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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD
--------------- TO
---------------.
COMMISSION FILE NUMBER 000-22249
INTERNATIONAL AIRCRAFT INVESTORS
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 95-4176107
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER ID NO.)
INCORPORATION OR ORGANIZATION)
3655 TORRANCE BOULEVARD, SUITE 410, 90503
TORRANCE, CALIFORNIA (ZIP CODE)
(ADDRESS OF REGISTRANT'S PRINCIPAL EXECUTIVE
OFFICES)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 316-3080
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
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 registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to Form 10-K. [X]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant at March 19, 1999 was approximately $25,607,022
(based on the closing price on Nasdaq National Market as reported by the Wall
Street Journal on such date).
At March 19, 1999, the registrant had issued and outstanding an aggregate
of 4,212,284 shares of its common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information included in the registrant's definitive proxy statement
("Proxy Statement") to be filed with the Securities and Exchange Commission for
the Annual Meeting of Stockholders of the registrant is incorporated by
reference into Part III hereof.
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INTERNATIONAL AIRCRAFT INVESTORS
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR END DECEMBER 31, 1998
TABLE OF CONTENTS
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ITEM PART I PAGE
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1. Business.................................................... 3
2. Properties.................................................. 14
3. Legal Proceedings........................................... 14
4. Submission of Matters to a Vote of Securities Holders....... 14
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 15
6. Selected Financial Data..................................... 16
7. Management's Discussion and Analysis of Financial Condition
and
Results of Operation........................................ 17
8. Financial Statements and Supplementary Data................. 20
9. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure........................................ 20
PART III
10. Directors and Executive Officers of the Registrant.......... 21
11. Executive Compensation...................................... 21
12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 21
13. Certain Relationships and Related Owners and Management..... 21
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 21
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PART I
ITEM 1. BUSINESS
GENERAL
We are primarily engaged in the acquisition of used, single-aisle jet
aircraft for lease and sale to domestic and foreign airlines and other
customers. As of December 31, 1998, we had thirteen aircraft on lease to twelve
airlines worldwide. We lease aircraft under "triple net" operating leases where
the lessee is responsible for all operating costs (i.e., crew, fuel, insurance,
taxes, licenses, landing fees, navigation charges, maintenance, repairs and
associated expenses) and we retain the potential benefit and risk of the
residual value of the aircraft, as distinct from finance leases where the full
cost of the aircraft is recovered over the term of the lease at generally lower
lease rates.
The Company was incorporated in California in 1988. Our principal executive
offices are located at 3655 Torrance Boulevard, Suite 410, Torrance, California
90503 and our telephone and facsimile numbers are (310) 316-3080 and (310)
316-8145, respectively.
STRATEGY
Our strategy is to focus on entering into operating leases of used,
single-aisle jet aircraft to a diversified base of customers worldwide, while
employing strict risk management criteria. Key elements of our business strategy
include the following:
Focus on Operating Leases. We believe that airlines are aware of the
benefits of financing their fleet equipment on an operating lease basis,
including preservation of cash flow and flexibility regarding fleet size and
composition. We believe the operating lease of jet aircraft, especially used jet
aircraft, offers the potential for a higher rate of return to us than other
methods of aircraft financing, such as finance leases.
Focus on Used Commercial Jet Aircraft with a Broad Market Acceptance. We
lease used, single-aisle jet aircraft which generally range between five and 15
years old at the time the aircraft is acquired by us. We currently focus on the
acquisition and lease of single-aisle jet aircraft, primarily aircraft with a
seating capacity of 121 to 240 passengers. According to the 1998 Current Market
Outlook published by the Boeing Commercial Airplane Group in June 1998, that
type of aircraft accounted for approximately 44.6% of the world fleet at
December 31, 1997. The Boeing Report estimates that the commercial replacement
cycle for this type of aircraft is 25 to 28 years from manufacture date. This
category of jet aircraft includes the Boeing 737-300/-400, the Boeing Model
757-200, the McDonnell Douglas MD80 series and the Airbus A320.
Optimize Relationship with ILFC. We have had a long and continuous
relationship with International Lease Finance Corporation. ILFC was an initial
investor in us and currently owns approximately 1.6% of our common stock. ILFC
is a major owner-lessor of commercial jet aircraft and has contacts with most
airlines worldwide, the aircraft and engine manufacturers and most of the
significant participants in the aircraft industry worldwide. We intend to use
our relationship with ILFC to gain access, where appropriate, to various
airlines and other participants in the market to facilitate the purchase, lease,
re-lease and sale of aircraft. ILFC's primary focus is the acquisition and
leasing of new, rather than used, commercial jet aircraft. Thus, we believe that
our business complements rather than competes with ILFC. See "Relationship With
ILFC" below.
Leverage Management Experience. The successful purchase and leasing of used
commercial jet aircraft requires skilled management in order to evaluate the
condition and price of the aircraft to be purchased and the current and
anticipated market demand for that aircraft. Our management and our Board of
Directors have significant experience in the aviation industry, with an average
of more than 20 years of experience, especially in the purchase, sale and
financing of commercial jet aircraft, and have extensive contacts with airlines
worldwide.
Access a Diversified Global Customer Base. Our objective is to diversify
our customer base to avoid dependence on any one lessee, geographic area or
economic trend.
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Employ Strict Risk Management Criteria. We will only purchase aircraft that
are currently under lease or are subject to a contractual commitment for lease
or purchase. We seek to finance our aircraft using a non-recourse loan
structure. We will not purchase aircraft on speculation. We evaluate carefully
the credit risk associated with each of our lessees and the lessee's ability to
operate and properly maintain the aircraft. We also evaluate the return
conditions in each lease since the condition of an aircraft at the end of a
lease can significantly impact the amount we will receive on the re-lease or
sale of an aircraft.
AIRCRAFT LEASING
All of our current leases are operating leases rather than finance leases.
Under an operating lease, we retain title to the aircraft, thereby retaining the
potential benefits and assuming the risk of the residual value of the aircraft.
Operating leases allow airlines greater fleet and financial flexibility due to
their shorter-term nature, the relatively small initial capital outlay necessary
to obtain use of the aircraft and off-balance sheet treatment. Operating lease
rates are generally priced higher than finance lease rates, in part because of
the risks to the lessor associated with the residual value. See "Cautionary
Statements."
We target the medium-term operating lease market, which generally consists
of three to eight year initial noncancelable lease terms. Our leases are "triple
net leases" whereby the lessee is responsible for all operating costs (i.e.,
crew, fuel, insurance, taxes, licenses, landing fees, navigation charges,
maintenance, repairs and associated expenses). In addition, our leases contain
extensive provisions regarding our remedies and rights in the event of a default
by the lessee. The leases have payment clauses that require the lessee to
continue to make the lease payments regardless of circumstances, including
whether or not the aircraft is in service. Certain of our leases limit the
lessee's obligation to make lease payments if we violate the covenant of quiet
enjoyment regarding the aircraft or if we enter bankruptcy and do not assume the
lease. During the term of the lease, we are required to be named as an
additional insured on the lessee's aviation hull and liability insurance
policies. Also, the leases contain very specific criteria for the maintenance
and regulatory status of the aircraft, as well as the return conditions for the
airframe, engines, landing gears, auxiliary power unit and associated
components.
Generally, the lessee provides us with an initial security deposit that is
returnable at the expiration of the lease if all lease return conditions are met
by the lessee and there is no default under the lease. Depending on the
creditworthiness of a lessee, in some instances the lessee will also pay into a
maintenance reserve account a certain amount monthly for each hour the aircraft
and/or engine has flown. The lessee may draw upon these maintenance reserves to
reimburse the cost of periodic scheduled overhaul and maintenance checks. At the
termination of the lease, the lessee is required to return the aircraft to us in
the same condition as it was received, normal wear and tear excepted, so the
aircraft is in a proper condition for re-lease or sale. See "Cautionary
Statements."
We make an analysis of the credit risk associated with each lease before
entering into a lease. We evaluate the prospective lessee's available financial
statements and trade and banking references, and working with our lender
evaluate country and political risk, insurance coverage, liability and
expropriation risk. The process for credit approval is a joint undertaking
between us and the senior lender providing the debt financing for the lease. We
obtain extensive financial information regarding the lessee. See "Cautionary
Statements."
Upon termination of a lease, our objective is to re-lease or sell the
aircraft. Our leases generally require that the lessee notify us six to nine
months prior to the termination of the lease as to whether the lessee intends to
exercise any option to extend the lease. This allows us to commence our
remarketing efforts well in advance of the termination of a lease. We generally
negotiate lease extensions with our lessees. However, since January 1, 1996, two
of our aircraft came off lease and were re-leased to new customers.
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CUSTOMERS
At December 31, 1998, our lessees included:
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DOMESTIC CUSTOMERS: FOREIGN CUSTOMERS:
- - Delta Airlines, Inc. - Air Belgium International N.V.
- - ILFC (subleased to - Air Liberte S.A.
COPA) - Air Transat A.T., Inc.
- - Southwest Airlines Co. - Asiana Airlines, Inc.
- - Trans World Airlines, - British Airways Plc.
Inc. - COPA
- New Zealand International Airlines
Ltd.
- Shanghai Airlines
- TransAer International Airlines
Limited
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During the years ended December 31, 1996, 1997 and 1998, lease revenues
from flight equipment generated from foreign customers accounted for
approximately 52%, 61% and 68%, respectively, of total revenues.
Many foreign countries have currency and exchange laws regulating the
international transfer of currencies. We attempt to minimize our currency and
exchange risks by negotiating all of our aircraft leases in U.S. Dollars. We
require, as a condition to any foreign transaction, that the lessee in a foreign
country first obtain, if required, written approval of the appropriate
government agency, finance ministry or central bank for the remittance of all
funds contractually owed to us in U.S. Dollars. Although we have attempted to
minimize the foreign currency risk, to the extent that significant currency
fluctuations result in materially higher rental costs to a foreign lessee, the
foreign lessee may be unable or unwilling to make the required lease payments.
The following customers accounted for more than 10% of our total revenues
in one or more of the three years ended December 31, 1998:
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Air Belgium International N.V. ILFC
1998 - 10% 1996 - 10%
Air Transat A.T. Inc. New Zealand International Airlines Limited
1998 - 15% 1996 - 10%
Alaska Airlines, Inc. Shanghai Airlines
1997 - 17% 1998 - 11%
1996 - 21% 1997 - 13%
British Airways Plc. Southwest Airlines Co.
1998 - 12% 1997 - 13%
1997 - 11% 1996 - 15%
British Midland Airways Limited
1996 - 23%
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FINANCING/SOURCE OF FUNDS
We purchase used aircraft and aircraft engines on lease to airlines
directly from other leasing companies or from airlines for leasing back to the
airlines. Our typical purchase requires both secured debt and an equity
investment by us. We generally make an equity investment of approximately 5% to
15% of the purchase price of aircraft and engines from internally generated and
other cash and seller financing (primarily from ILFC). We typically finance the
balance of the purchase price with the proceeds of borrowings from banks or
other financial institutions secured by the aircraft being financed (to date
with the support of ILFC as the seller of the flight equipment).
We maintain banking relationships primarily with five commercial banks
providing long-term secured equipment financing to us in an aggregate amount of
$138.5 million at December 31, 1998. ILFC has provided certain guarantees and
other financial support with respect to our borrowings which have allowed us to
finance
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our aircraft at more favorable leverage than we could have obtained without
ILFC's support. See Notes 5 and 6 to Consolidated Financial Statements.
