================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------------
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 JUNE 30, 2003
OR
|_| 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 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
August 4, 2003 was 31,428,632.
================================================================================
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- -------------------------
2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------------------
Net sales $ 250,848 193,109 502,338 360,712
Cost of sales 208,461 150,583 417,611 281,094
------------------------------------------------------------------------------------------------------------------------
Gross profit 42,387 42,526 84,727 79,618
Selling and administrative expenses 24,115 24,444 49,358 48,526
Impairment loss 1,707 -- 1,707 --
------------------------------------------------------------------------------------------------------------------------
Operating income 16,565 18,082 33,662 31,092
Loss on extinguishment of debt 17,315 -- 17,315 --
Interest expense 5,609 5,653 11,472 11,243
------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (6,359) 12,429 4,875 19,849
Provision (benefit) for income taxes (2,395) 4,649 1,669 7,543
------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) (3,964) 7,780 3,206 12,306
Less deemed dividend from beneficial
conversion feature -- -- -- (20,533)
Less preferred stock dividends (907) (1,038) (2,016) (2,053)
Less noncash reduction for conversion of preferred
stock (24,335) -- (24,335) --
------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) applicable to common shares $ (29,206) 6,742 (23,145) (10,280)
------------------------------------------------------------------------------------------------------------------------
Basic net earnings (loss) per share $ (1.35) 0.26 (1.22) (0.56)
Weighted average common shares 21,705,400 18,382,482 20,551,965 18,382,757
------------------------------------------------------------------------------------------------------------------------
Diluted net earnings (loss) per share $ (1.35) 0.26 (1.22) (0.56)
Weighted average common and potentially
dilutive common shares 30,112,651 28,657,865 29,619,716 26,057,973
------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
2
AVIALL, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(Unaudited)
JUNE 30, DECEMBER 31,
2003 2002
--------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 5,597 4,997
Receivables 103,828 95,222
Inventories 314,427 348,027
Prepaid expenses and other current assets 3,787 2,166
Deferred income taxes 23,266 23,266
--------------------------------------------------------------------------------------------------------------------------
Total current assets 450,905 473,678
--------------------------------------------------------------------------------------------------------------------------
Property and equipment 31,480 32,604
Goodwill 46,843 46,843
Intangible assets 46,420 49,567
Deferred income taxes 35,452 37,013
Other assets 13,276 12,759
--------------------------------------------------------------------------------------------------------------------------
Total assets $ 624,376 652,464
--------------------------------------------------------------------------------------------------------------------------
LIABILITIES, CONVERTIBLE REDEEMABLE PREFERRED STOCK
AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 3,686 3,207
Revolving line of credit 1,628 140,301
Accounts payable 94,748 114,263
Accrued expenses 37,701 37,736
--------------------------------------------------------------------------------------------------------------------------
Total current liabilities 137,763 295,507
--------------------------------------------------------------------------------------------------------------------------
Long-term debt, net of unamortized discount of $9,652 at December 31, 2002 205,322 77,899
Other liabilities 4,688 6,086
Commitments and contingencies -- --
Convertible redeemable preferred stock (160,000 shares authorized;
49,301 shares issued and outstanding at December 31, 2002) -- 44,370
Shareholders' equity:
Common stock ($0.01 par value, 80,000,000 shares authorized; 32,873,793
shares and 21,612,380 shares issued at June 30, 2003
and December 31, 2002, respectively) 329 216
Additional paid-in capital 432,094 361,377
Accumulated deficit (122,871) (99,726)
Treasury stock, at cost (2,007,887 shares at June 30 2003 and
December 31, 2002) (27,789) (27,789)
Unearned compensation - restricted stock (1,053) (1,369)
Accumulated other comprehensive loss (4,107) (4,107)
--------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 276,603 228,602
--------------------------------------------------------------------------------------------------------------------------
Total liabilities, convertible redeemable preferred stock and shareholders' equity $ 624,376 652,464
--------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
3
AVIALL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------
2003 2002
---------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net earnings $ 3,206 12,306
Loss on extinguishment of debt 17,315 --
Impairment loss 1,707 --
Depreciation and amortization 9,331 8,372
Deferred income taxes 1,596 6,959
Paid-in-kind interest 405 336
Compensation expense on restricted stock awards 316 189
Changes in:
Receivables (8,606) (32,174)
Inventories 33,600 (23,884)
Accounts payable (10,201) 35,753
Accrued expenses (3,284) 2,582
Other, net (2,809) (791)
---------------------------------------------------------------------------------------
Net cash provided by operating activities 42,576 9,648
---------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Capital expenditures (3,600) (3,102)
Purchase of distribution rights -- (2,661)
Sales of property, plant and equipment -- 125
---------------------------------------------------------------------------------------
Net cash used for investing activities (3,600) (5,638)
---------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Debt proceeds 200,000 --
Net change in revolving credit facility (138,763) (2,955)
Debt repaid (82,894) (1,187)
Cash overdrafts (9,314) 9,837
Debt issue costs paid (7,514) --
Issuance of common stock 110 192
Purchase of treasury stock -- (40)
Cash dividends paid on redeemable preferred stock (1) (5)
---------------------------------------------------------------------------------------
Net cash (used for) provided by financing activities (38,376) 5,842
---------------------------------------------------------------------------------------
Change in cash and cash equivalents 600 9,852
Cash and cash equivalents, beginning of period 4,997 2,526
---------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 5,597 12,378
---------------------------------------------------------------------------------------
CASH PAID FOR INTEREST AND INCOME TAXES:
Interest $ 9,367 6,511
Income taxes $ 625 185
NONCASH INVESTING AND FINANCING ACTIVITIES:
Conversion of redeemable preferred stock into common stock $ 46,385 --
Noncash reduction in retained earnings due to conversion
of redeemable preferred stock $ 24,335 --
Dividends on redeemable preferred stock $ 2,015 22,581
Property and equipment acquired with debt $ 829 --
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- and
six-month periods ended June 30, 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------------------
2003 2002 2003 2002
--------------------------------------------------------------------------------------------------
Net earnings (loss), as reported $ (3,964) 7,780 3,206 12,306
Deduct: Total stock-based employee compensation
expense determined under fair-value-based method
for all awards, net of related tax effects (285) (319) (595) (629)
--------------------------------------------------------------------------------------------------
Pro forma net earnings (loss) $ (4,249) 7,461 2,611 11,677
--------------------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic - as reported $ (1.35) 0.26 (1.22) (0.56)
Basic - pro forma $ (1.36) 0.24 (1.25) (0.59)
Diluted - as reported $ (1.35) 0.26 (1.22) (0.56)
Diluted - pro forma $ (1.36) 0.24 (1.25) (0.59)
5
NOTE 3 - NEW ACCOUNTING PRONOUNCEMENTS
On May 15, 2003, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 150, or SFAS 150, "Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity." SFAS 150 represents the first phase of the FASB's project on
liabilities and equity and requires financial instruments that meet the
definitions in the statement to be classified as liabilities. SFAS 150 requires
that mandatorily redeemable preferred stock be classified and accounted for as a
liability. However, it excludes from its scope convertible instruments, which
will be addressed in the second phase of the FASB's project. SFAS 150 is
effective at the beginning of the first interim period beginning after June 15,
2003. Because our convertible redeemable preferred stock was converted to common
stock on June 12, 2003, the adoption of this statement will not have an effect
on our consolidated financial position and results of operations.
On April 30, 2003, the FASB issued Statement of Financial Accounting
Standards No. 149, or SFAS 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." SFAS 149 amends and clarifies financial
accounting and reporting for derivative instruments to incorporate decisions
made by the Derivatives Implementation Group. The statement is generally
effective for contracts or hedging relationships entered into after June 30,
2003. We believe the adoption of this statement will not have a significant
effect on our consolidated financial position or results of operations.
