FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Quarterly or Transitional Report
U.S. 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 October 31, 1998
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934)
For the transition period from___________ to ____________
Commission File Number 0-21995
First Aviation Services Inc.
(Exact name of registrant as
specified in its charter)
Delaware 06-1419064
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
15 Riverside Avenue, Westport, Connecticut, 06880-4214
(Address of principal executive offices)
(203) 291-3300
(Issuer's telephone number)
____________________________________________________
(Former name, former address and formal fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) 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__
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDING DURING THE
PRECEDING FIVE YEARS
Indicate by check mark whether the registrant filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court. Yes __ No__
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of the registrant's common stock as of December
10, 1998 is 8,986,647 shares.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
First Aviation Services Inc.
Consolidated Balance Sheets
(in thousands, except share amounts)
October 31, January 31,
1998 1998
---------- -----------
Assets (unaudited)
Current assets:
Cash and cash equivalents $ 137 $ 237
Trade receivables, net of
allowance for doubtful accounts of
$409 and $346 at October 31, 1998
and January 31, 1998 28,945 27,841
Inventories, net 48,173 43,311
Deferred income taxes 2,381 2,381
Prepaid expenses and other 2,142 1,624
------- -------
Total current assets 81,778 75,394
Plant and equipment, net 8,485 5,027
Goodwill, net 1,856 1,873
Other assets 113 229
------- -------
$92,232 $82,523
======= =======
Liabilities and stockholders'
equity
Current liabilities:
Accounts payable $16,926 $14,106
Accrued compensation and
related expenses 1,781 2,146
Other accrued liabilities 3,190 2,631
Income taxes payable 1,948 2,776
Short term line of credit 4,950 --
------- -------
Total current liabilities 28,795 21,659
Revolving line of credit 16,460 13,866
Capital lease obligation 145 --
Minority interest 1,041 1,041
------- -------
Total liabilities 46,441 36,566
Stockholders' equity:
Common stock, $0.01 par value,
25,000,000 shares authorized,
8,985,471 and 8,928,925 shares
issued and outstanding at
October 31, 1998 and
January 31, 1998 90 89
Additional paid-in capital 38,455 38,378
Retained earnings 7,246 7,490
------- -------
Total stockholders' equity 45,791 45,957
------- -------
$92,232 $82,523
======= =======
See accompanying notes.
2
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First Aviation Services Inc.
Consolidated Statements of Operations (Unaudited)
(in thousands, except share amounts)
Three months ended
October 31,
1998 1997
----------- -----------
Net sales $ 39,331 $ 39,543
Cost of sales 32,275 32,784
---------- ----------
Gross Profit 7,056 6,759
Selling, general and administrative
expenses 5,415 4,329
---------- ----------
Income from operations 1,641 2,430
Interest expense 483 234
Minority interest in subsidiary 10 11
---------- ----------
Income before provision for income taxes 1,148 2,185
Provision for income taxes 344 549
---------- ----------
Net income available to
common stockholders $ 804 $ 1,636
========== ==========
Basic net income per common share:
Basic net income per common share $ 0.09 $ 0.18
========== ==========
Shares used in the
calculation of basic net
income per common share 8,984,678 8,915,971
========== ==========
Net income per common
share - assuming
dilution:
Net income per common
share - assuming
dilution $ 0.09 $ 0.18
========== ==========
Shares used in the
calculation of net
income per common
share - assuming
dilution 9,094,443 9,065,807
========== ==========
See accompanying notes.
3
<PAGE>
First Aviation Services Inc.
Consolidated Statements of Operations (Unaudited)
(in thousands, except share amounts)
Nine months ended
October 31,
1998 1997
----------- -----------
Net sales $ 111,192 $ 113,966
Cost of sales 92,254 95,849
----------- -----------
Gross Profit 18,938 18,117
Selling, general and administrative
expenses 15,134 11,175
Restructuring charge 1,750 --
Other non-recurring charges 1,028 --
----------- -----------
Income from operations 1,026 6,942
Interest expense, net 1,337 1,110
Minority interest in subsidiary 31 29
----------- -----------
Income/(loss) before provision/(benefit)
for income taxes, extraordinary item
and preferred dividends (342) 5,803
Provision/(benefit) for income taxes (103) 1,497
----------- -----------
Income/(loss) before extraordinary item (239) 4,306
Extraordinary item:
Loss on early extinguishment of debt
(net of income tax benefit) -- (108)
----------- -----------
Net income/(loss) (239) 4,198
Dividends on preferred stock -- 11
----------- -----------
Net income/(loss) available to
common stockholders $ (239) $ 4,187
=========== ===========
Basic net income/(loss) per common share:
Income/(loss) before extraordinary item
available to common stockholders $ (0.03) $ 0.52
Extraordinary item -- (0.01)
----------- -----------
Basic net income/(loss) per
common share $ (0.03) $ 0.51
=========== ===========
Shares used in the calculation of
basic net income/(loss)
per common share 8,966,893 8,287,330
=========== ===========
Net income per common share - assuming
dilution:
Income before extraordinary item
available to common stockholders N/A $ 0.50
Extraordinary item -- (0.01)
----------- -----------
Net income per common share - assuming
dilution N/A $ 0.49
=========== ===========
Shares used in the calculation of net
income per common share - assuming
dilution N/A 8,587,970
=========== ===========
See accompanying notes.