At December 31, 1998, $197.4 million (or 94.9%) of our borrowings to
finance aircraft purchases were on a non-recourse basis. Non-recourse loans are
structured as loans to special purpose subsidiaries which only own the assets
which secure the loan. Only the relevant special purpose subsidiary is liable
for the repayment of the non-recourse loan. We are only liable if we breach
certain limited representations and warranties under the applicable loan
documentation. The lender assumes the credit risk of each lease, and its only
recourse upon a default under the lease is against the lessee, the leased
equipment and the special purpose subsidiary. Interest rates under this type of
financing are negotiated on a transaction-by-transaction basis and reflect the
financial condition of the lessee, the terms of the lease, any guarantees and
the amount of the loan. The remaining $10.6 million of our borrowings are on a
recourse basis. ILFC has agreed to indemnify us for any payments under this
recourse loan not funded by lease or sale payments.
The terms of all of our current borrowings end within 30 to 60 days after
the minimum noncancelable period under the related lease, after which we will be
required to renegotiate the loan or obtain other financing in connection with
the re-lease of the aircraft. See "Cautionary Statements."
Notes payable due within one year totaled $58.3 million at December 31,
1998, of which $46 million represents balloon payments and $12.3 million
represents installment payments. We intend to refinance $45.5 million and repay
$.5 million of balloon payments in 1999. During 1996, 1997 and 1998, we
refinanced $31.3 million, $40.4 million and $29.7 million of balloon payments,
respectively.
At December 31, 1998, our borrowings had interest rates ranging from 6.0%
to 7.96% per annum, with a weighted average interest rate of 7.1% per annum. At
December 31, 1998, approximately 6.5% of our borrowings accrued interest on a
floating rate basis.
We have previously provided for all of our financing needs through
internally generated funds, borrowings and equity capital. There is no assurance
that those sources will provide us with additional capital resources. Our future
growth is dependent upon raising additional capital. See "Cautionary
Statements."
RELATIONSHIP WITH ILFC
ILFC was an initial investor in the Company, and owns approximately 1.6% of
our common stock. Eleven of our thirteen present aircraft were acquired from
ILFC and ILFC has provided certain guarantees and other financial support with
respect to our borrowings. See "Financing/Source of Funds" above. ILFC has also
paid various fees to us for consulting and remarketing services. We have entered
into an agreement with ILFC pursuant to which ILFC has agreed to assist us in
the remarketing of our aircraft if requested by us. See "Aircraft Leasing"
above, "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations," and Note 5 to Consolidated
Financial Statements. ILFC is a wholly owned subsidiary of American
International Group, Inc. and is a major owner-lessor of commercial jet
aircraft.
COMPETITION
The aircraft leasing industry is highly competitive. The level of
competition depends in part upon the type of aircraft being leased and
prospective lessees for the aircraft. Competition is primarily based upon the
availability of the aircraft required by the customer and the lease rate. We
believe that only a few comparably sized companies focus primarily on the same
segment of the aircraft leasing market as we do. In addition, a number of
aircraft manufacturers, airlines and other operators, distributors, equipment
managers, leasing companies (including ILFC), financial institutions and other
parties engaged in leasing, managing, marketing or remarketing aircraft compete
with us, although their primary focus is not on the same market segment on which
we focus. Many of these periodic competitors have significantly greater
financial resources than we have. Our competitors may lease aircraft at lower
rates than we do and provide benefits, such as direct maintenance, crews,
support services and trade-in privileges, which we do not intend to provide. We
believe
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that we are able to compete in the leasing of used jet aircraft due to our
experience in the industry and our reputation and expertise in acquiring and
leasing aircraft. See "Cautionary Statements."
GOVERNMENT REGULATION
The Federal Aviation Administration ("the FAA"), the Department of
Transportation and the Department of State exercise regulatory authority over
the air transportation industry in the United States. Most other countries have
similar regulatory agencies. The FAA has regulatory jurisdiction over
registration and flight operations of aircraft operating in the United States,
including equipment use, ground facilities, maintenance, communications and
other matters.
The FAA regulates the operation and maintenance of all aircraft operated in
the United States. Its regulations are designed to insure that all aircraft and
aviation equipment are continuously maintained in proper condition to ensure
safe operation of the aircraft. Similar rules apply in most other countries. All
aircraft must be maintained under a continuous condition monitoring program and
must periodically undergo thorough inspection and maintenance. The inspection,
maintenance and repair procedures for the various types of aircraft equipment
are prescribed by regulatory authorities and can be performed only by certified
repair facilities utilizing certified technicians. The FAA can suspend or revoke
the authority of air carriers or their licensed personnel for failure to comply
with its regulations and can ground aircraft if their airworthiness is in
question.
The Department of State and the Department of Transportation, in general,
have jurisdiction over economic regulation of air transportation, but since we
do not operate our aircraft for public transportation of passengers and
property, we are not directly subject to their regulatory jurisdiction.
To export aircraft from the U.S. to a foreign destination, we are required
to obtain an export license from the United States Department of Commerce. To
date, we have not experienced any difficulty in obtaining the required
certificates, licenses and approvals either from the FAA, the Department of
Commerce or any other regulatory agency or their foreign counterparts.
Member countries of the United Nations are signatories to the International
Civil Aviation Organization. Each signatory has agreed to comply with
airworthiness directives of the country of manufacture of the aircraft. We will
not lease our aircraft to any carrier domiciled in a country which is not a
member of ICAO. We also require our lessees to comply with the most restrictive
standards of either the FAA or its foreign equivalent. In some instances, we may
have to share in the cost of complying with regulatory airworthiness directives.
For older aircraft, a special group of airworthiness directives require
extensive inspections and repairs to bring the aircraft into compliance, which
are required to be paid by the lessee.
The FAA and the civil aviation authorities of most countries and
international entities issue regulations limiting permitted noise and other
emissions from aircraft. In most instances, older non-complying aircraft may be
brought into compliance by modifying the engines. Ten of our aircraft currently
comply with these regulations. One of our aircraft will be modified to comply
with these regulations as a condition of an existing lease at the lessee's
expense. Our remaining two aircraft, currently on lease to 2001, are leased in
areas not requiring modification. These two aircraft may require modification if
moved to a jurisdiction requiring compliance. Currently, these modifications
range in cost from $1.7 million to $2.5 million per aircraft. In some instances,
it is necessary to perform noise compliance work to lease the aircraft into a
new jurisdiction. For example, Western Europe and the United States have
non-addition rules which state that an aircraft which does not meet specified
noise compliance regulations cannot be brought into the region and operated by
an airline licensed by one of these governments. A non-complying aircraft can
only be leased or sold into a market that does not require compliance with the
stricter standards. See "Cautionary Statements."
INSURANCE
We require our lessees to carry those types of insurance which are
customary in the air transportation industry, including comprehensive third
party liability insurance and aircraft hull insurance. We are named as
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an additional insured on both the liability and hull policies carried by our
lessees. All policies contain a breach of warranty endorsement so that our
interests are not prejudiced by any act or omission of the operator-lessee.
Insurance premiums are prepaid by the lessee on a periodic basis, with
payment acknowledged to us through an independent insurance broker. The
territorial coverage is, in each case, suitable for our lessee's area of
operations and the policies contain, among other provisions, a "no co-insurance"
clause and a provision prohibiting cancellation or material change without at
least 30 days advance written notice to us. Furthermore, the insurance is
primary and not contributory and all insurance carriers are required to waive
rights of subrogation against us.
The stipulated loss value schedule under aircraft hull insurance policies
is on an agreed value basis, which usually exceeds the book value of the
aircraft. Aircraft hull policies contain standard clauses covering aircraft
engines with deductibles required to be paid by the lessee. Furthermore, the
aircraft hull policies contain full war risk endorsements, including, but not
limited to, confiscation, seizure, hijacking and similar forms of retention or
terrorist acts, subject to certain specified exclusions. All losses under such
policies are payable in U.S. Dollars.
The comprehensive liability insurance policies include provisions for
bodily injury, property damage, passenger liability, cargo liability and such
other provisions reasonably necessary in commercial passenger and cargo airline
operations with minimal deductibles. These policies generally have combined
comprehensive single liability limits of not less than $200 million and require
all losses to be paid in U.S. Dollars.
Insurance policies are generally placed or reinsured in the Lloyds of
London or U.S. markets. The insurance carrier under the insurance policies must
be approved by us.
EMPLOYEES
As of December 31, 1998, we had six employees. None of our employees is
covered by a collective bargaining agreement and we believe our employee
relations are good.
CAUTIONARY STATEMENTS
This Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, and are intended to be
covered by the safe harbors created thereby. The cautionary statements made in
this Report on Form 10-K should be read as being applicable to all related
forward-looking statements wherever they appear in this Report on Form 10-K. Our
actual results could differ materially from those discussed herein. Factors that
could cause or contribute to such differences include those discussed below, as
well as those discussed elsewhere in this Report.
We retain the residual value risk and the risk of the re-lease or sale of
the aircraft.
We lease our portfolio of aircraft under operating leases rather than
finance leases. Under an operating lease, we retain title to the aircraft and
assume the risk of not recovering our entire investment in the aircraft through
the re-leasing and remarketing process. Operating leases require us to re-lease
or sell aircraft in our portfolio in a timely manner upon termination of the
lease in order to minimize off-lease time and recover our original investment in
the aircraft. Numerous factors, many of which are beyond our control, may have
an impact on our ability to re-lease or sell an aircraft on a timely basis or to
re-lease at a satisfactory lease rate. Among the factors are:
- the demand for various types of aircraft
- general market and economic conditions
- regulatory changes, including those imposing environmental, maintenance
or operational requirements
- changes in supply or cost of aircraft
- technological developments
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In addition, the success of an operating lease depends in significant part
upon having the aircraft returned by the lessee in marketable condition as
required by the lease. Consequently, we cannot assure you that our estimated
residual value for aircraft will be realized. If we are unable to re-lease or
resell aircraft on favorable terms, our business, financial condition and
results of operations could be adversely affected.
We depend on the airline industry
We are in the business of providing leases of commercial jet aircraft to
international and domestic airlines. Consequently, we are affected by downturns
in the air transportation industry in general. We could be negatively impacted
by any of the following factors affecting the air transportation industry:
- substantial increases in fuel costs or interest rates
- fare competition
- slower growth in traffic
- the number and quality of available aircraft
- significant downturn in the general economy
In recent years, a number of commercial airlines have experienced financial
difficulties, in some cases resulting in bankruptcy proceedings. While we
believe that our lease terms protect our aircraft and our investment in our
aircraft, we cannot assure you that the financial difficulties experienced by
airlines will not have an adverse effect on our business, financial condition
and results of operations.
We have a limited number of aircraft and lessees
We currently own and lease thirteen aircraft to thirteen lessees. The loss
of any one aircraft or the financial difficulty of or lease default by any one
lessee could have a material adverse effect on our business, financial condition
and results of operations.
We depend upon ILFC
Eleven of our current thirteen aircraft were acquired from ILFC. See
"Relationship With ILFC". In connection with all of our aircraft, ILFC has
provided guarantees or other financial support which have allowed us to finance
the aircraft at more favorable leverage than we could have obtained without the
guarantees and financial support of ILFC. In addition, ILFC has provided a
portion of the consulting fees reported by us. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." We cannot assure you
that we will be able to continue to acquire from ILFC or from other entities
aircraft and leases of the type and on terms as favorable as or better than the
aircraft and leases acquired from ILFC. If aircraft and leases are acquired from
ILFC or others, we cannot assure you that guarantees or financial support will
be given by the seller or whether we will be able to receive as favorable
leverage and interest rates from its lenders. If we are unable to acquire
aircraft and leases and to finance the acquired aircraft at competitive rates,
our business, financial condition and results of operations could be adversely
affected. See "Relationship With ILFC," and Note 5 to Consolidated Financial
Statements.