NOTE 4 - SEGMENT INFORMATION
The following tables present information by operating segment (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------------------
NET SALES 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------
Aviall Services $ 243,837 186,346 488,314 347,372
ILS 7,011 6,763 14,024 13,340
-------------------------------------------------------------------------------------------------------------
Total net sales $ 250,848 193,109 502,338 360,712
-------------------------------------------------------------------------------------------------------------
PROFIT
-------------------------------------------------------------------------------------------------------------
Aviall Services $ 18,412 17,996 35,520 31,803
ILS 702 2,433 3,070 4,641
-------------------------------------------------------------------------------------------------------------
Reportable segment profit 19,114 20,429 38,590 36,444
Loss on extinguishment of debt (17,315) -- (17,315) --
Corporate (2,549) (2,347) (4,928) (5,352)
Interest expense (5,609) (5,653) (11,472) (11,243)
-------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes $ (6,359) 12,429 4,875 19,849
-------------------------------------------------------------------------------------------------------------
6
NOTE 5 - 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------------------------------
NUMERATOR (IN THOUSANDS) 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (3,964) 7,780 3,206 12,306
Preferred stock dividends (907) (1,038) (2,016) (22,586)
Noncash reduction for conversion of preferred stock (24,335) -- (24,335) --
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) available for distribution (29,206) 6,742 (23,145) (10,280)
Undistributed earnings allocated to participating preferred
stockholders -- (2,036) (1,847) --
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) for purposes of computing basic net
earnings (loss) per share (29,206) 4,706 (24,992) (10,280)
Preferred stock dividends 907 1,038 2,016 22,586
Noncash reduction for conversion of preferred stock 24,335 -- 24,335 --
Undistributed earnings allocated to participating preferred
stockholders -- 2,036 1,847 --
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) for purposes of computing
diluted net earning per share $ (3,964) 7,780 3,206 12,306
--------------------------------------------------------------------------------------------------------------------------
DENOMINATOR
--------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding
for purposes of computing basic net earnings
per share 21,705,400 18,382,482 20,551,965 18,382,757
Effect of dilutive securities:
Stock options 346,957 348,235 218,854 217,559
Restricted stock rights 362,124 226,743 339,030 208,370
Warrants 821,611 1,748,166 821,501 1,039,138
Convertible redeemable preferred stock 6,876,559 7,952,239 7,688,366 6,210,149
--------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding
for purposes of computing diluted net earnings
per share 30,112,651 28,657,865 29,619,716 26,057,973
--------------------------------------------------------------------------------------------------------------------------
Basic EPS is generally computed by allocating net earnings (loss)
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." For the three
months ended June 30, 2002 and the six months ended June 30, 2003, net earnings
(loss) is reduced by dividends to preferred stockholders to arrive at net
earnings (loss) available for distribution. Net earnings (loss) available for
distribution is 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.
Given the losses in these periods, for the three months ended June 30,
2003 and the six months ended June 30, 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 (loss) 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- and
six-month periods ended June 30, 2003 and 2002 and is therefore presented equal
to basic EPS.
7
NOTE 6 - DEBT
On June 30, 2003, we issued $200.0 million of new senior unsecured notes,
or the New Senior Notes. The New Senior Notes bear interest at 7.625% per annum
and mature on July 1, 2011, unless previously redeemed at our option. We may
redeem some or all of the New Senior Notes at specified redemption prices at any
time after July 1, 2007. In addition, prior to July 1, 2006, we may redeem up to
35% of the New Senior Notes from the proceeds of qualifying equity offerings.
The New Senior Notes are our senior unsecured obligations and are equal in right
of payment to all of our senior indebtedness. The New Senior Notes are
guaranteed on a senior unsecured basis by each of our domestic subsidiaries. The
New Senior Notes contain various covenants, including limitations on incurring
debt or liens, selling assets, paying dividends, making distributions and
entering into transactions with affiliates.
We used the net proceeds from the issuance of the New Senior Notes to
redeem the entire principal amount of our existing 14% senior unsecured notes,
or the 14% Notes, and to repay approximately $106.3 million of the outstanding
revolving indebtedness under our senior secured credit facility, or the Credit
Facility.
In connection with the redemption of the 14% Notes, we recorded a $17.3
million pretax loss on extinguishment which consists of a $3.2 million
prepayment premium on the outstanding principal amount of the 14% Notes, $8.7
million of unamortized debt discount and $5.4 million of unamortized original
debt issuance costs. 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." We
adopted SFAS 145 on January 1, 2003. As a result of the adoption, these
unamortized costs, along with the prepayment premium, are included in earnings
from continuing operations instead of being treated as an extraordinary item net
of tax.
NOTE 7 - 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.
On June 12, 2003, affiliates of the Carlyle Group, or the Carlyle
Investors, converted all of the outstanding shares of Series D Redeemable
Preferred Stock into 11,100,878 shares of our common stock, following a
reduction by our board of directors of the conversion price of the shares of
Series D Redeemable Preferred Stock from $5.80 per share to approximately $4.62
per share. We accounted for this reduction in the conversion price as a $24.3
million noncash reduction to our net earnings available to common shareholders
for the three- and six-month periods ended June 30, 2003. The shares of common
stock issued to the Carlyle Investors as a result of the conversion represented
approximately 36% of our outstanding common stock on the date of conversion. At
the time of the conversion, the outstanding shares of Series D Redeemable
Preferred Stock had an aggregate liquidation preference, plus accrued and unpaid
dividends, of approximately $51.3 million and a 9.0% annual payment-in-kind
dividend rate.
NOTE 8 - GUARANTOR AND NONGUARANTOR FINANCIAL STATEMENTS
The New Senior Notes are fully and unconditionally and jointly and
severally guaranteed on a senior unsecured basis by each direct and indirect
domestic subsidiary of Aviall, Inc., each a guarantor subsidiary. Each guarantor
subsidiary is directly or indirectly 100% owned by Aviall, Inc. The New Senior
Notes are not guaranteed by any direct or indirect foreign subsidiary of Aviall,
Inc., each a nonguarantor subsidiary.
The condensed consolidating financial information presents the
consolidating balance sheets as of June 30, 2003 and December 31, 2002, the
related statements of income for the three- and six-month periods ended June 30,
2003 and 2002 and the statements of cash flows for the six month periods ended
June 30, 2003 and 2002 with separate columns for:
a) Aviall, Inc., the parent;
b) the guarantor subsidiaries on a combined basis;
c) the nonguarantor subsidiaries on a combined basis; and
d) total consolidated amounts.
The information includes elimination entries necessary to consolidate
Aviall, Inc., the parent, with the guarantor and nonguarantor subsidiaries.
8
Investments in subsidiaries are accounted for by the parent using the
equity method of accounting. The guarantor and nonguarantor subsidiaries are
presented on a combined basis. The principal elimination entries eliminate
investments in subsidiaries and intercompany balances and transactions. Separate
financial statements for the guarantor and nonguarantor subsidiaries are not
presented because management believes such financial statements would not be
meaningful to investors.
Pursuant to the terms of the Credit Facility, no subsidiary of Aviall
other than Aviall Services may pay cash dividends to Aviall. Aviall Services may
only pay cash dividends to Aviall for the purpose of funding (i) ordinary
operating expenses and scheduled debt service and (ii) payments by Aviall of
taxes in respect of Aviall and its subsidiaries, up to the amount that would be
payable by Aviall Services, on a consolidated basis, if it were the taxpayer.
