Form 10-K for the year ended December
31, 2002.
OUTLOOK
We participate in the global aerospace aftermarket through Aviall
Services and ILS. Our operations and results of operations are affected by the
general economic climate, particularly as it influences flight activity in the
government/military, general aviation/corporate and commercial airline segments.
We benefit from our participation in all aviation segments and most particularly
in the global aviation aftermarket where we generate revenue from the aviation
sectors of many countries other than those in North America.
The demand for commercial air transport has been reduced by the
prevailing global economic slowdown, the Iraqi conflict and the uncertainty
caused by Severe Acute Respiratory Syndrome, or SARS. This lower flight
activity, which has promoted accelerated retirement of older aircraft and caused
the deferral of nonessential aircraft maintenance and overhaul services, has
reduced demand for new replacement parts we sell. In addition, some air
operations have been reduced because commercial airlines, air freight carriers
and other commercial airline-related firms around the world are experiencing
large financial losses. These losses have resulted in several bankruptcies,
which detrimentally affect the immediate future business prospects of the
affected companies, as well as the prospects for many that perform related
business services for these companies.
While we believe our current reserves for doubtful accounts are
adequate, we could be negatively affected if our receivables from several of our
major customers become uncollectible. We regularly review our exposure to these
customers to determine appropriate loss reserve amounts and credit limits, if
any, that should be recorded to cover our potential loss, as well as determining
the strategies that could minimize exposure in the case of bankruptcy. During
the third quarter of 2002, US Airways Group and Vanguard Airlines each filed for
bankruptcy protection. During the fourth quarter of 2002, United Airlines filed
for bankruptcy and US Airways Group filed a plan of reorganization. Aviall
Services' net sales to these customers combined during 2002 were less than $4.1
million. In the first quarter of 2003, Air Canada filed for bankruptcy and
several other commercial airline accounts remain uncertain. Included in the
first quarter of 2003 is a $1.2 million provision for doubtful accounts which we
believe at March 31, 2003 provides for our exposure to Air Canada and its
affiliates, as well as for the estimated uncollectability of other airline
accounts receivable.
The length of time required for a recovery of the global commercial
aviation sector is not known, and the recovery could be further threatened by a
number of factors, including slower economic growth, foreign political
instability, or acts of war or terrorism. However, general aviation/corporate
flight activity generally remained relatively stable during 2002 and into early
2003, although both sectors have recently exhibited a weakness in flight-related
activity. At the same time, the U.S. military and other foreign militaries,
which utilize airframes powered by the RR T56 engine, have significantly
increased their flight activities in connection with increased military and
other government-sponsored operations around the world. Our RR T56 military
business has benefited us materially by broadening our product offering and
offsetting the continuing slowdown in commercial aviation as the use of these
aircraft increased to deal with strategic threats in the Middle East.
In 2003, we have a purchase commitment to Rolls-Royce that requires us
to purchase $367.4 million of RR T56 parts. We also have a similar requirement
to purchase not less than $112.5 million of Rolls-Royce Model 250 series gas
turbine parts. As of March 31, 2003, we have purchased $111.5 million of RR T56
parts and $26.4 million of Rolls-Royce Model 250 parts. Based on our current
plans and our sales and marketing activities, we expect to fulfill the remainder
of these obligations in the ordinary course of business. We have no future
contractual inventory purchase commitments beyond 2003 except those required
under normal purchasing lead times. Both of the Rolls-Royce contracts continue
to meet our revenue expectations. In addition, we expect the current sales
levels under these contracts to continue into the foreseeable future.
In the first quarter of 2003, Aviall Services' net sales were derived
approximately 54% from government/ military sales, 25% from general
aviation/corporate sales and 21% from commercial airline sales. We are pursuing
a number of opportunities; however, we do not have any immediate prospects that
could represent an opportunity of the magnitude of the RR T56 contract in 2003
or beyond. Accordingly, our sales are unlikely to grow by a similar amount
during 2003.
12
While our revenue in the first quarter of 2003 increased by 50%, our
selling and administrative expenses for the same period experienced only a 5%
increase, including the allowance for doubtful accounts of $1.2 million. This
continues to demonstrate our belief that both Aviall Services and ILS are
scalable businesses with significant portions of their expenses being relatively
fixed in the short-term. This scalability produces positive results in a growing
marketplace as evidenced by the impact of the RR T56 agreement.
In 2002, ILS experienced a slight decrease in commercial
airline-related subscribers. This decrease was partially offset by an increase
in the number of government-related and general aviation/corporate subscribers.