We are exposed to our lessees' credit risk
Certain of our existing and prospective customers are smaller domestic and
foreign passenger airlines which, together with major passenger airlines, may
suffer from the factors which have historically affected the airline industry.
See "We depend on the airline industry" above. A lessee may default in
performance of its lease obligations and we may be unable to enforce our
remedies under a lease. A number of airlines have experienced financial
difficulties, and certain airlines have filed for bankruptcy. A number of these
airlines have ceased operations. In most cases where a debtor seeks protection
under Chapter 11 of the United States Bankruptcy Code, creditors are stayed
automatically from enforcing their rights. In the case of United States
certificated airlines, Section 1110 of the Bankruptcy Code provides certain
relief to lessors of aircraft. Specifically, the airline has 60 days from the
date the lessor makes its claim to agree to perform its obligations
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and to cure any defaults before the lessor may repossess the aircraft. The scope
of Section 1110 has been the subject of significant litigation and we cannot
assure you that the provisions of Section 1110 will protect our investment in an
aircraft in the event of a lessee's bankruptcy. In addition, Section 1110 does
not apply to lessees located outside of the United States and applicable foreign
laws may not provide comparable protection.
We face special risks because of the number of foreign customers
Leases to foreign customers may present greater risks to us because certain
foreign laws, regulations and judicial procedures may not be as protective of
lessor rights as those which apply in the United States. We are subject to the
timing and access to courts and the remedies local laws impose in order to
collect our lease payments and recover our assets. Political instability abroad
and changes in international policy also present risks associated with
expropriation of our leased aircraft. Although we have experienced no problems
to date with our foreign lessees, we cannot assure you that we will not
experience problems in collecting amounts due under leases to foreign customers
or reacquiring aircraft from customers in the future. International collection
problems and problems in recovering aircraft could have a material adverse
effect on our business, financial condition and results of operations.
Many foreign countries have currency and exchange laws regulating the
international transfer of currencies. We attempt to minimize currency and
exchange risks by negotiating all of our aircraft leases in U.S. Dollars. We
require, as a condition to any foreign transaction, that the lessee in a foreign
country first obtain, if required, written approval of the appropriate
government agency, finance ministry or central bank for the remittance in U.S.
Dollars of all funds contractually owed to us. Although we have attempted to
minimize the foreign currency risk, to the extent that significant currency
fluctuations result in materially higher rental costs to a foreign lessee, the
foreign lessee may be unable or unwilling to make the required lease payments.
Our revenues and income may be affected by political instability abroad,
changes in national policy and other political or economic events adversely
affecting world or regional trading markets or impacting a particular customer.
Our aircraft can be subject to certain foreign taxes and airport fees.
Unexpected liens on an aircraft could be imposed in favor of a foreign entity,
such as Eurocontrol or the airports of the United Kingdom.
We may need to comply with certain aircraft noise requirements for some of our
aircraft
The Airport Noise and Capacity Act of 1990 requires the phaseout of Stage 2
aircraft (defined as aircraft that comply with the Stage 2 noise levels
prescribed in Part 36 of the Federal Aviation Regulations) by December 31, 1999,
subject to certain exceptions. Similar rules exist in other countries, including
the countries in Western Europe, Australia, New Zealand and Japan, which either
require compliance with regulations substantially identical to Stage 3 or which
forbid the operation of additional non-Stage 3 aircraft by carriers based in
those jurisdictions. This has the effect of limiting our ability to place our
Stage 2 aircraft on lease in those jurisdictions until they have been modified
to meet Stage 3 requirements.
Ten of our aircraft currently meet Stage 3 requirements. One of our
aircraft will be modified to meet Stage 3 requirements as a condition of an
existing lease at the lessee's expense. Our remaining two aircraft are currently
leased in areas not imposing Stage 3 requirements. These two aircraft may
require modification if moved to a jurisdiction requiring Stage 3 compliance.
Currently, these modification costs range from $1.7 million to $2.5 million per
aircraft. See "Government Regulation." We cannot assure you that we will be able
to obtain financing for any of these modifications.
The ANCA also recognizes the right of airport operators with special noise
problems to implement local noise abatement procedures as long as these
procedures do not interfere unreasonably with the interstate and foreign
commerce of the national air transportation system. ANCA generally requires FAA
approval of local noise restrictions on Stage 3 aircraft and establishes a
regulatory notice and review process for local restrictions on Stage 2 aircraft
first proposed after October 1990. As the result of litigation and pressure from
airport area residents, airport operators have taken local actions over the
years to reduce aircraft noise. These actions have
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<PAGE> 11
included regulations requiring aircraft to meet prescribed decibel limits by
designated dates, curfews during night time hours, restrictions on frequency of
aircraft operations and various operational procedures for noise abatement.
The imposition of and the cost of compliance by us with statutory and
regulatory requirements concerning noise restriction and abatement could have a
material adverse effect on our business, financial condition and results of
operations.
We depend on our ability to obtain financing
The operating lease business is a capital intensive business. Our typical
operating lease transaction requires a cash investment by us of approximately 5%
to 15% of the aircraft purchase price, commonly known as an "equity investment."
Our equity investments have historically been financed from internally generated
funds and other cash, seller financing (primarily from ILFC) and proceeds from
our initial public offering. The balance of the purchase price of an aircraft is
typically financed with the proceeds of non-recourse, secured borrowings from
banks or other financial institutions (to date with the support of ILFC as the
seller of the flight equipment). Accordingly, our ability to successfully
execute our business strategy and to sustain our operations is dependent, in
part, on the availability of debt and equity capital.
In addition, the terms of our loans generally require a substantial balloon
payment at the end of the noncancelable portion of the lease of the related
aircraft, at which time we will be required to re-lease the aircraft and
renegotiate the loan with its lender or obtain other financing. Refinancing the
balloon amount of the loan is dependent upon our re-leasing the related
aircraft. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources." We cannot assure you
that the necessary amount of capital will continue to be available to us on
favorable terms, or at all. If we are unable to continue to obtain any portion
of required financing on favorable terms, our ability to add new leases to our
lease portfolio, renew leases, re-lease an aircraft, repair or recondition an
aircraft if required or retain ownership of an aircraft on which financing has
expired could be limited, which could have a material adverse effect on our
business, financial condition and results of operations. In addition, our
financing arrangements to date have been dependent in part upon ILFC. See
"Reliance Upon ILFC" above and "Relationship With ILFC," and Note 5 to
Consolidated Financial Statements.
We face risks of changes in interest rates
Our leases are generally structured at fixed rental rates for specified
terms. See "Lease Portfolio" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources." We cannot assure you that we will be able to finance or refinance
our borrowings at fixed rates which result in acceptable interest rate spreads
to the applicable leases, or at fixed rates at all. Increases in interest rates
could narrow or eliminate the spread, or result in a negative spread, between
the lease rates we realize under our leases and the interest rate that we pay
under our loans. Our business, financial condition and operating results could
be adversely affected during any period of increases in interest rates.
We face actual and potential competition from many sources
The aircraft leasing industry is highly competitive. The level of
competition depends in part upon the type of aircraft being leased and
prospective lessees for the aircraft. We believe that only a few comparably
sized companies on a worldwide basis focus primarily on the same segment of the
aircraft leasing market as we do. In addition, a number of aircraft
manufacturers, airlines and other operators, distributors, equipment managers,
leasing companies (including ILFC), financial institutions and other parties
engaged in leasing, managing, marketing or remarketing aircraft compete with us,
although their primary focus is not on the market segment on which we focus.
Many of these periodic competitors have significantly greater financial
resources than we have. Our competitors may lease aircraft at lower rates than
we do and provide benefits, such as direct maintenance, crews, support services
and trade-in privileges, which we do not intend to provide. We cannot assure you
that we will continue to compete effectively against present and future
competitors or
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<PAGE> 12
that competitive pressures will not have a material adverse effect on our
business, financial condition and results of operations.
Foreign ownership of companies owning U.S. registered aircraft is limited
We intend to maintain United States registration of some of the aircraft
which we own. Aircraft may not be registered in the United States unless the
registered owner is a citizen of the United States or other permissible persons
under the Federal Aviation Act. If a corporation is the registered owner of an
aircraft, the corporation must be organized under the laws of the United States
or any State, and the president and two-thirds or more of the board of directors
and at least 75% of the voting interest of the corporation must be controlled by
persons who are citizens of the United States. Non-U.S. citizens may hold stock
in a U.S. corporation through an appropriate voting trust. Any successful
challenge to registration of an aircraft by the FAA may result in substantial
penalties, including the forced sale of the aircraft, the potential for
uninsured casualties to the aircraft, the loss of the benefits of the central
recording system under federal law (thereby leaving the aircraft exposed to
liens or other interests not of record with the FAA), and a breach by us of any
leases or financing agreements with respect to the aircraft.
The limits on liability of lessors are uncertain
Section 44112 of Title 49 of the United States Code provides that a lessor
of aircraft generally will not be liable for any personal injury or death, or
damage to or loss of property, provided that the lessor is not in actual
possession or control of the aircraft at the time of such injury, death or
damage. Under certain circumstances, however, courts have interpreted Section
44112 narrowly, limiting its protection to certain aircraft lessors and have
held that state common law remedies may apply, notwithstanding the limitations
on liability under Section 44112. Under common law, the owner of an aircraft may
be held liable for injuries or damage to passengers or property, and damage
awards can be substantial. Because there is little case law interpreting Section
44112, we cannot assure you that the provisions of Section 44112 would fully
protect us from all liabilities in connection with any injury, death, damage or
loss that may be caused by any aircraft we own. For example, Section 44112 may
not preempt state law with respect to liability for third party injuries arising
from a lessor's or owner's own negligence. It is anticipated that each lessee
under the terms of each lease to be entered into by us will be obligated to
indemnify us for, or insure us against, virtually all claims by third parties;
however, in the event that Section 44112 were not applicable, we cannot assure
you that the lessees could fulfill their indemnity obligations under any such
leases or that any insurance obtained will be sufficient.
We could be subject to substantial costs if lessees do not properly maintain
their leased aircraft
The maintenance and operation of aircraft are strictly regulated by the FAA
and foreign aviation authorities. The cost of complying with these requirements
is significant. We will seek to lease our aircraft to lessees that agree to bear
all or a significant portion of the costs of complying with governmental
regulations. All of our current leases require the lessee to bear all of the
costs of complying with governmental regulations. However, in the event a lessee
fails to maintain aircraft in accordance with the terms of a lease or a lease
terminates shortly before a major required overhaul, we may be required to spend
substantial sums to repair or recondition the aircraft and may be required to
borrow funds for the purpose. The FAA issued several Airworthiness Directives in
1990 mandating changes to the maintenance programs for older aircraft. These ADs
were issued to ensure that the oldest portion of the United States' transport
aircraft fleet remains airworthy. The FAA is requiring that these aircraft
undergo extensive structural modifications. These modifications are required
upon accumulation of 20 years' time in service or prior to the accumulation of a
designated number of flight-cycles, whichever occurs later. Future regulatory
changes may also increase the cost of operating or maintaining the aircraft and
may adversely affect the residual value of the aircraft. The failure of a lessee
to comply with lease maintenance and operation obligations or the imposition of
governmental requirements involving substantial compliance costs could have a
material adverse effect on our business, financial condition and results of
operations.