Additionally, the Credit Facility restricts intercompany loans made to Aviall
from its direct and indirect subsidiaries, with the exception of intercompany
loans made by Aviall Services to fund required payments under the New Senior
Notes. The net assets of consolidating subsidiaries subject to these
restrictions was $579.7 million at December 31, 2002.
CONSOLIDATED STATEMENT OF INCOME
THREE MONTHS ENDED JUNE 30, 2003
------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------------------------------------------------------------------------------------------------------------------
Net sales $ -- 239,463 25,012 (13,627) 250,848
Cost of sales -- 202,010 20,078 (13,627) 208,461
---------------------------------------------------------------------------------------------------------------------
Gross profit -- 37,453 4,934 -- 42,387
Selling and administrative expenses 5 22,262 1,848 -- 24,115
Impairment loss -- 1,707 -- -- 1,707
---------------------------------------------------------------------------------------------------------------------
Operating (expense) income (5) 13,484 3,086 -- 16,565
Loss on extinguishment of debt -- 17,315 -- -- 17,315
Interest expense (income) (5,785) 11,427 (33) -- 5,609
Equity in (earnings) loss of
subsidiaries 7,652 (2,400) -- (5,252) --
---------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (1,872) (12,858) 3,119 5,252 (6,359)
Provision (benefit) for income taxes 2,092 (5,206) 719 -- (2,395)
---------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $(3,964) (7,652) 2,400 5,252 (3,964)
---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
SIX MONTHS ENDED JUNE 30, 2003
-------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
----------------------------------------------------------------------------------------------------------------------
Net sales $ -- 476,650 51,694 (26,006) 502,338
Cost of sales -- 401,532 42,085 (26,006) 417,611
----------------------------------------------------------------------------------------------------------------------
Gross profit -- 75,118 9,609 -- 84,727
Selling and administrative expenses 5 43,975 5,378 -- 49,358
Impairment loss -- 1,707 -- -- 1,707
----------------------------------------------------------------------------------------------------------------------
Operating (expense) income (5) 29,436 4,231 -- 33,662
Loss on extinguishment of debt -- 17,315 -- -- 17,315
Interest expense (income) (11,146) 22,359 259 -- 11,472
Equity in (earnings) loss of
subsidiaries 3,902 (3,009) -- (893) --
----------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes 7,239 (7,229) 3,972 893 4,875
Provision (benefit) for income taxes 4,033 (3,327) 963 -- 1,669
----------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 3,206 (3,902) 3,009 893 3,206
----------------------------------------------------------------------------------------------------------------------
9
CONSOLIDATED STATEMENT OF INCOME
THREE MONTHS ENDED JUNE 30, 2002
--------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
-----------------------------------------------------------------------------------------------------------------------
Net sales $ -- 183,010 23,934 (13,835) 193,109
Cost of sales -- 144,713 19,705 (13,835) 150,583
-----------------------------------------------------------------------------------------------------------------------
Gross profit -- 38,297 4,229 -- 42,526
Selling and administrative expenses -- 22,201 2,243 -- 24,444
-----------------------------------------------------------------------------------------------------------------------
Operating income -- 16,096 1,986 -- 18,082
Interest expense (income) (5,532) 10,865 320 -- 5,653
Equity in (earnings) loss of
subsidiaries (4,090) (1,072) -- 5,162 --
-----------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes 9,622 6,303 1,666 (5,162) 12,429
Provision for income taxes 1,842 2,213 594 -- 4,649
-----------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 7,780 4,090 1,072 (5,162) 7,780
-----------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
SIX MONTHS ENDED JUNE 30, 2002
------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------------------------------------------------------------------------------------------------------------------
Net sales $ -- 341,652 44,228 (25,168) 360,712
Cost of sales -- 270,212 36,050 (25,168) 281,094
----------------------------------------------------------------------------------------------------------------------
Gross profit -- 71,440 8,178 -- 79,618
Selling and administrative expenses -- 43,888 4,638 -- 48,526
----------------------------------------------------------------------------------------------------------------------
Operating income -- 27,552 3,540 -- 31,092
Interest expense (income) (10,818) 21,419 642 -- 11,243
Equity in (earnings) loss of
subsidiaries (5,398) (1,829) -- 7,227 --
----------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes 16,216 7,962 2,898 (7,227) 19,849
Provision for income taxes 3,910 2,564 1,069 -- 7,543
----------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 12,306 5,398 1,829 (7,227) 12,306
----------------------------------------------------------------------------------------------------------------------
10
CONSOLIDATED BALANCE SHEET
JUNE 30, 2003
------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ -- 2,796 2,801 -- 5,597
Receivables -- 83,807 20,021 -- 103,828
Inventories -- 301,369 13,058 -- 314,427
Prepaid expenses and other
current assets -- 3,539 248 -- 3,787
Deferred income taxes -- 23,225 41 -- 23,266
----------------------------------------------------------------------------------------------------------------------
Total current assets -- 414,736 36,169 -- 450,905
----------------------------------------------------------------------------------------------------------------------
Property and equipment -- 30,741 739 -- 31,480
Investment in subsidiaries 608,679 28,339 -- (637,018) --
Intercompany receivables -- 148,238 -- (148,238) --
Goodwill -- 44,904 1,939 -- 46,843
Intangible assets -- 46,420 -- -- 46,420
Deferred income taxes -- 35,322 130 -- 35,452
Other assets 7,514 5,761 1 -- 13,276
----------------------------------------------------------------------------------------------------------------------
Total assets $ 616,193 754,461 38,978 (785,256) 624,376
----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ -- 3,282 404 -- 3,686
Revolving line of credit -- 1,628 -- -- 1,628
Accounts payable 33 93,864 851 -- 94,748
Accrued expenses 6,466 28,714 2,521 -- 37,701
----------------------------------------------------------------------------------------------------------------------
Total current liabilities 6,499 127,488 3,776 -- 137,763
----------------------------------------------------------------------------------------------------------------------
Long-term debt 200,000 5,298 24 -- 205,322
Intercompany payables 133,091 -- 15,147 (148,238) --
Other liabilities -- 4,688 -- -- 4,688
Commitments and contingencies -- -- -- -- --
Shareholders' equity
Common stock 329 33 7,542 (7,575) 329
Additional paid-in capital 432,094 741,916 9,919 (751,835) 432,094
Retained earnings (accumulated
deficit) (122,871) (120,855) 2,570 118,285 (122,871)
Treasury stock, at cost (27,789) -- -- -- (27,789)
Unearned compensation - restricted
stock (1,053) -- -- -- (1,053)
Accumulated other comprehensive
loss (4,107) (4,107) -- 4,107 (4,107)
----------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 276,603 616,987 20,031 (637,018) 276,603
----------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 616,193 754,461 38,978 (785,256) 624,376
----------------------------------------------------------------------------------------------------------------------
11
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2002
------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ -- 3,330 1,667 -- 4,997
Receivables -- 74,806 20,416 -- 95,222
Inventories -- 335,721 12,306 -- 348,027
Prepaid expenses and other
current assets -- 2,023 143 -- 2,166
Deferred income taxes -- 23,226 40 -- 23,266
------------------------------------------------------------------------------------------------------------------------
Total current assets -- 439,106 34,572 -- 473,678
------------------------------------------------------------------------------------------------------------------------
Property and equipment -- 32,259 345 -- 32,604
Investment in subsidiaries 612,582 25,310 -- (637,892) --
Intercompany receivables -- 353,349 -- (353,349) --
Goodwill -- 44,904 1,939 -- 46,843
Intangible assets -- 49,567 -- -- 49,567
Deferred income taxes -- 36,933 80 -- 37,013
Other assets -- 12,758 1 -- 12,759
------------------------------------------------------------------------------------------------------------------------