4
<PAGE>
First Aviation Services Inc.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
Nine months ended
October 31,
1998 1997
----------- -----------
Cash flows from operating activities
Net income/(loss) (239) $ 4,198
Adjustments to reconcile net income
to net cash provided by/
(used in) operating activities:
Depreciation and amortization 773 709
Extraordinary item, net loss on
early extinguishment of debt -- 108
Changes in assets and liabilities:
Trade receivables (1,106) (4,985)
Inventories (4,863) (1,416)
Prepaid expenses and other assets (402) (401)
Accounts payable 2,820 (2,972)
Accrued compensation and related
expenses, and other accrued
liabilities 194 (2,279)
Income taxes payable (828) 1,258
Other non-current liabilities -- (1,280)
------- --------
Net cash used in operating activities (3,651) (7,060)
Cash flows from investing activities
Purchase of assets from former owners,
including acquisition costs -- (11,214)
Purchases of plant and equipment (4,028) (1,251)
------- --------
Net cash used in investing activities (4,028) (12,465)
Cash flows from financing activities
Net borrowings on short term line of credit 4,950 --
Net borrowings/(repayments) on revolving
line of credit 2,594 (10,719)
Principal payments on capital lease obligation (42) --
Repayment of term loans and
subordinated note -- (4,400)
Proceeds from sale of preferred stock
of subsidiary -- 1,100
Proceeds from issuance of common stock
in initial public offering -- 39,000
Expenses relating to initial public offering -- (4,486)
Payment of dividends on preferred stock -- (231)
Other 77 70
------- --------
Net cash provided by financing
activities 7,579 20,334
Net increase/(decrease) in cash
and cash equivalents (100) 809
Cash and cash equivalents at
beginning of period 237 --
------- --------
Cash and cash equivalents at
end of period $ 137 $ 809
======= ========
Supplemental cash flow disclosures:
Interest paid $ 1,067 $ 1,327
Income taxes paid $ 730 $ --
Acquisition of equipment
through capital lease $ 187 $ --
See accompanying notes.
5
<PAGE>
First Aviation Services Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
(in thousands, except share amounts)
October 31, 1998
1. Basis of Presentation
First Aviation Services Inc. ("First Aviation") and its subsidiaries, Aircraft
Parts International Combs, Inc. ("API") and National Airmotive Corporation
("NAC"), (collectively, the "Company") repairs and overhauls commercial and
military aircraft engines and industrial turbines, and sells and distributes
aircraft parts and components. The Company is headquartered in Westport,
Connecticut. Customers of the Company include passenger and cargo airlines,
foreign governments, U.S. and foreign military services, fleet operators, fixed
base operators, certified repair facilities and industrial companies. The
accompanying unaudited condensed consolidated financial statements of First
Aviation and its subsidiaries 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, they 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 material adjustments, consisting only of the elimination of
intercompany balances and transactions, and normal recurring accruals, except as
described in Note 4, considered necessary for a fair presentation have been
included in the accompanying unaudited financial statements. In addition,
certain amounts for prior periods have been reclassified to be comparable with
the current period presentation. Operating results for the quarter and nine
months ended October 31, 1998 are not necessarily indicative of the results that
may be expected for the full year ending January 31, 1999. For further
information, refer to the financial statements and footnotes thereto included in
the Company's Form 10-K for the year ended January 31, 1998, and Proxy Statement
and Notice of Annual Meeting of Stockholders dated August 4, 1998.
2. Inventories
Inventories consist of the following:
October 31, January 31,
1998 1998
----------- -----------
Parts held for manufacturing or resale $ 34,158 $ 31,025
Work in-process 11,470 8,099
Finished goods 4,458 6,566
-------- --------
50,086 45,690
Less: allowance for obsolete and
slow moving inventory (1,913) (2,379)
-------- --------
$ 48,173 $ 43,311
======== ========
3. Debt
NAC is a party to a credit agreement that provides for borrowings up to a total
of $40 million, principally through a revolving credit facility. The original
term of the credit agreement is through May 15, 1999. Termination of the
agreement prior to that date will trigger a prepayment penalty of 1% of the
total facility. Thereafter, provided that NAC is in compliance with the terms,
conditions and covenants contained in the credit agreement, the agreement
automatically renews for additional one-year periods, and may be terminated
without penalty.
Historically, management has classified these borrowings as long-term since
repayment of the debt has been due more than one year from the date of the
Company's financial statements and the borrowing base supporting this credit
facility always has exceeded outstanding borrowings. Management believes that
the borrowing base will exceed borrowings for at least the next twelve months.
Although this facility expires within the next year, management intends either
to renew the current facility or replace it with a new long-term facility.
Management believes that it has the ability to refinance this facility in a
manner that will not require the use of working capital. Therefore, management
will continue to classify this obligation as long-term.
6
<PAGE>
API is a party to a credit agreement that provides for borrowings up to a total
of $10 million through a revolving credit facility. The term of this credit
agreement is through April 1999. This facility has been classified as a current
liability.
4. Restructuring Charge and Other Non-recurring Charges
On April 6, 1998, the Company announced that it had initiated a plan to
streamline and restructure operations at NAC in order to reduce costs and
improve operating efficiencies. In connection with this plan, the Company
recorded a $1.75 million pre-tax restructuring charge in the first quarter. The
restructuring charge included $0.85 million in severance and other employee
termination costs related to a reduction in NAC's workforce of approximately 78
people and $0.90 million in inventory write-downs. During the quarter and nine
months ended October 31, 1998, approximately $0.90 million and $1.75 million,
respectively, was charged against the restructuring reserve for severance and
other employee costs, and to write-down inventory.
In addition, the Company also recorded other non-recurring charges totaling
$1.03 million pre-tax. The other non-recurring charges consist of costs to
consolidate certain facilities ($0.6) and other charges ($0.43).
5. Earnings/(Loss) per Common Share
The following sets forth the computation of basic earnings per share and
earnings per share - assuming dilution.