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<PAGE> 13
Changes in tax laws or accounting principles could adversely affect us
Our leasing activities generate significant depreciation allowances that
provide us with substantial tax benefits on an ongoing basis. In addition, some
of our lessees currently enjoy favorable accounting and tax treatment by
entering into operating leases. Any change to current tax laws or accounting
principles that make operating lease financing less attractive could adversely
affect our business, financial condition and results of operations.
We are dependent on key management
Our business operations are dependent in part upon the expertise of certain
key employees. The loss of the services of those employees, particularly William
E. Lindsey and Michael P. Grella, would have a material adverse effect on our
business, financial condition and results of operations.
Our quarterly operating results fluctuate
We have experienced fluctuations in our quarterly operating results and
anticipate that these fluctuations may continue. The factors causing
fluctuations include:
- the timing of purchases or sales of aircraft
- the timing and extent of consulting and remarketing fees
- unanticipated early lease terminations
- termination of a lease and the subsequent re-lease at a different lease
rate
- default by a lessee
Given the possibility of fluctuations, we believe that comparisons of the
results of our operations for preceding quarters are not necessarily meaningful
and that results for any one quarter should not be relied upon as an indication
of future performance. In the event our revenues or earnings for any quarter are
less than the level expected by securities analysts or the market in general,
the shortfall could have an immediate and significant adverse impact on the
market price of our common stock.
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<PAGE> 14
ITEM 2. PROPERTIES
FLIGHT EQUIPMENT
We review opportunities to acquire suitable jet aircraft that meet our
portfolio strategy based on market demand and customer airline requirements, as
well as our portfolio mix and planning strategies. Before committing to purchase
an aircraft, we take into consideration factors such as estimates of future
values, potential for remarketing, trends in supply and demand for the
particular type, make and model of aircraft and engines and anticipated
obsolescence. As a result, certain types and vintages of aircraft do not meet
the profile for inclusion in our portfolio of aircraft. At December 31, 1997 and
1998, the average age of our flight equipment was 12.8 and 12.5 years,
respectively. As of December 31, 1997 and 1998, our portfolio contained seven
and ten aircraft, respectively that were Stage 3 compliant. See "Item 1.
Business -- Cautionary Statements."
The following table shows the scheduled lease terminations (for the minimum
noncancellable period) by aircraft type for our lease portfolio at December 31,
1998:
<TABLE>
<CAPTION>
AIRCRAFT TYPE 1999 2000 2001 2002 2003 2004 TOTAL
------------- ---- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C>
A320-200....................................... -- -- 1 -- -- -- 1
727-200........................................ -- -- -- -- 1 -- 1
737-200........................................ -- -- 3 -- -- -- 3
737-300........................................ 1 -- 1 1 -- -- 3
737-400........................................ -- -- 2 -- -- -- 2
757-200........................................ -- -- -- -- 1 -- 1
MD-82.......................................... -- -- -- -- -- 1 1
MD-83.......................................... -- -- 1 -- -- -- 1
-- -- -- -- -- -- --
Total................................ 1 -- 8 1 2 1 13
== == == == == == ==
</TABLE>
FACILITIES
Our principal offices are located at 3655 Torrance Boulevard, Suite 410,
Torrance, California. We occupy space in Torrance under a lease that covers
approximately 3,254 square feet of office space and expires on May 31, 2004. We
believe that our current facilities are adequate for our needs and do not
anticipate any difficulty replacing those facilities or locating additional
facilities, if needed. See Note 7 to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
We are not currently involved in any litigation.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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<PAGE> 15
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Our common stock is listed on the National Association of Securities
Dealers Automated Quotation National Market (Nasdaq National Market) under the
trading symbol "IAIS." Our stock began trading on November 5, 1997 after we
completed an initial public offering of 2.6 million shares at $10 per share. The
high and low sale prices, as reported by The Nasdaq Stock Market, Inc., for the
years ended December 31, 1997 and 1998 were as follows:
<TABLE>
<CAPTION>
1997 1998
------------- -------------
HIGH LOW HIGH LOW
---- --- ---- ---
<S> <C> <C> <C> <C>
First Quarter...................................... -- -- $10 7/8 $9 1/8
Second Quarter..................................... -- -- $10 5/8 $8 5/8
Third Quarter...................................... -- -- $ 9 13/16 $6 3/4
Fourth Quarter..................................... $10 15/16 $9 $ 7 $5 3/8
</TABLE>
On March 19, 1999, the number of holders of record of our common stock was
76.
We have not paid any cash dividends on our capital stock. The payment of
cash dividends in the future will be made at the discretion of the Board of
Directors and will depend on a number of factors, including future earnings,
capital requirements, our financial condition and future prospects and such
other factors as the Board of Directors may deem relevant. We intend to retain
all available funds for use in our business. Accordingly, we do not anticipate
declaring or paying any dividends on our common stock in the foreseeable future.
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<PAGE> 16
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial and operating data should be
read in conjunction with the accompanying Consolidated Financial Statements and
the related notes thereto and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this Form
10-K.
<TABLE>
<CAPTION>
AT AND FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA AND OTHER DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA
Revenues:
Rental of flight equipment................ $ 8,108 $ 7,765 $12,681 $ 15,433 $ 26,985
Consulting fees........................... 213 491 461 212 605
Gain on sale of aircraft equipment........ -- -- 141 -- --
Interest income........................... 68 118 169 483 1,727
------- ------- ------- -------- --------
Total revenues....................... 8,389 8,374 13,452 16,128 29,317
Expenses..................................... 7,261 7,656 12,380 15,028 24,596
Equity in earnings of affiliates............. -- 183 -- -- --
------- ------- ------- -------- --------
Income before income taxes and cumulative
effect of accounting change............... 1,128 901 1,072 1,100 4,721
Income tax expense........................... 59 30 37 433 1,542
------- ------- ------- -------- --------
Net income before cumulative effect of
accounting change......................... 1,069 871 1,035 667 3,179
Cumulative effect of accounting change....... -- -- -- -- 209
------- ------- ------- -------- --------
Net income................................... $ 1,069 $ 871 $ 1,035 $ 667 $ 3,388
======= ======= ======= ======== ========
Basic earnings per share(1):
Net income before cumulative effect of
accounting change....................... $ 22.27 $ 17.77 $ 14.79 $ .88 $ .72
Cumulative effect of accounting change.... -- -- -- -- .04
------- ------- ------- -------- --------
Net income................................ $ 22.27 $ 17.77 $ 14.79 $ .88 $ .76
======= ======= ======= ======== ========
Diluted earnings per share(1):
Net income before cumulative effect of
accounting change....................... $ .59 $ .48 $ .56 $ .30 $ .70
Cumulative effect of accounting change.... -- -- -- -- .05
------- ------- ------- -------- --------
Net income................................ $ .59 $ .48 $ .56 $ .30 $ .75
======= ======= ======= ======== ========
Weighted average number of common shares
outstanding............................... 48 49 70 754 4,430
Weighted average number of common shares
outstanding -- assuming dilution.......... 1,826 1,826 1,837 2,207 4,545
BALANCE SHEET DATA
Flight equipment under operating lease....... $56,162 $95,450 $89,885 $172,506 $236,909
Total assets................................. 57,131 96,779 92,620 204,552 267,891
Debt financing............................... 51,688 87,825 82,710 154,720 208,002
Shareholders' equity......................... 3,078 4,048 5,084 33,095 34,751
OTHER DATA
Aircraft equipment owned at period end(2).... 5 8 7 10 13
</TABLE>
- ---------------
(1) The earnings per share amounts have been restated as required to comply with
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share." For further discussion of earnings per share and the impact of SFAS
No. 128, see Note 1 to Consolidated Financial Statements.
(2) Aircraft equipment owned at December 31, 1995 includes one auxiliary power
unit which was purchased in 1995 and sold for a gain of $141 in December
1996.
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<PAGE> 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
We are primarily engaged in the acquisition of used, single-aisle jet
aircraft for lease and sale to domestic and foreign airlines and other
customers. We lease aircraft under short-term to medium-term operating leases
where the lessee is responsible for all operating costs and we retain the
potential benefit or risk of the residual value of the aircraft. This is
distinct from finance leases where the full cost of the aircraft is generally
recovered over the term of the lease.
Rental amounts are accrued evenly over the lease term and are recognized as
revenue from the rental of flight equipment. Our flight equipment is recorded on
the balance sheet at cost and is depreciated on a straight-line basis over the
estimated useful life to our estimated salvage value. Revenue, depreciation
expense and resultant profit for operating leases are recorded evenly over the
life of the lease. Initial direct costs related to the origination of leases are
capitalized and amortized over the lease terms.
ACCOUNTING CHANGE
Effective January 1, 1998, we changed our method of accounting for income
recognition for ancillary payments under lease agreements to a full accrual
method from recognition upon lease termination. This new method, which was
accounted for as a change in accounting method, was made to better reflect the
earnings process under lease agreements. The effect of this change on net
earnings, before cumulative effect of accounting change, for the year ended
December 31, 1998, was an increase of $983. The cumulative effect on retained
earnings at January 1, 1998 of the accounting change was an increase of
approximately $209, net of related income taxes of $139.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
Revenues from rental of flight equipment increased by 22% to $15,433 in
1997 from $12,681 in 1996 primarily a result of the acquisition in 1997 of three
aircraft under lease and the re-lease of flight equipment at a higher lease
rate. Our lease portfolio increased from seven aircraft with a book value of
$89,885 at December 31, 1996 to ten aircraft with a book value of $172,506 at
December 31, 1997. The increase in rental revenues in 1998 to $26,985 from
$15,433 in 1997 was primarily the result of the acquisition of three aircraft
under lease in 1998, as well as the change in accounting method discussed above.
Our lease portfolio increased from ten aircraft with a book value of $172,506 at
December 31, 1997 to thirteen aircraft with a book value of $236,909 at December
31, 1998. During 1998, we purchased a 1990 MD-83 on lease until March 2001, a
Boeing Model 737-400 on lease to October 2001 and an Airbus A320-200 on lease to
October 2001.
In 1996, consulting revenues totaled $461, including $144 paid by Great
Lakes Holdings (which is owned by our Chief Executive Officer and our
President), $78 paid by ILFC and $239 paid by unrelated third parties. In 1997,
consulting revenues totaled $212, including $12 from Great Lakes, $25 from ILFC
and $175 from unrelated parties. The decrease in consulting fees of $249 in 1997
was partly the result of the termination in January 1997 of an arrangement with
Great Lakes. No further consulting fees are expected to be received from Great
Lakes. In 1998, consulting fee revenues totaled $605, paid from unrelated
parties.
In 1996, we realized a gain on sale of aircraft equipment of $141 for the
sale of an auxiliary power unit previously on lease. We did not sell aircraft
equipment in 1997 or 1998.
The increase in interest income of $314 to $483 in 1997 was primarily due
to interest on cash, primarily from our initial public offering in November 1997
and on increased restricted cash balances. Interest income increased to $1,727
in 1998 from $483 in 1997 principally as a result of a full year of interest
earned on increased cash from our initial public offering and on increased
restricted cash balances.
Expenses as a percent of total revenues were 92%, 93.2% and 83.9% in 1996,
1997 and 1998, respectively. The increase in the percentage from 1996 to 1997
was primarily the result of the net effect of a 20% increase in total revenues
in 1997 and a 21% increase in total expenses. The decrease in the percent of
total revenues from
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<PAGE> 18
1997 to 1998 was due to the effect of an 82% increase in total revenues and only
a 64% increase in total expenses.