Total assets $ 612,582 994,186 36,937 (991,241) 652,464
------------------------------------------------------------------------------------------------------------------------
LIABILITIES, CONVERTIBLE REDEEMABLE PREFERRED
STOCK AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ -- 2,714 493 -- 3,207
Revolving line of credit -- 140,301 -- -- 140,301
Accounts payable 33 113,181 1,049 -- 114,263
Accrued expenses 2,446 33,144 2,146 -- 37,736
------------------------------------------------------------------------------------------------------------------------
Total current liabilities 2,479 289,340 3,688 -- 295,507
------------------------------------------------------------------------------------------------------------------------
Long-term debt -- 77,869 30 -- 77,899
Intercompany payables 337,131 -- 16,218 (353,349) --
Other liabilities -- 6,086 -- -- 6,086
Commitments and contingencies -- -- -- -- --
Convertible redeemable preferred stock 44,370 -- -- -- 44,370
Shareholders' equity
Common stock 216 33 7,532 (7,565) 216
Additional paid-in capital 361,377 741,916 9,909 (751,825) 361,377
Retained earnings (accumulated
deficit) (99,726) (116,951) (440) 117,391 (99,726)
Treasury stock, at cost (27,789) -- -- -- (27,789)
Unearned compensation - restricted
stock (1,369) -- -- -- (1,369)
Accumulated other comprehensive
loss (4,107) (4,107) -- 4,107 (4,107)
------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 228,602 620,891 17,001 (637,892) 228,602
------------------------------------------------------------------------------------------------------------------------
Total liabilities, convertible redeemable
preferred stock and shareholders'
equity $ 612,582 994,186 36,937 (991,241) 652,464
------------------------------------------------------------------------------------------------------------------------
12
CONSOLIDATED STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2003
--------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
-----------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net earnings (loss) $ 3,206 (3,902) 3,009 893 3,206
Loss on extinguishment of debt -- 17,315 -- -- 17,315
Impairment loss -- 1,707 -- -- 1,707
Depreciation and amortization -- 9,252 79 -- 9,331
Deferred income taxes -- 1,611 (15) -- 1,596
Paid-in-kind interest -- 405 -- -- 405
Compensation expense on restricted
stock awards 316 -- -- -- 316
Changes in:
Receivables -- (9,001) 395 -- (8,606)
Inventories -- 34,352 (752) -- 33,600
Intercompany receivables and payables (204,039) 205,110 (1,071) -- --
Accounts payable -- (9,971) (230) -- (10,201)
Accrued expenses 4,020 (7,679) 375 -- (3,284)
Other, net -- (2,670) (139) -- (2,809)
-----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating
activities (196,497) 236,529 1,651 893 42,576
-----------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Capital expenditures -- (3,126) (474) -- (3,600)
Investment in subsidiaries 3,902 (3,029) 20 (893) --
-----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing
activities 3,902 (6,155) (454) (893) (3,600)
-----------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Debt proceeds 200,000 -- -- -- 200,000
Debt issue costs paid (7,514) -- -- -- (7,514)
Issuance of common stock 110 -- -- -- 110
Net change in revolving credit facility -- (138,673) (90) -- (138,763)
Cash overdrafts -- (9,346) 32 -- (9,314)
Debt repaid -- (82,889) (5) -- (82,894)
Cash dividends paid on redeemable
preferred stock (1) -- -- -- (1)
-----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing
activities 192,595 (230,908) (63) -- (38,376)
-----------------------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents -- (534) 1,134 -- 600
Cash and cash equivalents, beginning of
period -- 3,330 1,667 -- 4,997
-----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ -- 2,796 2,801 -- 5,597
-----------------------------------------------------------------------------------------------------------------------
13
CONSOLIDATED STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002
----------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
(IN THOUSANDS) PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
-------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net earnings (loss) $ 12,306 5,398 1,829 (7,227) 12,306
Depreciation and amortization -- 8,305 67 -- 8,372
Deferred income taxes -- 6,948 11 -- 6,959
Paid-in-kind interest -- 336 -- -- 336
Compensation expense on restricted
stock awards 189 -- -- -- 189
Changes in:
Receivables -- (28,653) (3,521) -- (32,174)
Inventories -- (24,596) 712 -- (23,884)
Intercompany receivables and payables (11,369) 10,202 1,167 -- --
Accounts payable -- 35,225 528 -- 35,753
Accrued expenses 4,192 (1,630) 20 -- 2,582
Other, net -- (776) (15) -- (791)
-------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating
activities 5,318 10,759 798 (7,227) 9,648
-------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Capital expenditures -- (3,096) (6) -- (3,102)
Purchase of distribution rights -- (2,661) -- -- (2,661)
Investment in subsidiaries (5,398) (1,829) -- 7,227 --
Sales of property, plant and equipment -- 125 -- -- 125
-------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing
activities (5,398) (7,461) (6) 7,227 (5,638)
-------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net change in revolving credit facility -- (2,706) (249) -- (2,955)
Cash overdrafts -- 9,707 130 -- 9,837
Debt repaid -- (1,182) (5) -- (1,187)
Issuance of common stock 192 -- -- -- 192
Purchase of treasury stock (40) -- -- -- (40)
Cash dividends paid on redeemable
preferred stock (5) -- -- -- (5)
-------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing
activities 147 5,819 (124) -- 5,842
-------------------------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents 67 9,117 668 -- 9,852
Cash and cash equivalents, beginning
of period 56 1,159 1,311 -- 2,526
-------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 123 10,276 1,979 -- 12,378
-------------------------------------------------------------------------------------------------------------------------
14
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 presents gross profit and selling
and administrative expenses as a percentage of our net sales for the three- and
six-month periods ended June 30, 2002 including approximately $36 million and
$74 million, respectively, 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. The discussion and analysis also includes
percentage increases in net sales between comparable periods that include these
direct sales. These percentage of sales ratios and percentage of sales increases
are "non-GAAP financial measures" as defined in Item 10 of Regulation S-K of the
Securities Exchange Act of 1934, as amended, or the Exchange Act. 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 gross profit and
selling and administrative expenses for the first six months of 2002 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 including the approximately $36 million and $74
million, respectively, of RR T56 sales made by Rolls-Royce in the presentation
of gross profit and selling and administrative expenses as a percentage of net
sales, and using them to calculate percentage of sales increases, for the three-
and six-month periods ended June 30, 2002, provides a more appropriate reference
point for comparing the three- and six-month periods of 2002 to the three- and
six-month periods of 2003 than calculating these ratios 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.
RESULTS OF OPERATIONS-THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS
ENDED JUNE 30, 2002
NET SALES. Net sales for Aviall Services were $243.8 million, an increase
of $57.5 million or 30.9%, from the $186.3 million recorded in the second
quarter of 2002. The increase was primarily due to higher military sales under
the RR T56 contract that began in 2002 and sales from the Honeywell agreements
implemented during 2002. The second quarter 2002 net sales amount does not
include approximately $36 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. If these sales
had been included, Aviall's year-over-year net sales increase for the quarter
would have been 10%. Excluding net sales from the RR T56 product line, higher
net sales year-over-year were reported by only the general aviation/corporate
sector, and the only geographic regions that posted higher year-over-year sales
were the Europe and Asia-Pacific regions. Sales of products supplied by
Rolls-Royce and Honeywell were $162.8 million and $96.6 million in the second
quarter of 2003 and 2002, respectively.
Net sales for Inventory Locator Service LLC, or ILS, were $7.0 million or
a 3.7% increase from the $6.8 million recorded in the second quarter of 2002.