<TABLE>
<CAPTION>
Three months ended Nine months ended
------------------------ --------------------------
October 31, October 31, October 31, October 31,
1998 1997 1998 1997
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Numerator:
Net income/(loss) before
extraordinary item $ 804 $ 1,636 $ (239) $ 4,306
Preferred stock dividends -- -- -- (11)
---------- ----------- ----------- -----------
Numerator for earnings/(loss)
per share - net income/(loss)
available to common stockholders
before extraordinary item 804 1,636 (239) 4,295
Effect of extraordinary item,
net of associated income
tax benefit -- -- -- (108)
---------- ----------- ----------- -----------
Numerator for earnings/(loss)
per share - net income/(loss)
available to common stockholders $ 804 $ 1,636 $ (239) $ 4,187
========== =========== =========== ===========
Denominator:
Denominator for basic earnings/(loss)
per share - weighted average shares 8,984,678 8,915,971 8,966,893 8,287,330
Effect of dilutive warrants and
employee stock options 109,765 149,836 N/A 300,640
---------- ----------- ----------- -----------
Denominator for earnings per
share - assuming dilution
- adjusted weighted average
shares and assumed conversions 9,094,443 9,065,807 N/A 8,587,970
========== =========== =========== ===========
</TABLE>
For the nine months ended October 31, 1998 net loss per share - assuming
dilution was not presented because the effect of warrants and options would have
been antidilutive.
Stock options to purchase shares of common stock at prices ranging from $6 to
$10 per share have been issued to employees but were not included in the
computations of earnings per share - assuming dilution because the exercise
price of the options was greater than the average market price of the common
stock during the periods presented and, therefore, the effect would be
antidilutive.
7
<PAGE>
Item 2. Management's Discussion and Analysis or Plan of Operation
Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995.
Statements which are not historical facts in this report constitute forward
looking statements, within the meaning of the Private Securities Litigation
Reform Act of 1995. Such forward looking statements, including those concerning
the Company's expectations, all involve risk and uncertainties, which may cause
the actual results, performance or achievements of the Company to be materially
different from any future results, performance or achievement expressed or
implied by such forward looking statements. Such factors include, among others,
the Company's ability to obtain parts from its suppliers on a timely basis, the
ability to consummate suitable acquisitions, and other items that are beyond the
Company's control and may cause actual results to differ from management's
expectations.
General
The Company's net sales are derived from the overhaul and repair of aircraft
engines, engine components and industrial turbines, and the sale of aircraft
engine and other aircraft parts and components. Engines for which overhaul and
repair services are performed include those engines used on the C-130 Hercules
aircraft and a large variety of aircraft and helicopters powered by light
turbine engines. Net sales generally are recorded when repaired or overhauled
engines and components are completed, tested and shipped. Net sales of spare
parts and components are recorded when parts are shipped.
During the quarter ended October 31, 1998, NAC was awarded a contract by the
United States Navy for the repair and overhaul of the majority of its Allison
T-56 engine fleet that previously had been overhauled at the Kelly Air Force
Base. After the initial one-year term of the contract, the Navy may exercise
options to extend the contract for four additional one-year periods, depending
upon its needs and NAC's performance under this contract. Revenues over the
first twelve months of the contract are estimated to be approximately $11
million, and may be as high as $35 million. The total value of the contract,
assuming all options are exercised, is estimated to range from approximately $65
million to $189 million. The Company will commence work under the contract
during the fourth quarter of the current fiscal year.
In connection with the scheduled closure of the Propulsion Business Area of
Kelly Air Force Base in San Antonio Texas, the United States Air Force had
decided to bundle the workload for the T-56 engine along with that of the TF-39
and F-100 aircraft engines into one solicitation. On November 12, 1998 NAC filed
a complaint in the United States District Court for the Northern California
District seeking declaratory and injunctive relief to prevent the Air Force from
proceeding with the award of or performance on a contract. NAC has challenged
the Air Force's decision to bundle the depot engine and overhaul maintenance
requirements for the three unrelated engines into one solicitation. NAC has also
alleged that the Air Force has violated the Small Business Reauthorization Act
of 1997, the Competition in Contracting Act and the 1998 Defense Authorization
Act. On December 4, 1998 the Air Force moved for dismissal of the complaint and
for summary judgement against NAC. A hearing on the motion is scheduled for
January 9, 1999.
During the quarter ended October 31, 1998, the Company, upon the authorization
of an independent member present at a meeting of the Board of Directors, entered
into an advisory agreement with a related party, First Equity Development Inc.
("First Equity"). Pursuant to the agreement, First Equity is to provide the
Company investment and financial advisory services relating to potential
acquisitions and other financial transactions. The agreement runs through
February 1, 2000 but may be terminated by either party upon 30-days written
notice to the other. Under the terms of the agreement, the Company will pay a
fee to First Equity for the successful completion of certain transactions (the
"Success Fee"), and will reimburse First Equity for its out-of-pocket expenses.
The amount of the Success Fee will be established by the independent members of
the Board of Directors and will be dependent upon a variety of factors,
including, but not limited to, the scope of the services to be provided, the
size and type of acquisition, and the successful completion of a transaction.
The agreement requires the Company to pay First Equity a $30,000 monthly
retainer effective February 1, 1998, which can be applied as a credit against
the Success Fee, subject to certain limitations. During the quarter ended
October 31, 1998 the Company paid First Equity retainer fees totaling $270,000,
all of which can be applied against the Success Fee.
The Company previously reported that NAC was in discussions with the Allison
Engine Company ("Allison"), its principal supplier, to renew two of its
Authorized Maintenance Center Agreements (the "AMC Agreements"). During the
quarter ended July 31, 1998, NAC and Allison signed new AMC Agreements effective
retroactive to May 1, 1998 covering the Model 250 and Model T56/501 engines. The
new AMC Agreements, both of which expire on December 31, 2000, contain terms and
conditions similar to the expired agreements. The renewal fee for each agreement
was one dollar.