Interest expense increased from $6,277 in 1996 to $7,480 in 1997 and
$12,120 in 1998. The increase from 1996 to 1997 was principally the result of
additional financing to acquire three aircraft in 1997, offset by loan paydowns
and lower interest rates on new financings. Interest expense increased in 1998
as a result of interest on financing related to the acquisition of three
additional aircraft, offset by loan paydowns and lower interest rates on new
financings. Our weighted average interest rate was 7.3% and 7.1% at December 31,
1997 and 1998, respectively.
Depreciation expense increased from $3,354 in 1996 to $6,550 in 1997 and
$10,697 in 1998. The increase from 1996 to 1997 principally resulted from the
acquisition of three aircraft in 1997. The increase in 1998 from 1997 resulted
from the acquisition of three additional aircraft in 1998. General and
administrative expenses were $553, $747 and $1,529 in 1996, 1997 and 1998,
respectively. The increase from 1996 to 1997 was primarily the result of the
addition of two employees. The increase from 1997 to 1998 was primarily the
result of additional compensation expense as the result of new employment
agreements with our Chief Executive Officer and with our President, as well as
the additional costs associated with maintaining our status as a public company.
In 1997 and 1998, we incurred $250 of non-cash compensation expense related to
the vesting of options. We expect to incur $250 of non-cash compensation expense
related to the vesting of these options in both 1999 and 2000. See Note 8 to
Consolidated Financial Statements.
We recognized income tax expense of $37, $433 and $1,542, representing
effective income tax rates of 3%, 40% and 33%, during 1996, 1997 and 1998,
respectively. The increase in income tax expense in 1997 represents a non-cash
provision for deferred income taxes at an effective rate of 40%. We paid no
federal income taxes in 1996 or 1997 due to substantial operating loss
carryforwards primarily resulting from accelerated tax depreciation. The $1,109
increase in income tax expense in 1998 primarily represents a non-cash provision
for deferred income taxes. Our effective tax rate decreased to 33% as a result
of an increasing number of foreign aircraft in our portfolio and tax planning
associated with our federal net operating loss carryforwards. During 1998, we
continued to generate substantial federal net operating loss carryforwards. At
December 31, 1998, we had $18,979 of federal net operating loss carryforwards.
See Note 3 to Consolidated Financial Statements.
Net income decreased from $1,035 in 1996 to $667 in 1997 and increased to
$3,388 in 1998 due to the factors described above, as well as the $209
cumulative effect of accounting change in 1998.
LIQUIDITY AND CAPITAL RESOURCES
Our principal external sources of funds have been term loans from banks and
seller financing secured by aircraft. As a result, a substantial amount of our
cash flow from the rental of flight equipment is applied to principal and
interest payments on secured debt. The terms of our loans generally require a
substantial balloon payment at the end of the noncancellable portion of the
lease of the related aircraft, at which time we will be required to re-lease the
aircraft and renegotiate the balloon amount of the loan or obtain other
financing. Refinancing of the balloon amount is dependent upon the re-leasing
the related aircraft. Accordingly, we begin lease remarketing efforts well in
advance of the lease termination. See "Item 1. Business -- Financing/Source of
Funds." The principal use of cash is for financing the acquisition of our
aircraft portfolio, which are financed by loans secured by the applicable
aircraft. We do not currently maintain a line of credit.
At December 31, 1997 and 1998, we had cash and cash equivalents of $23,838
and $15,924, respectively.
Net cash provided by operating activities increased from $6,796 in 1996 to
$12,776 in 1997 and to $15,900 in 1998. The increase in 1997 was principally the
result of the acquisition of three aircraft and their related leases. The
increase in 1998 was primarily the result of the acquisition of three additional
aircraft and their related leases.
In 1996, $156 of net cash was provided by investing activities as a result
of the sale of aircraft equipment for $355, offset by flight equipment purchases
of $199. In 1997, the $89,171 of net cash used in investing
18
<PAGE> 19
activities was primarily used to purchase three aircraft. In 1998, cash of
$75,100 was used in investing activities to purchase three additional aircraft.
In 1996, net cash used in financing activities was $5,812, consisting of
repayments of notes and other payables of $6,544 offset by the proceeds of
additional borrowings of $732. In 1997, net cash provided by financing
activities was $99,059 including the proceeds of borrowings of $80,463 primarily
to finance the acquisition of three aircraft, offset by repayments of notes of
$7,768, as well as $26,365 from both the issuance of 2,680,000 shares in our
initial public offering and the issuance of 488,501 shares upon the exercise of
stock options. In 1998, net cash provided by financing activities was $51,285,
including proceeds from borrowings of $64,384 to finance the purchase of three
aircraft, offset by repayments of $11,116 and $1,983 of common stock
repurchases.
Cash and cash equivalents vary from year to year principally as a result of
the timing of the purchase and sale of aircraft.
We use interest rate swap arrangements to reduce the potential impact of
increases in interest rates on floating rate long-term debt and does not use
swap arrangements for trading purposes. Premiums paid for purchased interest
rate swap agreements are amortized to interest expense over the terms of the
swap agreements.
Our ability to execute our business strategy successfully and to sustain
our operations is dependent, in part, on our ability to obtain financing and to
raise equity capital. We cannot assure you that the necessary amount of capital
will continue to be available to us on favorable terms or at all. If we are
unable to continue to obtain any portion of required financing on favorable
terms, our ability to add new aircraft to our lease portfolio, renew leases,
re-lease an aircraft, repair or recondition an aircraft if required, or retain
ownership of an aircraft on which financing has expired would be impaired, which
could have a material adverse effect on our business, financial condition and
results of operations. In addition, our financing arrangements to date have been
dependent in part upon ILFC. See "Item 1. Business -- Cautionary Statements."
IMPACT OF YEAR 2000 ISSUE
The Year 2000 issue results from computer programs written using two digits
to identify the year in the date field. These computer programs were designed
and developed without consideration of the impact of the upcoming change in the
century. If not corrected, these programs could create erroneous information by
or at the Year 2000.
We have performed a review and assessment of our internal computer systems
to determine the effect of the Year 2000 issue. Based on the results of this
review, we believe that the internal effects of the Year 2000 issue will not
materially affect our future financial results or financial condition.
Failure by our lessees, manufacturers of our aircraft and business partners
to properly comply with Year 2000 issues could result in lost revenues and
increased expenses. We have initiated formal communications with lessees,
manufacturers of our aircraft and business partners to determine the extent to
which we and our aircraft are vulnerable to those third parties' failure to
address their own Year 2000 issues. Based on the responses from third parties we
have received, we do not expect a material affect on our financial results or
our financial position. As such, no contingency plan has been developed. If
future responses indicate a material exposure as a result of third parties, we
will develop a contingency plan.
We expect to be Year 2000 compliant by December 31, 1999. We have incurred
no additional costs associated with the Year 2000 issue and estimate that no
additional costs will be incurred.
We will continue assessing our internal and external risk as we acquire
additional information systems and enter into business relationships with
additional lessees, manufacturers of aircraft and other business partners.
A possible scenario is that one or more of our lessees would be unable to
operate and generate revenues and as a result be unable to make lease payments.
At this time, we are unable to estimate the likelihood or the magnitude of the
resulting lost revenue.
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<PAGE> 20
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
This analysis presents the hypothetical loss in earnings, cash flows or
fair value of the financial instruments which we held at December 31, 1998 and
are sensitive to changes in interest rates. In the normal course of business, we
also face risks that are either nonfinancial or non-quantifiable. These risks
principally include country risk, credit risk and legal risk and are not
included in the following analysis. See "Item 1. Business -- Cautionary
Statements."
From time to time, we enter into interest rate swaps with financial
institutions under terms that provide payment of interest on the notional amount
of the swap. In accordance with these arrangements, we pay interest at a fixed
rate and the financial institution pays interest at variable rates pursuant to
terms of the loans. We had no swap agreements at December 31, 1998.
The carrying amounts of cash and cash equivalents approximate fair market
value because of the short-term nature of these items. Market risk was estimated
as the potential decrease in fair value resulting from a hypothetical 10%
increase in interest rates for our cash equivalents and was not materially
different from the year-end carrying value.
The fair values of the our debt instruments, including the related AVGs,
approximate the carrying values because (1) the rates currently offered to us
are similar to the rates for these items, or (2) the yields to maturity
approximate the rates for these items. Market risk associated with our debt
instruments primarily results from our ability to refinance balloon payments at
comparable or lower interest rates. Market risk was estimated as the potential
increase in interest expense in 1999 resulting from a hypothetical 10% increase
in our weighted average borrowing rate at December 31, 1998 or $1,286.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During the two fiscal periods prior to the date of our most recent
financial statements, we have not reported a change in accountants nor have
there been any disagreements reported on any matter of accounting principles or
practices or financial statement disclosure.
20
<PAGE> 21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The section entitled "Election of Directors" in the Proxy Statement is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" in the Proxy Statement is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Beneficial Ownership of Shares" in the Proxy
Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Certain Relationships and Related Transactions" in
the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS
See Index to Consolidated Financial Statements on page 23 of this report.
FINANCIAL STATEMENT SCHEDULES
None.
EXHIBITS
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------ -----------
<C> <S>
3.1 Amended and Restated Articles of Incorporation of the
Company. Filed as Exhibit 3.1 to Form 10-Q for the quarterly
period ended September 30, 1997, and incorporated herein by
reference
3.2 Amended and Restated Bylaws of the Company. Filed as Exhibit
3.2 to Form 10-Q for the quarterly period ended September
30, 1997, and incorporated herein by reference
4.1 Senior Term Loan Agreement, dated December 10, 1997, between
IAI V, Inc. and City National Bank. Filed as Exhibit 4.11 to
Form 10-Q for the quarterly period ended September 30, 1997,
and incorporated herein by reference
4.2 The Company hereby agrees to furnish to the Commission upon
request a copy of any instrument with respect to long-term
debt where the total amount of securities authorized
thereunder does not exceed 10% of the consolidated assets of
the Company
*10.1 Employment Agreement with William E. Lindsey. Filed as
Exhibit 10.1 to Form 10-Q for the quarterly period ended
September 30, 1997, and is incorporated herein by reference
*10.2 Employment Agreement with Michael P. Grella. Filed as
Exhibit 10.2 to Form 10-Q for the quarterly period ended
September 30, 1997, and is incorporated herein by reference
*10.3 1997 Stock Option and Award Plan. Filed as Exhibit 6 to
Registration Statement No. 333-46411, and incorporated
herein by reference
*10.4 1997 Eligible Director Stock Option Plan. Filed as Exhibit 6
to Registration Statement No. 333-46413, and incorporated
herein by reference
* 10.5 Form of Indemnity Agreement. Filed as Exhibit 10.3 to
Registration Statement No. 333-19875, and incorporated
herein by reference
</TABLE>
21
<PAGE> 22
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------ -----------
<C> <S>
10.6 Letter Agreement, dated November 6, 1996 between the Company
and ILFC. Filed as Exhibit 10.4 to Registration Statement
No. 333-19875, and incorporated herein by reference
10.7 Letter Agreement, dated January 14, 1997, between the
Company and ILFC. Filed as Exhibit 10.5 to Registration
Statement No. 333-19875, and incorporated herein by
reference
23.1 Consent of KPMG LLP, independent certified public
accountants
27.1 Financial Data Schedule for the year ended December 31, 1998
27.2 Financial Data Schedule for the year ended December 31,
1997 -- Restated
</TABLE>
- ---------------
* Management contracts.