This increase is the fifth consecutive year-over-year quarterly increase for
ILS.
GROSS PROFIT. Gross profit of $42.4 million was flat in the second quarter
of 2003 compared to $42.5 million in the second quarter of 2002. Gross profit as
a percentage of net sales was 16.9% in the second quarter of 2003 as compared to
22.0% in the second quarter of 2002. If the full sales impact of the
approximately $36 million of RR T56 sales made directly by Rolls-Royce to the
U.S. military were reflected in Aviall Services' net sales for the second
quarter of 2002, gross profit as a percentage of net sales would have been
18.6%. The decline in the comparable gross profit percentage is primarily
attributable to the increased proportion of RR T56 sales to the U.S. military.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses
decreased $0.3 million to $24.1 million in the second quarter of 2003 and
decreased as a percentage of net sales to 9.6% from 12.7% reported in the second
quarter of 2002. If the approximately $36 million of RR T56 sales made directly
by Rolls-Royce to the U.S. military were reflected in Aviall Services' net sales
in the second quarter of 2002, selling and administrative expenses as a
percentage of net sales would have been 10.7%.
15
IMPAIRMENT LOSS. The $1.7 million impairment loss resulted from the
write-off of a vendor software license purchased in 2001. In the second quarter
of 2003, the Company decided to pursue other cost-effective alternatives
resulting from the vendor's change in strategic focus. These alternatives will
allow ILS to proceed in a less expensive and more timely manner with a strategy
of offering electronic marketplace capabilities from the initial contact between
buyer and seller through the conclusion of a transaction, which ILS calls its
"Contact to Contract" plans.
LOSS ON EXTINGUISHMENT OF DEBT. On June 30, 2003, Aviall issued $200
million of 7 5/8% Senior Notes due 2011. A portion of the net proceeds was used
to redeem the entire principal amount of Aviall Services' 14% Senior Notes due
2007. The remaining proceeds were used to repay approximately $106.3 million of
outstanding indebtedness under our revolving credit facility. This refinancing
resulted in a $17.3 million noncash charge arising from the extinguishment of
debt.
INTEREST EXPENSE. Interest expense decreased slightly to $5.6 million in
the second quarter of 2003 from $5.7 million in the second quarter of 2002.
Noncash interest expense included in the $5.6 million amounted to $1.3 million.
INCOME TAX (BENEFIT) EXPENSE. Our income tax benefit for the second
quarter of 2003 was $2.4 million, and our effective tax rate was 37.7%. Our
second quarter 2002 income tax expense was $4.7 million, and our effective tax
rate was 37.4%.
NET EARNINGS (LOSS). The net loss for the second quarter of 2003 was $4.0
million compared to net earnings of $7.8 million for the second quarter of 2002.
PREFERRED STOCK DIVIDEND. The noncash preferred stock dividend of $0.9
million in June 2003 represents accrued and unpaid dividends on the Series D
Redeemable Preferred Stock prior to their conversion into shares of common stock
on June 12, 2003. The noncash preferred stock dividend of $1.0 million in June
2002 resulted from the issuance of 1,035 shares of Series D Redeemable Preferred
Stock as payment of the quarterly payable-in-kind dividend on the Series D
Redeemable Preferred Stock due June 30, 2002.
NONCASH REDUCTION FOR CONVERSION OF PREFERRED STOCK. The $24.3 million
noncash reduction for conversion of preferred stock in June 2003 resulted from
the conversion of all of our outstanding shares of Series D Redeemable Preferred
Stock into 11,100,878 shares of our common stock on June 12, 2003 following a
reduction by our board of directors of the conversion price of the shares of
Series D Redeemable Preferred Stock from $5.80 per share to approximately $4.62
per share.
RESULTS OF OPERATIONS-SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS
ENDED JUNE 30, 2002
NET SALES. Net sales for Aviall Services were $488.3 million, an increase
of $140.9 million or 40.6%, from the $347.4 million recorded in the first six
months of 2002. The increase was primarily due to higher military 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 2002 net sales amount does not include
approximately $74 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. If these sales
had been included, Aviall's year-over-year net sales increase for the first six
months would have been 16%. Excluding net sales from the RR T56 product line,
higher net sales year-over-year were reported by two of Aviall Services' three
major sectors: general aviation/corporate and government/military. In addition,
all geographic regions posted higher year-over-year sales, except for the
Domestic and Latin America geographic regions. Sales of products supplied by
Rolls-Royce and Honeywell were $327.8 million and $180.2 million in the first
six months of 2003 and 2002, respectively.
Net sales for ILS were $14.0 million or a 5.1% increase from the $13.3
million recorded in the first six months of 2002.
GROSS PROFIT. Gross profit of $84.7 million increased $5.1 million or 6.4%
in the first six months of 2003 compared to $79.6 million in the first six
months of 2002. Gross profit as a percentage of net sales was 16.9% in the first
six months of 2003 as compared to 22.1% in the first six months of 2002. If the
full sales impact of the approximately $74 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 six months of 2002, gross profit as a percentage of net sales
would have been 18.3%. The decline in the comparable gross profit percentage is
primarily attributable to the increased proportion of RR T56 sales to the U.S.
military.
16
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses
increased $0.8 million to $49.4 million in the first six months of 2003 but
decreased as a percentage of net sales to 9.8% from 13.5% reported in the first
six months of 2002. If the approximately $74 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 six months of 2002, selling and administrative expenses
as a percentage of net sales would have been 11.2%. Included in the first six
months of 2003 amount is a $0.9 million provision for doubtful accounts in the
commercial airline sector, net of $0.3 million in recoveries.
IMPAIRMENT LOSS. The $1.7 million impairment loss resulted from the
write-off of a vendor software license purchased in 2001. In the second quarter
of 2003, the Company decided to pursue other cost-effective alternatives
resulting from the vendor's change in strategic focus. These alternatives will
allow ILS to proceed in a less expensive and more timely manner with a strategy
of offering electronic marketplace capabilities from the initial contact between
buyer and seller through the conclusion of a transaction, which ILS calls its
"Contact to Contract" plans.
LOSS ON EXTINGUISHMENT OF DEBT. On June 30, 2003, Aviall issued $200
million of 7 5/8% Senior Notes due 2011. A portion of the net proceeds was used
to redeem the entire principal amount of Aviall Services' 14% Senior Notes due
2007. The remaining proceeds were used to repay approximately $106.3 million of
outstanding indebtedness under our revolving credit facility. This refinancing
resulted in a $17.3 million noncash charge arising from the extinguishment of
debt
INTEREST EXPENSE. Interest expense increased $0.2 million to $11.5 million
in the first six months of 2003 from $11.2 million in the first six months of
2002. Noncash interest expense included in the $11.5 million amounted to $2.7
million. This increase was primarily due to higher borrowings in 2003.
INCOME TAX EXPENSE. Our income tax expense for the first six months of
2003 was $1.7 million, and our effective tax rate was 34.2%. Our income tax
expense for the first six months of 2002 was $7.5 million, and our effective tax
rate was 38.0%. The reduction in the effective tax rate year-over-year resulted
primarily from the impact of the loss on the extinguishment of debt in the
second quarter of 2003.
NET EARNINGS. Net earnings for the first six months of 2003 were $3.2
million, a decrease of 74.0% compared to the $12.3 million reported in the first
six months 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 $2.0
million in the first six months of 2003 and $2.1 million in the first six months
of 2002 resulted from the issuance of 1,108 shares of Series D Redeemable
Preferred Stock and 2,048 shares of Series D Redeemable Preferred Stock,
respectively, as payment of the quarterly payable-in-kind dividends on the
Series D Redeemable Preferred Stock due in the first six months of 2003 and
2002. The 2003 noncash preferred stock dividend of $2.0 million includes $0.9
million of accrued and unpaid dividends on the Series D Redeemable Preferred
Stock prior to their conversion into shares of common stock on June 12, 2003.