8
<PAGE>
On April 6, 1998, the Company announced that it had initiated a plan to
streamline operations and improve efficiency at NAC (the "Restructuring"). In
accordance with this plan, the Company recorded a pre-tax restructuring charge
of approximately $1.75 million in the first quarter. In addition, the Company
recorded other non-recurring charges of approximately $1.03 million pre-tax. The
Company had estimated that annual savings from the Restructuring would
approximate $3.4 million on a pre-tax basis. Through October 31, 1998 management
estimates that actual savings from the date of the restructuring are in excess
of $3.0 million.
The Restructuring included the consolidation of a substantial portion of the
Light Turbine business unit to the Long Beach, California facility. This
consolidation is expected to bring increased efficiency and focus, as well as
improved customer service. The Light Turbine business unit will continue to have
its headquarters in Oakland, California.
The Restructuring also included the elimination of approximately 78 positions at
the Oakland facility. The reduction in force at Oakland was the result of
softness in the Large Flight Engine business unit as well as the consolidation
of the Light Turbine operations. The Large Flight Engine business unit's Allison
Model T-56 repair and overhaul business had slowed due to the deteriorating
financial situation in Asia and a postponement of inputs from customers located
primarily in Middle Eastern countries.
On March 5, 1997, the Company completed an initial public offering of 3,900,000
shares of common stock, $0.01 par value per share (the "Offering"). The Company
received net proceeds of approximately $34.5 million after deducting expenses of
approximately $4.5 million. The net proceeds were used for, among other things,
the repayment of term and subordinated debt, a paydown of the Company's credit
facility (for a total debt reduction of $22.6 million), payment of accrued
dividends on preferred stock ($0.2 million), and the acquisition of Aircraft
Parts International (the "API Business") from AMR Combs, Inc. ("AMR Combs") for
$10.6 million.
Results of Operations
Net Sales
Net sales for the quarter ended October 31, 1998 decreased $0.2 million, or
0.5%, to $39.3 million from $39.5 million in the quarter ended October 31, 1997.
Net sales from parts and components increased 5.3% from the comparable period of
the prior fiscal year while net sales from repair and overhaul activities
decreased 6.0% from the comparable period of the prior fiscal year. API has been
growing at double-digit rates since it was acquired during the first quarter of
the last fiscal year. API's rapid growth rate has been sufficient to offset the
weakness in net sales at NAC.
Net sales for the nine months ended October 31, 1998 decreased $2.8 million, or
2.4%, to $111.2 million from $114.0 million for the nine months ended October
31, 1997. Net sales of parts and components increased 7.5% over the comparable
period of the prior fiscal year. Net sales of parts and components for the nine
months ended October 31, 1998 were favorably impacted by the inclusion of API's
results for a full nine months, as compared to approximately eight months in the
comparable period of the prior fiscal year. Net sales from repair and overhaul
activities decreased 9.8% from the nine months ended October 31, 1997.
Cost of Sales
Cost of sales for the quarter ended October 31, 1998 decreased $0.5 million, or
1.6%, to $32.3 million from $32.8 million in the quarter ended October 31, 1997.
As a percentage of net sales, cost of sales decreased 0.8% to 82.1% from 82.9%
in the quarter ended October 31, 1997. The decrease in cost of sales was due to
lower overall sales volume, the positive impact of the Restructuring and
improvements in margins at both API and NAC. In addition, API is a distribution
business and, as is typical in such businesses, incurs less direct labor costs
than a company such as NAC that performs engine repair and overhaul services,
which require a larger potion of direct labor cost.
For the nine months ended October 31, 1998, cost of sales decreased $3.6
million, or 3.8%, to $92.3 million from $95.8 million for the nine months ended
October 31, 1997. As a percentage of net sales, cost of sales decreased 1.1% to
83.0% from 84.1% for the nine months ended October 31, 1997. The decrease in the
percentage of cost of sales to net sales was due to lower overall sales volume,
the positive impact of the Restructuring and improvements in margins at both API
and NAC. In addition, API is a distribution business and, as is typical in such
businesses, incurs less direct labor costs than a company such as NAC that
performs engine repair and overhaul services, which require a larger portion of
direct labor cost.
9
<PAGE>
Gross Profit
Gross profit for the quarter ended October 31, 1998 increased $0.3 million, or
4.4%, to $7.1 million from $6.8 million in the quarter ended October 31, 1997.
As a percentage of net sales, gross profit increased 0.8% to 17.9% from 17.1% in
the quarter ended October 31, 1997. The increase in gross profit was due to the
positive impact of the Restructuring and the increase in the proportion of the
Company's net sales of parts and components relative to net sales from repair
and overhaul activities.
For the nine months ended October 31, 1998 gross profit increased $0.8 million,
or 4.5%, to $18.9 million from $18.1 million for the nine months ended October
31, 1997. As a percentage of net sales, gross profit increased 1.1% to 17.0%
from 15.9% for the nine months ended October 31, 1997. The increase in the
percentage of gross profit to net sales also was due to the positive impact of
the Restructuring and an increase in the proportion of the Company's net sales
of parts and components relative to net sales from repair and overhaul
activities.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the quarter ended October 31,
1998 increased $1.1 million, or 25.6%, to $5.4 million from $4.3 million in the
quarter ended October 31, 1997. Approximately 82% of the increase is due to
costs associated with API's growth, including the operation of API's new
facility, additional advertising and marketing costs incurred by both API and
NAC to pursue new business opportunities, and legal and other costs incurred in
connection with the Company's protest of the U.S. Air Force's acquisition
strategy for the privatization of the Kelly Air Force Base Propulsion Business
Area ("Kelly PBA").