REPORTS ON FORM 8-K:
During the quarter ended December 31, 1998, we did not file any reports on
Form 8-K.
22
<PAGE> 23
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ 24
Consolidated Balance Sheets as of December 31, 1998 and
1997...................................................... 25
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996.......................... 26
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1996,
1997 and 1998............................................. 27
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.......................... 28
Notes to Consolidated Financial Statements.................. 29
</TABLE>
23
<PAGE> 24
INDEPENDENT AUDITORS' REPORT
The Board of Directors
International Aircraft Investors:
We have audited the accompanying consolidated balance sheets of
International Aircraft Investors and subsidiaries as of December 31, 1998 and
1997 and the related consolidated statements of income, shareholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in note 1 to the consolidated financial statements, the
Company changed its method of accounting for income recognition for ancillary
payments under lease agreements effective January 1, 1998.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
International Aircraft Investors and subsidiaries as of December 31, 1998 and
1997 and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1998 in conformity with
generally accepted accounting principles.
KPMG LLP
Los Angeles, California
January 19, 1999
24
<PAGE> 25
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash and cash equivalents................................... $ 15,923,982 $ 23,838,306
Flight equipment, at cost, net.............................. 236,908,773 172,506,257
Deferred fees............................................... 1,180,681 628,103
Cash, restricted............................................ 13,387,878 6,976,974
Other assets................................................ 489,702 602,486
------------ ------------
$267,891,016 $204,552,126
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued interest and other accrued expenses................. $ 1,000,291 $ 1,343,677
Notes payable............................................... 208,001,908 154,719,546
Lease and other deposits.................................... 18,629,524 11,236,113
Deferred rent............................................... 3,030,812 3,334,000
Deferred taxes, net......................................... 2,477,876 823,800
------------ ------------
233,140,411 171,457,136
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value. Authorized 15,000,000
shares; none issued and outstanding.................... -- --
Common stock, $.01 par value. Authorized 20,000,000
shares; issued and outstanding 4,216,284 shares at
December 31, 1998 and 4,497,584 shares at December 31,
1997................................................... 42,163 44,976
Additional paid-in capital................................ 31,292,324 33,272,435
Deferred stock compensation............................... (500,000) (750,000)
Retained earnings......................................... 3,916,118 527,579
------------ ------------
Net shareholders' equity.......................... 34,750,605 33,094,990
------------ ------------
$267,891,016 $204,552,126
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 26
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Rental of flight equipment............................ $26,985,395 $15,432,631 $12,681,153
Consulting fees....................................... 605,000 212,000 460,950
Gain on sale of aircraft equipment.................... -- -- 141,000
Interest income....................................... 1,727,480 482,842 169,023
----------- ----------- -----------
Total revenues................................ 29,317,875 16,127,473 13,452,126
Expenses:
Interest.............................................. 12,119,746 7,480,490 6,277,388
Depreciation.......................................... 10,697,484 6,550,000 5,549,700
General and administrative............................ 1,529,200 747,287 552,778
Stock compensation.................................... 250,000 250,000 --
----------- ----------- -----------
Total expenses................................ 24,596,430 15,027,777 12,379,866
Income before income taxes and cumulative effect of
accounting change..................................... 4,721,445 1,099,696 1,072,260
Income tax expense...................................... 1,541,906 433,000 37,000
----------- ----------- -----------
Net income before cumulative effect of accounting
change................................................ 3,179,539 666,696 1,035,260
Cumulative effect of accounting change.................. 209,000 -- --
----------- ----------- -----------
Net income.............................................. $ 3,388,539 $ 666,696 $ 1,035,260
----------- ----------- -----------
Basic earnings share:
Net income before cumulative effect of accounting
change............................................. $ .72 $ .88 $ 14.79
Cumulative effect of accounting change................ .04 -- --
----------- ----------- -----------
Net income............................................ $ .76 $ .88 $ 14.79
=========== =========== ===========
Diluted earnings per share:
Net income before cumulative effect of accounting
change............................................. $ .70 $ .30 $ .56
Cumulative effect of accounting change................ .05 -- --
----------- ----------- -----------
Net income............................................ $ .75 $ .30 $ .56
=========== =========== ===========
Weighted average common shares outstanding.............. 4,430,183 754,131 70,000
=========== =========== ===========
Weighted average common shares -- assuming dilution..... 4,545,191 2,206,863 1,836,762
=========== =========== ===========
Pro forma effect assuming the change in accounting
principle is retroactively applied:
Net income......................................... $ 3,179,539 $ 706,696 $ 1,035,260
Earnings per share:
Basic............................................ $ .72 $ .94 $ 14.79
Diluted.......................................... $ .70 $ .32 $ .56
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE> 27
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
RETAINED
CONVERTIBLE COMMON STOCK ADDITIONAL DEFERRED EARNINGS
PREFERRED ------------------- PAID-IN STOCK (ACCUMULATED
STOCK SHARES AMOUNT CAPITAL COMPENSATION DEFICIT) NET
----------- --------- ------- ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995...... $ 49,410 315,000 $ 3,150 $ 5,170,098 $ -- $(1,174,377) $ 4,048,281
-------- --------- ------- ----------- ----------- ----------- -----------
Reverse stock split............... -- (245,000) (2,450) 2,450 -- -- --
-------- --------- ------- ----------- ----------- ----------- -----------
Adjusted balance at December 31,
1995............................ 49,410 70,000 700 5,172,548 -- (1,174,377) 4,048,281
Net income...................... -- -- -- -- -- 1,035,260 1,035,260
-------- --------- ------- ----------- ----------- ----------- -----------
Balance at December 31, 1996...... 49,410 70,000 700 5,172,548 -- (139,117) 5,083,541
Issuance of common stock from
exercise of stock options..... -- 488,501 4,885 2,418,374 -- -- 2,423,259
Issuance of common stock from
conversion of convertible
preferred stock............... (49,410) 1,103,528 11,035 38,375 -- -- --
Issuance of common stock
From conversion of convertible
note payable................ -- 155,555 1,556 727,844 -- -- 729,400
Issuance of common stock, net of
stock issuance costs.......... -- 2,680,000 26,800 23,915,294 -- -- 23,942,094
Deferred stock compensation..... -- -- -- 1,000,000 (1,000,000) -- --
Stock compensation.............. -- -- -- -- 250,000 -- 250,000
Net income...................... -- -- -- -- -- 666,696 666,696
-------- --------- ------- ----------- ----------- ----------- -----------
Balance at December 31, 1997...... -- 4,497,584 44,976 33,272,435 (750,000) 527,579 33,094,990
Repurchase of common stock...... -- (281,300) (2,813) (1,980,111) -- -- (1,982,924)
Stock compensation.............. -- -- -- -- 250,000 -- 250,000
Net income...................... -- -- -- -- 3,388,539 3,388,539
-------- --------- ------- ----------- ----------- ----------- -----------
Balance at December 31, 1998...... $ -- 4,216,284 $42,163 $31,292,324 $ (500,000) $ 3,916,118 $34,750,605
======== ========= ======= =========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE> 28
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Cash flow from operating activities:
Net income............................................ $ 3,388,539 $ 666,696 $ 1,035,260
Adjustments to reconcile net income to net cash
provided by operating activities: cumulative effect
of accounting change................................ 209,000 -- --
Depreciation of flight equipment.................... 10,697,484 6,550,000 5,549,700
Amortization of deferred fees....................... 257,647 235,653 158,410
Deferred taxes, net of effect of accounting
change........................................... 1,654,076 423,800 30,983
Stock compensation.................................. 250,000 250,000 --
Gain on sale of aircraft equipment.................. -- -- (141,000)
Increase in assets:
Cash, restricted................................. (6,410,904) (6,766,147) (33,819)
Other assets..................................... (683,191) (72,277) (389,565)
Increase (decrease) in liabilities:
Accrued interest and other accrued expenses...... (343,386) 515,984 547,381
Lease deposits and other deposits................ 7,184,411 9,933,053 286,634
Deferred rent.................................... (303,188) 1,039,000 (247,850)
------------ ------------ -----------
Net cash provided by operating activities... 15,900,488 12,775,762 6,796,134
Cash flows from investing activities: purchase of
flight equipment.................................... (75,100,000) (89,171,283) (198,974)
Proceeds from sale of flight equipment.............. -- -- 355,000
------------ ------------ -----------
Net cash provided by (used in) investing
activities................................ (75,100,000) (89,171,283) 156,026
Cash flows from financing activities:
Repayment of notes payable.......................... (8,152,498) (6,293,592) (5,322,926)
Repayment of notes payable to ILFC.................. (2,880,390) (1,274,803) (524,292)
Repayment of notes payable to GLH................... (83,000) (200,000) --
Proceeds from notes payable......................... 31,250,000 52,500,000 244,724
Proceeds from notes payable to ILFC................. 33,134,000 27,762,500 --
Proceeds from notes payable to GLH.................. -- 200,000 487,500
Issuance of common stock............................ -- 26,365,353 --
Repurchase of common stock.......................... (1,982,924) -- --
Payable to ILFC..................................... -- -- (696,695)
Net cash provided by (used in) financing
activities................................ 51,285,188 99,059,458 (5,811,689)
------------ ------------ -----------
Net increase (decrease) in cash and cash
equivalents............................... (7,914,324) 22,663,937 1,140,471
Cash and cash equivalents at beginning of year........ 23,838,306 1,174,369 33,898
------------ ------------ -----------
Cash and cash equivalents at end of year.............. $ 15,923,982 $ 23,838,306 $ 1,174,369
============ ============ ===========
Supplemental disclosure of cash flow information --
Cash paid for interest........................... $ 12,205,485 $ 6,772,358 $ 5,722,256
============ ============ ===========
Cash paid for taxes.............................. $ 26,830 -- --
============ ============ ===========
</TABLE>
Supplemental disclosure of noncash investing and financing activities: During
1997, a 5% convertible note with a balance of $729,400 was converted to common
stock.
See accompanying notes to consolidated financial statements.
28
<PAGE> 29
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
International Aircraft Investors (the Company) is primarily engaged in the
acquisition of used, single-aisle jet aircraft for lease and sale to domestic
and foreign airlines and other customers. The Company leases aircraft under
short-term to medium-term operating leases where the lessee is responsible for
all operating costs and the Company retains the potential benefit and risk of
the residual value of the aircraft, as distinct from finance leases where the
cost of the aircraft is generally recovered over the term of the lease.
Eleven of the Company's thirteen aircraft at December 31, 1998 were
acquired from International Lease Finance Corporation (ILFC), a 1.6% shareholder
of the Company. In connection with certain of these aircraft acquisitions, ILFC
has provided loan guarantees or other financial support which have provided more
favorable borrowing arrangements than the Company could otherwise have obtained.
Additionally, the Company has derived certain consulting fees from ILFC for
providing remarketing and other services.
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation. Certain
reclassifications have been made to prior year amounts to conform to current
year presentation.
Accounting Change
Effective January 1, 1998, the Company changed its method of accounting for
income recognition for ancillary payments under lease agreements to a full
accrual method from recognition upon lease termination. This new method, which
was accounted for as a change in accounting method, was made to better reflect
the earnings process under lease agreements. The effect of this change on net
earnings and earnings per share, before cumulative effect of accounting change,
for the year ended December 31, 1998, was an increase of $983,000 ($.22 per
basic and diluted share). The cumulative effect on retained earnings at January
1, 1998 of the accounting change was an increase of approximately $209,000 ($.04
per basic share and $.05 per diluted share), net of related income taxes of
$139,000. The pro forma amounts shown on the consolidated statements of income
have been adjusted for the effect of retroactive application.