NONCASH REDUCTION FOR CONVERSION OF PREFERRED STOCK. The $24.3 million
noncash reduction for conversion of preferred stock in June 2003 resulted from
the conversion of all of our outstanding shares of Series D Redeemable Preferred
Stock into 11,100,878 shares of our common stock on June 12, 2003 following a
reduction by our board of directors of the conversion price of the shares of
Series D Redeemable Preferred Stock from $5.80 per share to approximately $4.62
per share.
17
INCOME TAXES
Cash tax payments (refunds) made for federal, state and foreign income
taxes were $0.4 million and $0.6 million for the three- and six-month periods
ended June 30, 2003 compared to $(0.2) million and $0.2 million for the same
periods 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. The conversion of our Series D Redeemable Preferred
Stock into common stock did not result in an annual limitation on the amount of
our federal net operating loss carryforward that we could utilize. In addition,
the future exercise of our outstanding warrants will not be deemed to be
additional changes to our stock ownership, separate and apart from the original
issuance of the warrants in March 2002. However, if there are additional changes
to our equity ownership, particularly prior to June 30, 2004, there could be a
limitation on our ability to use our federal net operating loss carryforward in
the future, which could have a material adverse effect on our business. 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 operations was $42.6 million in the
first six months of 2003 compared to $9.6 million in the first six months of
2002. The increase in cash flow in the first half of 2003 resulted from reduced
inventory levels as compared to December 31, 2002. The increase in cash flow in
the first half of 2002 resulted from sales and gross margin increases and
working capital changes related to the RR T56 contract. Inventory levels as of
December 31, 2002 were unusually high due to inventory purchasing at year-end to
take advantage of pricing incentives. Aviall Services inventory turns decreased
slightly from 2.8 turns in December 2002 to 2.6 turns in June 2003 due to
slightly lower-than-expected sales volumes for some product lines. Offsetting
this, the days' sales outstanding for Aviall's receivables improved from 41 days
in December 2002 to 37 days in June 2003 resulting largely from the higher mix
of RR T56 contract sales which have comparatively short receivable terms.
Capital expenditures were $4.4 million in the first six months of 2003,
including $0.8 million for noncash capital expenditures, compared to $3.1
million in the first six 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 $(38.4) million in the first six months of 2003 compared to $5.8
million in the first six months of 2002.
In summary, our cash provided by operating activities improved by $32.9
million to $42.6 million during the six month period ended June 30, 2003
compared to $9.6 million during the same period in 2002. This was after
generating $14.8 million in working capital, defined as receivables, inventories
and accounts payable, in 2003 compared to investing $20.3 million in working
capital in 2002. In 2003, we used the cash provided by operating activities, as
well as $0.1 million received from the issuance of common stock and $200.0
million received from the issuance of the New Senior Notes, net of $7.5 million
of debt issue costs paid, to make $3.6 million of net capital expenditures, pay
down $221.7 million of debt and decrease our cash overdraft position by $9.3
million. In addition, we increased our cash on hand as of June 30, 2003 by $0.6
million. In 2002, we used the cash provided by operating activities, as well as
an increase in our cash overdraft position of $9.8 million and $0.2 million
received from the issuance of common stock, to make $5.6 million of net capital
expenditures and distribution rights and pay down $4.1 million of debt. We
increased our cash on hand as of June 30, 2002 by $9.9 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.
18
CONVERTIBLE PARTICIPATING REDEEMABLE PREFERRED STOCK. On March 15, 2002,
our Series B Redeemable Preferred Stock was automatically converted into 45,110
shares of 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.
On June 12, 2003, the Carlyle Investors converted all of the outstanding
shares of Series D Redeemable Preferred Stock into 11,100,878 shares of our
common stock, following a reduction by our board of directors of the conversion
price of the shares of Series D Redeemable Preferred Stock from $5.80 per share
to approximately $4.62 per share. We accounted for this reduction as a one-time
$24.3 million noncash reduction to our net earnings available to common
shareholders for the three- and six-month periods ended June 30, 2003. The
shares of common stock issued to the Carlyle Investors as a result of the
conversion represented approximately 36% of our outstanding common stock on the
date of the conversion. At the time of the conversion, the outstanding shares of
Series D Redeemable Preferred Stock had an aggregate liquidation preference,
plus accrued and unpaid dividends, of approximately $51.3 million and a 9.0%
annual payment-in-kind dividend rate.
SENIOR UNSECURED DEBT. On June 30, 2003, we issued $200.0 million of the
New Senior Notes pursuant to an offering under Rule 144A/Regulation S of the
Securities Act of 1933. The New Senior Notes bear interest at 7.625% per annum
and mature on July 1, 2011, unless previously redeemed at our option. We may
redeem some or all of the New Senior Notes at specified redemption prices at any
time after July 1, 2007. In addition, prior to July 1, 2006, we may redeem up to
35% of the New Senior Notes from the proceeds of qualifying equity offerings.
The New Senior Notes are our senior unsecured obligations and are equal in
right of payment to all of our senior indebtedness. The New Senior Notes are
guaranteed on a senior unsecured basis by each of our domestic subsidiaries.
We used the net proceeds from the issuance of the New Senior Notes to
redeem the entire principal amount of the 14% Notes and to repay a portion of
the outstanding revolving indebtedness under the Credit Facility. In connection
with the redemption of the 14% Notes, we recorded a $17.3 million pretax loss on
extinguishment which consists of a $3.2 million prepayment premium on the
outstanding principal amount of the 14% Notes, $8.7 million of unamortized debt
discount and $5.4 million of unamortized original debt issuance costs. While the
issuance of the New Senior Notes was not registered, we expect to exchange them
for new notes with nearly identical terms and conditions that are registered for
exchange in accordance with the terms of a registration rights agreement we
entered into in connection with the sale of the New Senior Notes.
SENIOR SECURED DEBT. Concurrently with the issuance of the New Senior
Notes, we amended the Credit Facility to permit us to issue the New Senior
Notes, to redeem the 14% Notes, to permit Aviall to service the interest and
principal on the New Senior Notes and to modify certain covenants to reflect,
among other items, the issuance of the New Senior Notes. Our amended 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 June
30, 2003, we had $1.6 million outstanding on the Credit Facility and issued
letters of credit for $1.0 million. We had $194.1 million available for
additional borrowings under the Credit Facility and our borrowing base was
$196.7 million as of June 30, 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 June 30,
2003, the average interest rate on the Credit Facility was 5.75%. 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 the 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 CAD $6.0
million credit facility is currently available and had an outstanding balance at
June 30, 2003 equivalent to U.S. $0.4 million.
19
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. Our Adjusted EBITDA for the trailing four
quarters ended June 30, 2003 was $77.3 million, composed of $19.3 million, $18.2
million, $20.2 million and $19.6 million during the third and fourth quarters of
2002 and the first and second quarters of 2003, respectively.