For the nine months ended October 31, 1998, selling, general and administrative
expense increased $3.9 million, or 34.8% to $15.1 million from $11.2 million in
the nine months ended October 31, 1997. Approximately 86% of the increase is
attributable to the inclusion of API's results for a full nine months, as
compared to approximately eight months in the comparable period of the prior
fiscal year, costs associated with API's growth, including the operation of
API's new facility, additional advertising and marketing costs incurred by both
API and NAC to pursue new business opportunities, and legal and other costs
incurred in connection with the Company's protest of the U.S. Air Force's
acquisition strategy for the privatization of the Kelly Air PBA.
As API maintains its rapid rate of growth, management expects that selling,
general and administrative costs will increase accordingly.
Interest Expense
Interest expense for the quarter ended October 31, 1998 increased $0.3 million
to $0.5 million from $0.2 million in the quarter ended October 31, 1997. The
increase was attributable principally to higher average borrowings under NAC's
credit facility as a result of increased working capital needs, and borrowings
to support growth and increased service levels at API.
Interest expense for the nine months ended October 31, 1998 increased $0.2
million to $1.3 million from $1.1 million for the comparable period of the prior
fiscal year. The increase was attributable principally to higher average
borrowings under NAC's credit facility as a result of increased working capital
needs, and borrowings to support growth and increased service levels at API.
Provision/(Benefit) for Income Taxes
Management estimates that the Company's effective income tax rate for the
quarter and nine months ended October 31, 1998 is 30%. The effective income tax
rate for the quarter and nine months ended October 31, 1997 was 25%. The
Company's effective tax rate is less than statutory rates due to benefits that
the Company expects to derive from the implementation of certain tax saving
strategies.
Net Income/(Loss)
For the quarter ended October 31, 1998 net income was approximately $0.8
compared to $1.6 million for the comparable period of the prior fiscal year. The
decrease in net income was due to the factors described above.
The Company incurred a net loss of $0.2 million for the nine months ended
October 31, 1998 after the Restructuring charge and other non-recurring charges
totaling $2.8 million pre-tax. This compares to net income of approximately $4.2
million for
10
<PAGE>
the comparable period of the prior fiscal year. (Results for the prior year
include an extraordinary item and preferred dividends totaling $0.1 million.)
The decrease is due to the factors described above.
Extraordinary Item
No extraordinary charge was incurred during the three and nine months ended
October 31, 1998. During the nine months ended October 31, 1997 the Company
recorded an extraordinary charge of $0.1 million, net of associated income tax
benefit. The extraordinary charge reflected a write-off of costs associated with
the early extinguishment of certain debt.
Liquidity and Capital Resources
The Company's liquidity requirements arise primarily from its working capital
needs, principally inventory and trade receivables, and investments in plant and
equipment.
The Company's cash used in operations for the nine months ended October 31, 1998
was $3.7 million, compared to $7.1 million for the nine months ended October 31,
1997. Cash used in investing activities during these same periods was $4.0
million and $12.5 million, respectively. Investment activities during the nine
months ended October 31, 1998 consisted entirely of the purchase of machinery
and equipment, while cash used in investing activities during the nine months
ended October 31, 1997 was due almost entirely to the acquisition of the API
Business. Cash generated by financing activities during the nine months ended
October 31, 1998 was $7.6 million, compared to $20.3 million for the nine months
ended October 31, 1997. Cash generated by financing activities during the nine
months ended October 31, 1997 includes the positive impact of the Offering,
offset by debt repayments of approximately $18.7 million.
The Company has not declared or paid any cash dividends or distributions on its
common stock since its inception. The Company anticipates that, for the
foreseeable future, all earnings will be retained for use in the Company's
business and no cash dividends will be paid on the common stock. Any payment of
cash dividends on the common stock in the future will be dependent upon the
Company's financial condition, results of operations, current and anticipated
cash requirements, plans for expansion, the ability of its subsidiaries to pay
dividends or otherwise make cash payments or advances to First Aviation and
restrictions, if any, under any future debt obligations, as well as other
factors that the Board of Directors deems relevant. Further, the Company's
current credit facilities prohibit the payment of cash dividends from either
subsidiary to First Aviation, except with the lender's consent, and contain
other covenants and restrictions.
Borrowings under NAC's $40.0 million credit facility totaled approximately $16.5
million at October 31, 1998. During the quarter ended April 30, 1998, API
entered into a new $10.0 million revolving credit facility. At October 31, 1998,
borrowings under this facility approximated $5.0 million.
The initial term of NAC's credit facility is through May 15, 1999. A termination
prior to that date will trigger a prepayment penalty of 1% of the total
facility. Thereafter, provided that NAC is in compliance with the terms,
conditions and covenants contained in the credit agreement, the agreement
automatically renews for additional one-year periods, and may be terminated
without penalty. Historically, management has classified these borrowings as
long-term since repayment of the debt has been due more than one year from the
date of the Company's financial statements, and the borrowing base supporting
this credit facility always has exceeded outstanding borrowings. Management
believes that the borrowing base will exceed borrowings for at least the next
twelve months. Although this facility expires within the next year, management
intends either to renew the existing agreement or replace it with a new
facility. Management believes that the Company has the ability to replace the
facility in a manner that will not require the use of working capital.
Therefore, management continues to classify this obligation as long-term.