Cash and Cash Equivalents
Cash and cash equivalents includes cash and highly liquid investments
purchased with an original maturity of less than 90 days. Certain cash and
short-term investments for the repayment of a security deposit and maintenance
reserves are restricted pursuant to certain loan agreements. Such security
deposit and maintenance reserves mature through November 2004.
Deferred Fees
The direct costs related to purchase and lease agreements are capitalized
and amortized to expense using the straight-line method, which approximates the
effective interest method, over the term of the related lease.
The costs related to asset value guarantees (AVGs) are capitalized and
amortized to expense using the straight-line method over the term of the AVG,
generally ten years. At December 31, 1998 and 1997, deferred fees related to
AVGs were $255,106 and $291,417, respectively.
Rentals
The Company leases flight equipment under operating leases. Accordingly,
income is recognized over the life of noncancelable lease terms under the
straight-line method.
29
<PAGE> 30
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
Flight Equipment and Depreciation
Flight equipment is stated at cost. Major additions and modifications are
capitalized. Depreciation of flight equipment is generally computed on a
straight-line method over the estimated remaining useful lives (25 year original
life less years in service at the date of acquisition) assuming a 15% estimated
residual value.
Maintenance Reserves and Interest Income
Normal maintenance and repairs of flight equipment on lease are provided by
and paid for by the lessee. Maintenance reserves received under certain leases
amounted to $5,959,306, $7,672,043 and $268,581 during the years ended December
31, 1998, 1997 and 1996, respectively. Additionally, one of the Company's
lessees held a related maintenance reserve with ILFC in accordance with an
agreed-upon arrangement. The Company received interest earned on this reserve
held with ILFC which amounted to $40,699 and $62,100 during 1997 and 1996,
respectively. The lease and related arrangement expired April 1997.
Impairment of Long-Lived Assets
Statement of Financial Accounting Standards No. 121 (SFAS No. 121),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," issued in March 1995 and effective for fiscal years beginning
after December 15, 1995, establishes accounting standards for the recognition
and measurement of impairment of long-lived assets, certain identifiable
intangibles and goodwill either to be held or disposed of. The Company adopted
SFAS No. 121 during 1996. The adoption of SFAS No. 121 did not have a material
impact on the Company's financial position or results of operations.
The Company evaluates the carrying value of its flight equipment using
undiscounted operating cash flows and when required will provide for any
permanent impairment of long-lived assets.
Interest Rate Swap Agreements
The Company uses interest rate swap arrangements to reduce the potential
impact of increases in interest rates on certain floating rate long-term debt
and does not use them for trading purposes. Premiums paid for purchased interest
rate swap agreements are amortized to interest expense over the terms of the
swap agreements.
All outstanding swap agreements are hedges and, therefore, are not marked
to market.
Fair Values of Financial Instruments
The carrying amounts of cash and cash equivalents and accrued interest and
other accrued expenses approximate fair market value because of the short-term
nature of these items.
The fair values of the Company's interest rate swaps approximate
unamortized costs as the remaining amortization periods are short-term. The fair
value of the amount due from ILFC approximates the carrying value as the fair
value was determined using the present value method with the Company's internal
rate of return. The fair values of the Company's debt instruments, including the
related AVGs, approximate the carrying values because (1) the rates currently
offered to the Company are similar to the rates for these items, or (2) the
yields to maturity approximate the rates for these items.
Management Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions. These affect the reported amounts of assets,
30
<PAGE> 31
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
liabilities, revenues and expenses and the amount of any contingent assets or
liabilities disclosed in the financial statements. Actual results could differ
from the estimates made.
The Company leases aircraft to various commercial airlines, on short-term
to medium-term operating leases, generally three to five years. The related
aircraft are generally financed by borrowings that become due at or near the end
of the lease term through a balloon payment. As a result, the Company's
operating results depend on management's ability to roll over debt facilities,
renegotiate favorable leases and realize estimated salvage values.
Stock Compensation
Statement of Financial Accounting Standards No. 123 (SFAS No. 123),
"Accounting for Stock-Based Compensation," issued in October 1995 and effective
for fiscal years beginning after December 15, 1995, encourages, but does not
require, a fair-value-based method of accounting for employee stock options or
similar equity instruments. SFAS No. 123 allows an entity to elect to continue
to measure compensation cost under Accounting Principles Board Opinion No. 25
(APBO No. 25), "Accounting for Stock Issued to Employees," but requires pro
forma disclosures of net earnings and earnings per share as if the fair-value
based method of accounting had been applied. The Company elected to continue to
measure compensation cost under APBO No. 25. Had compensation cost been
determined using the fair value at the grant date for awards during 1998 and
1997, consistent with the provisions of SFAS No. 123, the Company's net earnings
and earnings per share would have been reduced to the pro forma amount as
indicated below. No options were issued in 1996.
<TABLE>
<S> <C>
Net earnings as reported.................................... $3,388,539
Pro forma net earnings...................................... 3,281,442
Net earnings per share, as reported:
Basic..................................................... .76
Diluted................................................... .75
Pro forma net earnings per share:
Basic..................................................... .74
Diluted................................................... $ .72
==========
</TABLE>
The fair value of each option is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants during the period ended December 31, 1998; dividend
yield of 0%; expected volatility of 32.3%; risk-free interest rate of between
4.4% and 5.1% and expected lives of five years.
The weighted average fair value per share of options granted during the
periods ended December 31, 1998 is $3.57.
Income Taxes
The Company accounts for income taxes under the asset and liability method
whereby deferred tax assets and liabilities are recognized for the future tax
consequences for differences between the financial statement carrying amounts of
assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years when such temporary differences are expected to be recovered
or settled. The effect of a change in tax rates on deferred tax assets and
liabilities is recognized in income at the enactment date.
31
<PAGE> 32
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
Comprehensive Income
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income"
and SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information." SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components. The Company has no items of
comprehensive income and as a result SFAS. No. 130 has no impact on the
Company's financial reporting.
Earnings per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings per Share." SFAS No. 128 replaced the calculation of primary and
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented, and
where appropriate, restated to conform to SFAS No. 128 requirements.
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Numerator:
Net income before cumulative effect of accounting
change................................................ $3,179,539 $ 666,696 $1,035,260
Cumulative effect of accounting change................... 209,000 -- --
---------- ---------- ----------
Net income............................................... $3,388,539 $ 666,696 $1,035,260
========== ========== ==========
Denominator:
Denominator for basic earnings per share-weighted average
shares outstanding.................................... 4,430,183 754,131 70,000
Effect of dilutive securities:
Employee stock options................................... 115,008 187,267 273,165
Non-employee stock options............................... -- 202,580 240,069
Convertible preferred stock.............................. -- 931,196 1,097,973
Convertible note payable................................. -- 131,689 155,555
---------- ---------- ----------
Dilutive potential common shares........................... 115,008 1,452,732 1,766,762
Denominator for diluted earnings per share-adjusted
weighted average shares and assumed conversions....... 4,545,191 2,206,863 1,836,762
========== ========== ==========
Basic earnings per share:
Net income before cumulative effect of accounting
change................................................ $ .72 $ .88 $ 14.79
Cumulative effect of accounting change................... .04 -- --
---------- ---------- ----------
Net income............................................... $ .76 $ .88 $ 14.79
========== ========== ==========
Diluted earnings per share:
Net income before cumulative effect of accounting
change................................................ $ .70 $ .30 $ .56
Cumulative effect of accounting change................... .05 -- --
---------- ---------- ----------
Net income............................................... $ .75 $ .30 $ .56
========== ========== ==========
</TABLE>
The Company issued its underwriters warrants to purchase 260,000 shares of
its common stock at $12 per share in connection with its initial public
offering. These warrants were excluded from the compensation computation of
diluted net income per common share because they were anti-dilutive. The
warrants are exercisable through November 5, 2000.
32
<PAGE> 33
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
In 1998, the Company issued options to purchase 25,000 shares of common
stock at $10.25 per share under its Eligible Directors Option Plan. These
options were excluded from the compensation computation of diluted net income
per common share because they were anti-dilutive. The options are exercisable
through May 21, 2003.
Significant Customers
The following customers individually accounted for 10% or more of revenues:
<TABLE>
<CAPTION>
NUMBER
OF
SIGNIFICANT PERCENTAGE OF REVENUES BY
CUSTOMERS SIGNIFICANT CUSTOMERS
----------- -------------------------
<S> <C> <C>
YEAR ENDED DECEMBER 31:
1998......................................... 4 10%, 11%, 12% and 15%
1997......................................... 4 11%, 13%, 13% and 17%
10%, 10%, 15%, 21% and
1996......................................... 5 23%
</TABLE>
Segment Information
In 1998, the Company adopted SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information." SFAS No. 131 supersedes previous reporting
requirements for reporting on segments of a business enterprise. The Company's
operations are generally limited to the aircraft leasing industry. These
operations included the acquisition of used single-aisle jet aircraft and
engines for lease and sale to domestic and foreign airlines and other customers.
Revenues include rentals of flight equipment to foreign airlines of $19,824,984,
$9,407,081 and $6,605,700 in 1998, 1997 and 1996, respectively.
The following table sets forth the dollar amount and percentage of rentals
of flight equipment attributable to the indicated geographic areas for the years
indicated:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
United States and Canada........................ $11,624,832 $ 6,167,050 $ 6,075,500
Europe.......................................... 7,797,163 3,668,181 3,115,853
Central America................................. 2,112,000 2,112,000 2,112,000
Asia and the Pacific............................ 5,451,400 3,485,400 1,377,800
----------- ----------- -----------
$26,985,395 $15,432,631 $12,681,153
=========== =========== ===========
</TABLE>
(2) FLIGHT EQUIPMENT
The Company's investment in flight equipment (primarily purchased from
ILFC) as of December 31, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Flight equipment, at cost................................. $273,008,257 $197,908,257
Accumulated depreciation.................................. (36,099,484) (25,402,000)
------------ ------------
Flight equipment, net..................................... $236,908,773 $172,506,257
============ ============
</TABLE>
33
<PAGE> 34
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(3) INCOME TAXES
Provision for taxes on income consisted of the following:
<TABLE>
<CAPTION>
TOTAL CURRENT DEFERRED
---------- ------- ----------
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31:
1998:
Federal..................................... $1,184,560 $16,430 $1,168,130
State....................................... 357,346 10,400 346,946
---------- ------- ----------
$1,541,906 $26,830 $1,515,076
========== ======= ==========
1997:
Federal..................................... $ 423,800 $ -- $ 423,800
State....................................... 9,200 9,200 --
---------- ------- ----------
$ 433,000 $ 9,200 $ 423,800
========== ======= ==========
1996:
Federal..................................... $ 31,000 $ -- $ 31,000
State....................................... 6,000 6,000 --
---------- ------- ----------
$ 37,000 $ 6,000 $ 31,000
========== ======= ==========
</TABLE>
As of December 31, 1998, the Company had net operating loss carryforwards
("NOL") for Federal and state income tax purposes as follows:
<TABLE>
<CAPTION>
EXPIRES FEDERAL NOL STATE NOL
------- ----------- ----------
<S> <C> <C>
1999....................................................... -- $ 530,000
2000....................................................... -- 136,000
2001....................................................... -- 435,000
2002....................................................... -- 167,000
2003....................................................... -- 93,000
2004-2008.................................................. $ 9,663,000 --
2009-2013.................................................. 4,313,000 --
2014-2018.................................................. 5,003,000 --
----------- ----------
$18,979,000 $1,361,000
=========== ==========
</TABLE>
Temporary differences which give rise to net deferred tax liabilities
result primarily from timing differences for depreciation and net operating
losses. The net deferred tax liabilities are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Net operating loss carryforward......................... $ 6,453,075 $ 8,097,839
Deferred and advanced rent.............................. 1,085,933 1,205,850
Flight equipment, principally due to differences
in depreciation....................................... (10,103,117) (10,030,992)
Other................................................... 291,399 60,945
------------ ------------
(2,272,708) (666,358)
Valuation allowance..................................... (205,168) (157,442)
------------ ------------
$ (2,477,876) $ (823,800)
============ ============
</TABLE>
34
<PAGE> 35
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
Management believes it is more likely than not that the results of future
operations will generate sufficient taxable income to realize deferred tax
assets net of the valuation allowance.