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 June 30, 2003, the
required ratio was 3.50 to 1. 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 June 30, 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 June 30, 2003, the required tangible net
worth was $177.3 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 New Senior Notes also contain various restrictive covenants. We may
not incur additional indebtedness unless we maintain a consolidated interest
coverage ratio of at least 2.0 to 1.0 or unless the debt is otherwise permitted
under the indenture. The consolidated interest coverage ratio measures the ratio
of our EBITDA, as defined in the indenture relating to the New Senior Notes, for
the trailing four quarters to our interest expense for such quarters. Subject to
specified exceptions, we may not make payments on or redeem our capital stock,
make certain investments or make other restricted payments unless we maintain a
consolidated interest coverage ratio of at least 2.0 to 1.0 and otherwise have
available 50% of cumulative consolidated net income or capital stock sale
proceeds from which such payments may be made. Our ability to incur liens is
limited to the extent not expressly permitted or to the extent the New Senior
Notes are not equally and ratably secured. We may not sell or otherwise dispose
of any of the capital stock of our subsidiaries unless specifically authorized.
We must receive fair market value for any asset sales and the consideration must
be paid at least 75% in cash, cash equivalents or assumed liabilities. To the
extent such proceeds are received, we must reinvest any proceeds exceeding $10
million in additional assets within a period of 365 days or thereafter repay
senior debt or repurchase New Senior Notes. Additionally, we must repurchase the
New Senior Notes at a price equal to 101% of the principal amount of the New
Senior Notes upon a change of control. The indenture relating to the New Senior
Notes also contains additional covenants.
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 New Senior Notes.
The following table presents a reconciliation of our EBITDA and Adjusted
EBITDA, as defined in the Credit Facility, to net earnings (loss) for the
trailing four quarters ended June 30, 2003:
THIRD QUARTER FOURTH QUARTER FIRST QUARTER SECOND QUARTER
(IN THOUSANDS) 2002 2002 2003 2003 TOTAL
-------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 6,922 10,449 7,170 (3,964) 20,577
Earnings from discontinued
operations -- (3,026) -- -- (3,026)
-------------------------------------------------------------------------------------------------------------------------
Earnings (loss) from continuing
operations 6,922 7,423 7,170 (3,964) 17,551
Plus:
Income tax expense (benefit) 3,510 2,146 4,064 (2,395) 7,325
Interest expense 5,600 5,735 5,863 5,609 22,807
Depreciation and amortization
expense 3,189 3,129 3,449 3,532 13,299
-------------------------------------------------------------------------------------------------------------------------
EBITDA 19,221 18,433 20,546 2,782 60,982
Other noncash charges -- -- -- 17,315 17,315
Noncash (gains) losses 95 (221) (328) (534) (988)
-------------------------------------------------------------------------------------------------------------------------
Adjusted EBITDA $19,316 18,212 20,218 19,563 77,309
-------------------------------------------------------------------------------------------------------------------------
20
The Adjusted EBITDA calculation above is prepared in accordance with the
terms of the Credit Facility. The noncash gains and losses and other noncash
charges, 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 EBITDA and Adjusted EBITDA should not be
considered an alternative to operating results or cash flows calculated in
accordance with generally accepted accounting principles.
CONTRACTUAL OBLIGATIONS. The following table sets forth our remaining
contractual obligations as of June 30, 2003 for the periods shown (in
thousands):
REMAINDER
CONTRACTUAL OBLIGATION TOTAL OF 2003 2-3 YEARS 4-5 YEARS THEREAFTER
----------------------------------------------------------------------------------------------------------------
Debt $204,887 255 2,609 20 202,003
Capital lease obligations 5,749 1,402 3,700 647 --
Operating leases 34,934 4,129 13,178 7,424 10,203
Purchase commitments 256,100 256,100 -- -- --
----------------------------------------------------------------------------------------------------------------
Total contractual cash obligations $501,670 261,886 19,487 8,091 212,206
----------------------------------------------------------------------------------------------------------------
SUMMARIZED ARTICLE 11 PRO FORMA FINANCIAL INFORMATION. The following table
presents summarized pro forma financial information, in accordance with Article
11 of Regulation S-X, to reflect, on a pro forma basis, our net earnings for the
three- and six-month periods ended June 30, 2003 and 2002 as if the refinancing
and preferred stock conversion had been completed prior to January 1, 2002.
Included is a reconciliation of our actual net earnings (loss) applicable to
common shares with our pro forma net earnings and pro forma diluted net earnings
per share. Management believes this pro forma presentation is beneficial to
investors to provide information on how these consummated transactions would
have affected the historical financial statements had they occurred at an
earlier date. The refinancing and preferred stock conversion transactions in
June 2003 significantly changed our debt and capital structure. The preferred
stock conversion resulted in significant dilution to our common shares
outstanding due to the issuance of 11 million additional common shares, and the
refinancing lowered our net interest expense. Management believes this summary
of pro forma financial information provides it with a mechanism to evaluate
year-over-year operating performance on a comparable basis without including the
costs associated with the preferred stock, the issuance of new debt and the
retirement of old debt.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------------------------------
(IN THOUSANDS) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------------
Net earnings (loss) applicable to common shares $ (29,206) 6,742 (23,145) (10,280)
Pro forma adjustments:
Deemed dividend from beneficial conversion
feature -- -- -- 20,533
Preferred stock dividends 907 1,038 2,016 2,053
Noncash reduction for conversion of preferred
stock 24,335 -- 24,335 --
Net interest expense adjustment, net of tax 322 457 743 735
Loss on extinguishment of debt, net of tax 11,385 -- 11,385 --
-------------------------------------------------------------------------------------------------------------------
Pro forma net earnings $ 7,743 8,237 15,334 13,041
-------------------------------------------------------------------------------------------------------------------
Pro forma diluted net earnings per share $ 0.24 0.26 0.48 0.42
Pro forma weighted average common and
potentially dilutive common shares 32,019,204 31,806,504 31,866,942 30,948,702
-------------------------------------------------------------------------------------------------------------------
21
The pro forma adjustments, which are directly attributable to the
transactions discussed above, include a) the noncash deemed dividend from the
issuance of the Series D Redeemable Preferred Stock in March 2002, b) the
quarterly dividends paid on the Series D Redeemable Preferred Stock, c) a
noncash reduction of earnings available to common shareholders for the
conversion of all shares of our Series D Redeemable Preferred Stock into shares
of common stock, d) an after-tax adjustment reflecting the lower interest
expense of the pro forma interest expense on our new debt over our old debt, and
e) an after-tax charge of $11.4 million to write-off unamortized deferred
financing costs on our old debt in connection with the refinancing.
NEW ACCOUNTING PRONOUNCEMENTS
On May 15, 2003, the FASB issued Statement of Financial Accounting
Standards No. 150, or SFAS 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity." SFAS 150 represents the
first phase of the FASB's project on liabilities and equity and requires
financial instruments that meet the definitions in the statement to be
classified as liabilities. SFAS 150 requires that mandatorily redeemable
preferred stock be classified and accounted for as a liability. However, it
excludes from its scope convertible instruments, which will be addressed in the
second phase of the FASB's project. SFAS 150 is effective at the beginning of
the first interim period beginning after June 15, 2003. Because our convertible
redeemable preferred stock was converted to common stock on June 12, 2003, the
adoption of this statement will not have an effect on our consolidated financial
position and results of operations.
On April 30, 2003, the FASB issued Statement of Financial Accounting
Standards No. 149, or SFAS 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." SFAS 149 amends and clarifies financial
accounting and reporting for derivative instruments to incorporate decisions
made by the Derivatives Implementation Group. The statement is generally
effective for contracts or hedging relationships entered into after June 30,
2003. We believe the adoption of this statement will not have a significant
effect on our consolidated financial position or results of operations.
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. During the
first quarter of 2003, Air Canada filed for bankruptcy. Aviall Services' net
sales to these customers combined during 2002 and the first six months of 2003
were less than $5.6 million and $2.5 million, respectively.
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 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.