In connection with the acquisition of the API Business, AMR Combs purchased
10,407 shares of API Series A Cumulative Convertible Preferred Stock, $0.001 par
value, with dividends payable quarterly at $4.00 per share (the "Preferred
Stock"). In addition, First Aviation, API and AMR Combs entered into a
Stockholders Agreement. Pursuant to this agreement, AMR Combs agreed that it
would not sell its shares of the Preferred Stock or the shares of API common
stock into which the Preferred Stock is convertible (collectively the "API
Acquisition Shares") for a minimum period of three years. API has the right to
redeem the API Acquisition Shares at any time. AMR Combs has the right to cause
API to repurchase the API Acquisition Shares commencing three years after the
closing of the acquisition of the API Business. The redemption price is equal to
the fair market value of the API Acquisition Shares as determined by an
independent appraisal. The Stockholders Agreement also contains certain other
rights, including: (i) a right of first refusal on the part of First Aviation
with respect to any proposed sale of the API Acquisition Shares, (ii) the right
of First Aviation to require AMR Combs to participate, on a pro rata basis, with
it in the sale of the capital stock of API to a third party, (iii) the right of
AMR Combs to elect to participate, on a pro rata basis, in the sale of the
capital stock of API to a third party, and (iv) piggyback and demand
registration rights granted to AMR Combs with respect to the API Acquisition
Shares. The demand registration rights are not
11
<PAGE>
exercisable until three years after the closing of the acquisition of the API
Business, and, if API has not previously closed an underwritten public offering
of its common stock at the time AMR Combs elects to exercise its demand
registration rights, API may elect to treat the demand as an exercise by AMR
Combs of its put option with respect to the API Acquisition Shares. First
Aviation has no plans to cause API to conduct a public offering of its
securities.
Based upon current and anticipated levels of operations, the Company believes
that borrowings available under the existing lines of credit will be sufficient
to meet its current and anticipated cash operating requirements for the
foreseeable future, including scheduled interest and principal payments, capital
expenditures, the acquisition of the Preferred Stock, and working capital needs.
Year 2000
The Company is currently working to resolve the potential impact of the Year
2000 on the processing of date-sensitive information by the Company's
computerized information systems. The Year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define
the applicable year. Any of the Company's programs and systems that have
time-sensitive software may be unable to interpret dates beyond the year 1999.
This could result in miscalculations and/or system failures, causing disruptions
of operations controlled by such systems or devices.
The Company and each of its operating subsidiaries have conducted comprehensive
reviews of their systems and have developed plans to address any possible issues
related to the impact of the Year 2000 problem on both information technology
("IT") and non-IT systems (e.g., embedded technology). These plans address the
Year 2000 issue in multiple phases, including (i) determining an initial
inventory of the Company's systems, equipment, vendors, customers and third
party administrators that may be vulnerable to system failures or processing
errors as a result of Year 2000 issues, (ii) assessing and prioritizing of
inventoried items to determine risks associated with their failure to be Year
2000 compliant, (iii) testing of systems and equipment to determine Year 2000
compliance, and (iv) remediating and implementing systems and equipment. For
those systems which the Company determines are not currently Year 2000
compliant, implementation of the required changes is expected to be completed
during the next fiscal year.
As of October 31, 1998 all critical hardware and software systems utilized by
the Company have been tested and/or verified as either Year 2000 compliant or
appropriate remediation was taken or will be taken to effect compliance. Certain
non-critical software systems were determined not to be Year 2000 compliant and
have been or will be modified or converted to compliant systems. Conversion of
additional non-critical systems is in process. Testing systems utilized to
verify compliance include the posting to the systems of a date on or after
January 1, 2000 as though the date were effective. The Company has tested nearly
all of its critical IT and non-IT systems. Any necessary additional
modifications or replacements are scheduled to be completed during the fourth
quarter of fiscal year 1999 and the first two quarters of fiscal year 2000.
The Company is in the process of contacting its major suppliers and vendors to
assess their status relating to Year 2000 readiness and/or compliance, and the
potential impact on operations if such third parties are not successful in
ensuring that their systems are Year 2000 compliant in a timely manner. The
Company could suffer potential business interruptions and/or incur costs,
damages or losses related thereto, if other third parties such as governmental
agencies (e.g., Federal Aviation Administration) are not Year 2000 compliant.
The Company is unable to determine at this time whether it will be materially
affected by the failure of any of its suppliers, vendors or other third parties
to be Year 2000 compliant.
A failure by the Company, its major suppliers or vendors, or any third party
with which the Company interacts, to resolve a material Year 2000 issue could
result in the interruption in, or failure of, certain normal business activities
or operations and could materially and adversely affect the Company's financial
condition, results of operations and cash flows. The Company is currently
assessing those scenarios in which unexpected failures could have a material
adverse effect on the Company and anticipates that it will develop contingency
plans, as deemed appropriate, designed to deal with such scenarios. Based on
current plans and assumptions, the Company does not expect that the Year 2000
issue will have a material adverse impact on the Company as a whole. Due to the
general uncertainty inherent in the Year 2000 issue, however, there can be no
assurance that all Year 2000 issues will be foreseen and corrected on a timely
basis, or that no material disruption to the Company's business operations will
occur. Further, the Company's expectations are based on the assumption that
there will be no general failure of external local,
12
<PAGE>
national or international systems (including power, communications, postal,
transportation, or financial systems) necessary for the ordinary conduct of
business.
Costs associated with the Company's Year 2000 compliance effort, including
consulting costs and costs associated with internal resources used to modify
existing systems in order to achieve Year 2000 compliance, are charged to
expense as incurred. Management estimates that the expenditures relating to the
Company's Year 2000 compliance effort will total approximately $400,000. Through
October 31, 1998 management estimates that approximately $200,000 has been spent
addressing this issue. The remainder is expected to be spent over the next two
to three quarters. The Company does not separately track internal costs of the
Year 2000 compliance effort. The anticipated costs of the project and the dates
on which the Company believes it will complete the Year 2000 modifications and
assessments are based on management's best estimates, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources. There can be no guarantee that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area and the ability to locate and correct all relevant systems.
Management does not expect the financial impact of making the required system
changes to be material to the Company's overall consolidated financial position.