As a result, ILS has not experienced a material adverse impact on its business
as a result of the economic downturn. This stability has been maintained during
the first quarter of 2003. ILS is continuing to develop, evolve and improve its
electronic marketplace offerings to mitigate the prolonged effects of the
economic downturn and to improve its competitiveness. However, to do this, it
has to, among other things, adapt various software packages to meet the needs of
its customers. The software packages are extremely complex and do not always
provide the promised flexibility required by ILS's customer base. Therefore, the
deployment of the software requires significant alterations which may cause ILS
to incur unplanned, potentially significant costs.
FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements (as such term
is defined in the Private Securities Litigation Reform Act of 1995) that are
based on the beliefs of our management, as well as assumptions and estimates
made by, and information currently available to, our management. When used in
this report, the words "anticipate," "believe," "estimate," "expect," "intend"
and similar expressions, as they relate to us or our management, identify
forward-looking statements. Such statements reflect our current views with
respect to future events and are subject to risks, uncertainties and assumptions
relating to our operations and results of operations as well as those of our
customers and suppliers, including as a result of competitive factors and
pricing pressures, shifts in market demand, general economic conditions and
other factors including, among others, those that effect flight activity in the
commercial, business, government/military, and general/corporate aviation
segments, the business activities of our customers and suppliers and
developments in information and communication technology. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions or
estimates prove incorrect, actual results may vary materially from those
described in the forward-looking statements.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates and
foreign exchange rates. From time to time, we have used financial instruments to
offset these risks. These financial instruments are not used for trading or
speculative purposes. We did not experience any significant changes in market
risk during the first three months of 2003. Our market risk is described in more
detail in "Item 7A: Quantitative and Qualitative Disclosures About Market Risk"
of our Annual Report on Form 10-K for the year ended December 31, 2002.
ITEM 4: CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The term "disclosure controls and procedures" is defined in Rule
13a-14(c) of the Securities Exchange Act of 1934, or the Exchange Act. This term
refers to the controls and procedures of a company that are designed to ensure
that information required to be disclosed by a company in the reports that it
files under the Exchange Act is recorded, processed, summarized and reported
within required time periods. Our Chief Executive Officer and our Chief
Financial Officer have evaluated the effectiveness of our disclosure controls
and procedures as of a date within 90 days before the filing of this quarterly
report, and they have concluded that as of that date, our disclosure controls
and procedures were effective at ensuring that required information will be
disclosed on a timely basis in our reports filed under the Exchange Act.
CHANGES IN INTERNAL CONTROLS
There were no significant changes to our internal controls or in other
factors that could significantly affect our internal controls subsequent to the
date of their evaluation by our Chief Executive Officer and our Chief Financial
Officer.
13
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Not applicable.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Aviall, Inc. Supplemental Executive Retirement Income
Plan
10.2 Amendment to the Aviall, Inc. 1998 Stock Incentive
Plan, dated as of June 14, 2002
10.3 Amendment Number One to the Aviall, Inc. Amended and
Restated 1998 Directors Stock Plan, dated as of June
14, 2002
99.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
A Form 8-K was filed on January 9, 2003, under Item 9,
announcing that we issued a press release regarding price
reductions across selected turbine and gearshaft assemblies
installed on the Rolls-Royce Model 250 gas turbine engine.
A Form 8-K was filed on February 4, 2003, under Item 9,
announcing that we issued a press release regarding our financial
results for the quarter and fiscal year ended December 31, 2002.
14
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AVIALL, INC.
May 9, 2003 By: /s/ Colin M. Cohen
------------------------------------------
Colin M. Cohen
Vice President and Chief Financial Officer
(Principal Financial Officer)
15
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Paul E. Fulchino, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Aviall,
Inc.;
2. Based on my knowledge, this Quarterly Report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this Quarterly Report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
Quarterly Report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
Quarterly Report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
Quarterly Report (the "Evaluation Date"); and
(c) presented in this Quarterly Report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
Board of Directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this Quarterly Report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 9, 2003
By: /s/ Paul E. Fulchino
-----------------------------------------------
Paul E. Fulchino
Chairman, President and Chief Executive Officer
16
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Colin M. Cohen, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Aviall,
Inc.;
2. Based on my knowledge, this Quarterly Report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this Quarterly Report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
Quarterly Report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
Quarterly Report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
Quarterly Report (the "Evaluation Date"); and
(c) presented in this Quarterly Report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
Board of Directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this Quarterly Report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Dated: May 9, 2003
By: /s/ Colin M. Cohen
-----------------------------------------
Colin M. Cohen
Vice President and Chief Financial Officer
17
INDEX TO EXHIBITS
Exhibit No. Description
----------- -----------
10.1 Aviall, Inc. Supplemental Executive Income Plan
10.2 Amendment to the Aviall, Inc. 1998 Stock Incentive Plan, dated
as of June 14, 2002
10.3 Amendment Number One to the Aviall, Inc. Amended and Restated
1998 Directors Stock Plan, dated as of June 14, 2002
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
18