22
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 $103 million of Rolls-Royce Model 250 series gas turbine
parts. As of June 30, 2003, we have purchased $171.8 million of RR T56 parts and
$42.5 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 currently 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 six months 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 for additional growth; 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 in the future.
While our revenue in the first half of 2003 increased by 40%, our selling
and administrative expenses for the same period experienced only a 2% increase.
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 half 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. For example, in the second quarter of
2003, ILS took a $1.7 million write-off for a vendor software license purchased
in 2001 due to a change in the vendor's strategic focus and the availability of
other less expensive software alternatives.
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 affect flight activity in the
commercial, business, government/military, and general/corporate aviation
segments, the business activities of our customers and suppliers, developments
in information and communication technology and potential limitations on our
ability to realize our deferred tax assets. 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 six 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.
23
ITEM 4: CONTROLS AND PROCEDURES
The term "disclosure controls and procedures" is defined in Rules
13a-15(e) and 15d-15(e) of 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 or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified by the Securities and Exchange Commission. Our
management, including our Chief Executive Officer and Chief Financial Officer,
has evaluated the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this quarterly report. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures were effective as of the
end of the period covered by this quarterly report.
There were no changes to our internal control over financial reporting
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
24
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
We held our 2003 Annual Meeting of Stockholders on June 26, 2003, and the
matters voted upon at that meeting were the following:
The election of Alberto F. Fernandez, Paul E. Fulchino and Arthur E.
Wegner to serve as directors for a term expiring at our 2006 Annual Meeting of
Stockholders.
Nominee Votes For Votes Withheld
------- --------- --------------
Alberto F. Fernandez 22,163,672 3,258,811
Paul E. Fulchino 25,232,717 189,766
Arthur E. Wegner 22,167,365 3,255,118
The approval of an amendment to the Aviall, Inc. Amended and Restated 1998
Directors Stock Plan to provide for the following changes:
- the maximum number of shares of common stock that can be issued pursuant
to option grants to each eligible director in any fiscal year increased
from 3,000 shares of common stock to 5,000 shares of common stock;
- the grant date for the issuance of shares of restricted common stock and
options changed from the first New York Stock Exchange trading day in
July of each calendar year to the first New York Stock Exchange trading
day in February of each calendar year effective as of January 2004;
- the vesting date for grants of shares of restricted common stock changed
from the six-month anniversary of the grant date to the eleven-month
anniversary of the grant date effective as of January 2004; and
- the earliest date at which options can be exercised changed from the
six-month anniversary of the grant date to the eleven-month anniversary
of the grant date effective as of January 2004.
Votes For Votes Against Votes Abstaining Broker Non-Vote
--------- ------------- ---------------- ---------------
24,052,577 1,331,220 36,686 None
25
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NO. DESCRIPTION
-------- --------------------------------------------------------
4.1 Investor Rights Agreement, dated as of June 12, 2003, by
and among Aviall, Inc., Carlyle Partners III, L.P., CP
III Coinvestment, L.P., Carlyle High Yield Partners,
L.P. and Carlyle-Aviall Partners II, L.P. (Exhibit 4.1
to Aviall, Inc.'s Current Report on Form 8-K, dated as
of June 12, 2003 and incorporated by reference herein)
4.2 Form of 7 5/8% Senior Note due 2011 of Aviall, Inc.
4.3 Indenture, dated as of June 30, 2003, by and between
Aviall, Inc. and The Bank of New York, as Trustee,
relating to Aviall, Inc.'s 7 5/8% Senior Notes due 2011
4.4. Registration Rights Agreement, dated as of June 30,
2003, by and among Aviall, Inc., certain subsidiaries of
Aviall, Inc. party thereto, Citigroup Global Markets
Inc., Credit Suisse First Boston LLC and Wachovia
Securities, LLC
10.1 Purchase Agreement, dated as of June 25, 2003, by and
among Aviall, Inc., certain subsidiaries of Aviall, Inc.
party thereto, Citigroup Global Markets Inc., Credit
Suisse First Boston LLC and Wachovia Securities, LLC
10.2 Second Amended and Restated Credit Agreement, dated as
of June 30, 2003, by and among Aviall, Inc., Aviall
Services, Inc., Citicorp USA, Inc. and the lenders and
issuers party thereto
10.3 Amendment Number Two to the Aviall, Inc. Amended and
Restated 1998 Directors Stock Plan, dated as of June 26,
2003
31.1 Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934
31.2 Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934
32.1 Certifications pursuant to Rule 13a-14(b) of the
Securities Exchange Act of 1934 and 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 May 7, 2003, under Item 9, announcing that we
issued a press release regarding our financial results for the
quarter ended March 31, 2003.
A Form 8-K was filed on June 13, 2003, under Item 5, announcing that
affiliates of The Carlyle Group converted all of our Series D
Redeemable Preferred Stock into 11,100,878 shares of our common stock
and that we had entered into an Investor Rights Agreement with
affiliates of The Carlyle Group.
A Form 8-K was filed on June 13, 2003, under Item 5, announcing that
we issued a press release regarding our proposal to make an offering
of New Senior Notes.
26
A Form 8-K was filed on June 13, 2003, and a subsequent amendment to
this Form 8-K was filed on June 23, 2003, each under Item 9,
furnishing certain information previously provided to investors
regarding the proposed offering of the New Senior Notes.
A Form 8-K was filed on June 26, 2003, under Item 5, announcing that
we issued a press release regarding the pricing of the New Senior
Notes and the application of the proceeds from the sale of the New
Senior Notes.
A Form 8-K was filed on June 26, 2003, under Item 9, announcing the
effect of the sale of the New Senior Notes and conversion of the
Series D Redeemable Preferred Stock on our net earnings, EBITDA and
earnings (loss) per share.
27
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.
August 12, 2003 By: /s/ Colin M. Cohen
-------------------------------
Colin M. Cohen
Vice President and Chief Financial Officer
(Principal Financial Officer)
28
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
-------- --------------------------------------------------------
4.1 Investor Rights Agreement, dated as of June 12, 2003, by
and among Aviall, Inc., Carlyle Partners III, L.P., CP
III Coinvestment, L.P., Carlyle High Yield Partners,
L.P. and Carlyle-Aviall Partners II, L.P. (Exhibit 4.1
to Aviall, Inc.'s Current Report on Form 8-K, dated as
of June 12, 2003 and incorporated by reference herein)
4.2 Form of 7 5/8% Senior Note due 2011 of Aviall, Inc.
4.3 Indenture, dated as of June 30, 2003, by and between
Aviall, Inc. and The Bank of New York, as Trustee,
relating to Aviall, Inc.'s 7 5/8% Senior Notes due 2011
4.4 Registration Rights Agreement, dated as of June 30,
2003, by and among Aviall, Inc., certain subsidiaries of
Aviall, Inc. party thereto, Citigroup Global Markets
Inc., Credit Suisse First Boston LLC and Wachovia
Securities, LLC
10.1 Purchase Agreement, dated as of June 25, 2003, by and
among Aviall, Inc., certain subsidiaries of Aviall, Inc.
party thereto, Citigroup Global Markets Inc., Credit
Suisse First Boston LLC and Wachovia Securities, LLC
10.2 Second Amended and Restated Credit Agreement, dated as
of June 30, 2003, by and among Aviall, Inc., Aviall
Services, Inc., Citicorp USA, Inc. and the lenders and
issuers party thereto
10.3 Amendment Number Two to the Aviall, Inc. Amended and
Restated 1998 Directors Stock Plan, dated as of June 26,
2003
31.1 Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934
31.2 Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934
32.1 Certifications pursuant to Rule 13a-14(b) of the
Securities Exchange Act of 1934 and 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
29