13
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company's business exposes it to possible claims for personal injury, death
or property damage which may result from a failure of engines serviced by the
Company or spare parts sold by it. The Company takes what management believes to
be adequate precautions to ensure the quality of the work the Company performs
and the traceability of the aircraft spare parts which it sells. The Company
maintains what, in the opinion of management, is adequate liability insurance to
protect the Company from such claims.
On August 31, 1998 the Company was served with a complaint asserting wrongful
death claims deriving from the crash of a Nomad 24 type aircraft on February 12,
1996 in Port-au-Prince, Haiti. The complaint was filed with the district court
of Harris County, Texas on February 12, 1998. The complaint is very similar to
that which the Company received in March 1998 and which has previously been
described in Form 10K as filed.
In December 1997, NAC was added as a defendant to an amended complaint filed in
Superior Court, Los Angeles County, California, by plaintiff, H.S.
Hubscrauberservice, wherein they asserted claims based upon fraud, deceit,
negligent misrepresentation and breach of express and implied warranty against
non-NAC defendants deriving from the sale of an allegedly defective helicopter.
The plaintiff has asserted that NAC is liable as a successor in interest to
California Airmotive Group and other non-NAC corporate defendants. On August 28,
1998, the Superior Court for Los Angeles County dismissed the plaintiff's claims
against NAC for fraud, deceit, negligent misrepresentation and breech of implied
warranty. NAC sought to dismiss the remaining portion of the complaint which
asserts express warranty claims, but its motion was denied. A trial date has
been set for January 25, 1999. The Company maintains product liability coverage
which, while providing coverage for certain litigation costs, does not provide
coverage for warranty claims.
In 1997, a former director and officer of the Company initiated litigation in
the Alameda County Superior Court, California, against the Company, NAC, Aaron
P. Hollander, Michael C. Culver, First Equity and First Equity Group Inc. FAS
Inc. also was named as a defendant in October 1998. This litigation alleges
wrongful termination, breach of contract, and various acts of fraud, deceit and
misrepresentation and seeks various damages, as well as common shares of the
Company. This litigation relates to the termination of the employment of the
plaintiff by the Company, NAC and First Equity, and compensation matters
relating to employment of plaintiff and the claim by plaintiff of entitlements
to a portion of the outstanding shares of the Company.
On October 23, 1998, the defendants served and filed a motion for summary
judgment seeking dismissal of all of the plaintiff's claims. On November 4,
1998, the Court denied the defendants' motion. A trial date has been set for
February 11, 1999.
While the Company cannot predict the outcome of these matters, in the opinion of
management, any liability arising from these matters will not have a material
effect on the Company's financial position, liquidity or results of operations
after giving effect to provisions already recorded.
Item 2. Changes in Securities
NONE
Item 3. Defaults Upon Senior Securities
NONE
14
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Shareholders held on September 23, 1998, the
following proposals were adopted by the margins indicated.
(1) To elect two directors for a term to expire at the Annual Meeting of
Shareholders in the year 2001.
Votes For Votes Withheld
--------- --------------
Michael C. Culver 8,877,832 13,227
Robert L. Kirk 8,877,832 13,227
Joshua S. Friedman, Aaron P. Hollander, Robert L. Kirk and John A.
Marsalisi continued to serve as directors of the Company after the
annual meeting of shareholders.
(2) To ratify the appointment of Ernst & Young LLP as the Company's
independent auditors for the fiscal year ended January 31, 1999.
Votes For Votes Against Votes Abstained
--------- ------------- ---------------
8,886,400 3,500 1,159
Item 5. Other Information
NONE
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit
Number Description of Exhibit
- ------ ----------------------
10.40 Advisory Agreement between First Aviation Services Inc.
and First Equity Development Inc., dated September 23, 1998.
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
NONE
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
First Aviation Services Inc.
(Registrant)
Date: December 14, 1998 /s/ Michael C. Culver
--------------------------------------
Michael C. Culver,
President, Chief Executive Officer and
Director (Principal Executive Officer)
Date: December 14, 1998 /s/ John A. Marsalisi
--------------------------------------
John A. Marsalisi,
Vice President, Secretary, Director
and Chief Financial Officer (Principal
Financial and Accounting Officer)
16
Exhibit 10.40
September 23, 1998
Mr. John A. Marsalisi
Chief Financial Officer
First Aviation Services Inc.
15 Riverside Avenue
Westport, CT 06880-4214
Re: ENGAGEMENT LETTER between First Equity Development Inc. and its affiliate,
FED Securities Inc. and First Aviation Services Inc.
Dear Mr. Marsalisi:
This letter will confirm the terms and conditions by which First Equity
Development Inc. and its affiliate, FED Securities Inc. (collectively "First
Equity"), with offices at 15 Riverside Avenue, Westport, Connecticut, has been
engaged to serve as investment counselor and financial advisor to First Aviation
Services Inc. ("FAvS" or the "Company").
The undersigned hereby agree to the following terms and conditions:
1. Engagement Agreement. FAvS does hereby engage First Equity as investment
counselor and financial advisor for the purpose of locating possible
acquisitions and/or mergers, (hereinafter referred to as "Acquisitions"),
negotiating such Acquisitions, assisting in locating lenders for
appropriate credit facilities, negotiating the credit facilities,
providing advice and support for the implementation of such credit
facilities, (hereinafter referred to as the "Financing") and for the
possible divestment of certain assets (hereinafter referred to as
"Divestment"). The Company agrees to refer all proposals and inquiries
with respect to any potential Acquisition, Financing and/or Divestment to
First Equity. Execution of this agreement by both parties reconfirms First
Equity's authorization to proceed.
2. Services Provided. The specific services that First Equity will continue
to provide throughout this assignment will vary depending upon specific
needs and market conditions.
First Equity believes that several aspects of its role will be
particularly important in assisting in the completion of Acquisitions,
Financings and Divestments; these include, but are not limited to, the
following: valuation analysis, assistance with due diligence, development
of a strategy to identify potential targets, lenders, investors, and
acquirors, and negotiation of transactions. First Equity will manage the
day to day aspects of the transactions, bringing in FAvS management at
appropriate points in the negotiations and discussions to make decisions,
thus allowing FAvS management to focus on operating the Company's
business.
<PAGE>
FAvS Engagement Letter
September 23, 1998
Page 2
3. Term. Subject to the payment obligations set forth in Section 4 below,
this Agreement shall be considered effective as of September 1, 1998, and
shall remain in full force and effect until February 1, 2000, unless
otherwise amended or terminated as described in Paragraph 6.
4. Compensation.
(a) All reasonable out-of-pocket expenses incurred by First Equity,
including but not limited to transportation, food, lodging,
applicable sales taxes, etc., in the performance of the services to
be rendered hereunder, shall be borne by FAvS and reimbursed to
First Equity. First Equity makes it a practice of keeping its
clients' expenses to a minimum, while at the same time providing its
professionals with a productive working environment.
(b) During the Term of this Agreement, First Equity will receive a
retainer of thirty thousand dollars in U.S. funds (US $30,000) per
month (hereinafter referred to as "Retainer"). In recognition of
services previously provided, the Retainer shall be determined by
reference to February 1, 1998.
(c) In the event that FAvS or any of its subsidiaries or affiliates
consummates a Financing, an Acquisition or a Divestment (hereinafter
referred to as the "Closing") and if such agreement shall occur
during the Term of this Agreement as set forth in Paragraph 3 or
within Six (6) months from the end of the Term, then, upon the
Closing, First Equity shall be entitled to a fee ("Success Fee")
payable in cash in U.S. dollars at the Closing. The amount of the
Success Fee shall be subject to negotiation between First Equity and
FAvS, and subject to the approval of the independent members of the
FAvS Board of Directors.
(d) The Success Fee shall be reduced by the amount of the Retainer paid
during the prior twelve months, unless deducted on a prior
transaction, however, under no circumstances shall the Retainer
deducted exceed $360,000.
In the event of an Acquisition or a Divestiture, the Success Fee will be
based on total consideration which will be deemed to include, but not be
limited to, the total value of the equity as determined by the final
purchase price paid for the equity of the Acquisition or Divestiture plus
any debt assumed by the acquiror.
In the event that the event is a Financing, then the Success Fee will be
based on the total credit facility issued to FAvS or any of its
subsidiaries or affiliates, excluding affiliates that only relate to First
Equity.
<PAGE>
FAvS Engagement Letter
September 23, 1998
Page 3
5. Relationship. Nothing herein shall be deemed to constitute an employment
or agency relationship between First Equity and FAvS. Nevertheless,
nothing contained herein shall be deemed to preclude the creation of such
relationship by separate agreement of the parties, in writing, for a
particular purpose. Except as expressly agreed to in writing, First Equity
shall not have the authority to obligate, bind or commit FAvS in any
manner whatsoever.
Recognizing that transactions of the type contemplated in this engagement
sometimes result in litigation, and that First Equity's role is advisory,
FAvS agrees to indemnify First Equity (including its affiliated entities
and its officers, directors, agents, employees and controlling persons) to
the full extent lawful against claims, losses and expenses incurred
(including the expense of investigation, preparation and reasonable fees
and disbursements of First Equity and such persons' counsel) arising out
of First Equity's engagement as per this letter, and if indemnification
were for any reason not to be available, to contribute to the settlement,
loss or expenses involved in the proportion that FAvS' economic interest
bears to First Equity's economic interest in any transaction. However,
such indemnification and contribution shall not apply to any claim, loss
or expense which arises from First Equity's gross negligence or willful
misconduct in the performance of its services hereunder or which relate to
matters not envisioned by this letter.
First Equity shall use due care to avoid any litigation or claims relating
to First Equity's services hereunder. In the event of such claim or
litigation, First Equity shall immediately notify the Chief Executive
Officer of FAvS in writing, and shall cooperate and assist FAvS in the
defense and/or settlement of same. FAvS' obligation to indemnify First
Equity is conditioned upon such cooperation and assistance and FAvS shall
have the complete right to defend or settle any such indemnified claims
and/or litigation. First Equity may elect to have separate legal
representation at First Equity's expense.
6. Assignment, Amendment and Termination. This Agreement shall not be
assignable by either party except to successors to all or substantially
all of the business of either. Further, this Agreement shall not be
amended or terminated by either party for any reason whatsoever except
with 30 days written notice and with the prior written consent of the
other party, which consent may not be arbitrarily withheld by the party
whose consent is required. However, should FAvS terminate this Agreement
prior to February 1, 2000, FAvS would be liable for any Retainers due but
unpaid, any out of pocket expenses that are due and unpaid as well as for
any Success Fees payable as per the terms defined in Section 4c.
<PAGE>
FAvS Engagement Letter
September 23, 1998
Page 4
7. Contract Interpretation. This Agreement is subject to, and will be
interpreted, in accordance with the laws of the State of Connecticut.
ACCEPTED AND APPROVED BY:
/s/ John A. Marsalisi /s/ Aaron P. Hollander
--------------------- ----------------------
John A. Marsalisi Aaron P. Hollander
Chief Financial Officer Managing Director
First Aviation Services Inc. First Equity Development Inc.
AH/mef
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial information contained in the body of the accompanying 10-Q and is
qualified in its entirety by reference to such financial statements.
Restated
</LEGEND>
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<PERIOD-START> Feb-01-1998 Feb-01-1997
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