A reconciliation of total income tax expense with the expected amount
computed by applying the Federal and state statutory tax rates to earnings
before income taxes and cumulative effect of accounting change follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
---------- -------- --------
<S> <C> <C> <C>
Computed "expected" Federal tax expense............... $1,605,291 $375,000 $364,000
State taxes, net of Federal income tax benefit........ 86,391 64,000 10,000
Expiration of state net operating loss
carryforwards....................................... 7,407 207,000 --
Change in valuation allowance......................... (47,726) (126,000) (361,000)
Other................................................. (109,457) (87,000) 24,000
---------- -------- --------
$1,541,906 $433,000 $ 37,000
========== ======== ========
</TABLE>
(4) LONG-TERM DEBT
Long-term debt as of December 31, 1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Note payable to bank, bearing interest at 7.275% on
$6,500,000 and LIBOR plus 1.125% (5.57% at December 31,
1998) on $400,433, secured by flight equipment, 33 1/3%
guaranteed by ILFC, payable in monthly installments of
$75,000 including interest, balloon payment of $6,690,834,
due August 1999........................................... $ 6,900,431 $ 7,299,812
Note payable to bank, refinanced June 1998, bearing interest
at 6.97% on $2,500,000 and LIBOR plus 1.125% (5.531% at
December 31, 1998) on $1,195,292, secured by flight
equipment, 33 1/3% guaranteed by ILFC, payable in monthly
installments of $87,000 including interest, balloon
payment of $3,296,031, due June 1999...................... 3,695,297 4,446,551
Notes payable to bank, refinanced August 1998, bearing
interest at 7.1% secured by flight equipment, 65%
guaranteed by ILFC, balloon payment of $1,740,120, due May
2003...................................................... 3,470,668 3,829,704
Notes payable to bank, refinanced August 1998, bearing
interest at 7%, secured by flight equipment, 50%
guaranteed by ILFC, balloon, payment of $1,557,246, due
April 2001................................................ 3,612,093 4,408,879
Note payable to bank bearing interest at 7.96%, secured by
flight equipment, 53.4% guaranteed by ILFC, balloon
payment of $14,998,420, due May 2000...................... 16,414,944 17,666,617
Note payable to bank, bearing interest at LIBOR plus 1.2%
(5.3125% at December 31, 1998), secured by flight
equipment, 100% guaranteed by ILFC, payable in quarterly
installments of $445,000 including interest, balloon
payment of $7,354,276, due January 2003................... 11,940,979 12,842,892
Note payable to bank, bearing interest at 7.75%, secured by
flight equipment, guaranteed up to $2,175,000 by ILFC,
payable in quarterly installments of $510,000 including
interest, balloon payment of $9,514,719, due May 2001..... 12,181,112 13,225,980
Note payable to bank repaid August 1998..................... -- 885,556
</TABLE>
35
<PAGE> 36
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Note payable to bank bearing interest at 7.6%, secured by
flight equipment, guaranteed up to $5,000,000 by ILFC,
payable in quarterly installments of $598,000 including
interest, balloon payment of $19,806,718, due May 2001.... 21,437,596 22,339,000
Note payable to bank bearing interest at 7.3%, secured by
flight equipment, guaranteed up to $6,000,000 by ILFC,
payable in monthly installments including interest of
$256,000 through April 1999, $259,000 through April 2000,
$263,000 through April 2001, $266,000 through April 2002,
and $270,000 thereafter, balloon payment of $22,536,481,
due May 2003.............................................. 28,154,495 29,000,000
Note payable to bank bearing interest at 6.7%, secured by
flight equipment, payable in monthly installments of
$180,000 including interest, balloon payment of
$10,026,502, due April 2002............................... 14,227,700 --
Note payable to bank bearing interest at 7.1%, secured by
flight equipment, payable in monthly installments of
$152,000 including interest, balloon payment of
$14,470,694, due November 2001............................ 16,500,000 --
Note payable to ILFC bearing interest at 7.25% payable in
quarterly installments of $10,000 through October 2000,
$12,000 through October 2001 and $13,000 through October
2002, balloon payment of $3,320,000, due January 2003..... 3,504,000 3,540,000
Note payable to ILFC, refinanced July 25, 1997, bearing
interest at 6.0%, secured by flight equipment, payable in
quarterly installments of $50,000, balloon payment of
$301,757, due May 2000.................................... 601,757 801,757
Note payable to ILFC bearing interest at 6.0%, payable in
monthly installments of $15,000 plus interest, balloon
payment of $511,845, due August 1999...................... 616,845 796,845
Note payable to ILFC bearing interest at 7.8%, payable in
quarterly installments of $110,000 including interest,
balloon payment of $3,718,293, due December 2000.......... 3,985,164 4,104,103
Note payable to ILFC bearing interest at an effective rate
of 6.7%, payable in monthly installments of $180,000,
including interest, balloon payment of $15,775,482, due
December 1999............................................. 16,734,673 17,743,401
Note payable to ILFC bearing interest at an effective rate
of 6.9%, payable in monthly installments of $20,000,
including interest, balloon payment of $1,394,891, due
September 2002............................................ 1,856,839 1,968,530
Note payable to ILFC bearing interest at an effective rate
of 6.93%, payable in monthly installments of $32,000,
including interest, balloon payment of $2,361,994, due May
2003...................................................... 3,177,146 3,329,500
Note payable to ILFC bearing interest at 7.25%, payable in
quarterly installments of $126,500, including interest,
balloon payment of $3,725,840, due May 2001............... 4,153,373 4,390,419
Note payable to ILFC bearing interest at 7%, payable in
monthly installments of $30,000, including interest,
balloon payment of $1,750,025, due May 2002............... 2,479,536 --
Note payable to ILFC bearing interest at 7%, payable in
monthly installments of $208,000, including interest,
balloon payment of $17,660,339, due April 1999............ 17,971,526 --
Note payable to ILFC bearing interest at 6%, payable in
monthly installments of $30,000, including interest,
balloon payment of $122,362, due December 2007............ 2,368,734 --
</TABLE>
36
<PAGE> 37
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Note payable to ILFC bearing interest at 6.15%, payable in
monthly installments of $92,000, including interest,
balloon payment of $7,253,151, due December 2003.......... 10,000,000 --
Note payable to Great Lakes Holdings (affiliated company),
refinanced December 31, 1998, bearing interest at 6.5%,
due March 1999............................................ 672,000 700,000
Notes payable to Great Lakes Holdings (affiliated company),
refinanced December 31, 1998, bearing interest at 6.5%,
due March 1999............................................ 1,345,000 1,400,000
------------ ------------
Total............................................. $208,001,908 $154,719,546
============ ============
</TABLE>
The terms of the Company's aircraft financing loans generally require a
substantial balloon payment at the end of the noncancellable portions of the
lease of the related aircraft, at which time the Company will be required to
re-lease the aircraft and renegotiate the balloon amount of the loan on a
long-term basis or obtain other long-term financing. Refinancing of the balloon
amount is dependent upon the Company re-leasing the related aircraft;
accordingly, the Company begins lease remarketing efforts well in advance of the
lease termination. Notes payable due within one year totaled $58,289,665 at
December 31, 1998, of which $45,979,203 represents balloon payments and
$12,310,462 represents installment payments due within one year. The Company
intends to refinance $45,467,358 and repay $511,845 of balloon payments in 1999.
During 1998, 1997 and 1996, the Company refinanced $29,725,000, $40,382,963 and
$31,337,500 of balloon payments, respectively.
Scheduled future repayments of notes payable subsequent to December 31,
1998 are as follows:
<TABLE>
<S> <C>
YEAR ENDING DECEMBER 31:
1999...................................... $ 58,289,665
2000...................................... 28,477,094
2001...................................... 56,216,978
2002...................................... 17,769,581
2003...................................... 46,138,271
Thereafter................................ 1,110,319
------------
$208,001,908
============
</TABLE>
Certain notes payable contain various financial covenants including
maintaining specified minimum tangible net worth and delivery of audited
financial statements. The Company was in compliance with these covenants at
December 31, 1998.
From time to time, the Company enters into interest rate swaps with
financial institutions under terms that provide payment of interest on the
notional amount of the swap. In accordance with these arrangement, the Company
pays interest at a fixed rate and the financial institution pays interest at
variable rates pursuant to terms of the loans. The Company had no swap
agreements at December 31, 1998. The following table presents the Company's
interest rate swap agreements at December 31, 1997:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
TYPE NOTIONAL AMOUNT INTEREST RATE(%) MATURITY
---- --------------- ---------------- --------
<S> <C> <C> <C>
Fixed/variable............................. $3,829,000 7.60/7.20 5/98
</TABLE>
The net effect of swaps was to record $6,000, $109,000 and $265,000 of
additional interest expense during 1998, 1997 and 1996, respectively.
37
<PAGE> 38
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(5) RELATED PARTY TRANSACTIONS
During 1998 and 1997, the Company purchased aircraft from ILFC aggregating
$75,100,000 and $89,090,000, respectively. No aircraft were purchased in 1996.
At December 31, 1998 and 1997, 91% and 88%, respectively, of the Company's gross
fleet cost was comprised of aircraft acquired from ILFC. The Company financed
these acquisitions through bank loans, partially guaranteed by ILFC, as well as
loans from ILFC (note 4). ILFC provides these guarantees to lenders through an
AVG. ILFC's financial support has allowed the Company to finance aircraft
purchases at more favorable leverage than the Company could otherwise obtain.
The Company's typical operating lease transaction with an AVG requires a cash
investment by the Company of approximately 5% to 15% of the aircraft purchase
price while the industry standard ranges from 20% to 30%. At December 31, 1998
and 1997, $39,219,482 or 19% and $44,067,000 or 28%, of long-term debt was
covered by AVGs and $67,450,465, or 32%, and $36,674,555, or 24%, was due to
ILFC, respectively.
During 1996, the Company sold certain aircraft equipment in connection with
an ILFC transaction to a third party. The Company recognized a gain on sale of
this equipment of $141,000.
The Company had one aircraft leased to ILFC which is subleased to an
airline at December 31, 1998 and 1997. The Company recognized rental income of
$960,000 from this lease in each of the years ended 1998, 1997 and 1996. The
lease expires in August 2001.
During 1998 and 1997, the Company leased an aircraft to a third party for a
three-year period for which ILFC guaranteed certain rental revenue. In
connection with the lease, ILFC also guaranteed repayment of the related lease
deposit to the lessee of $1,632,000 included in the accompanying consolidated
balance sheet. During 1998, the Company purchased an aircraft from ILFC for
which ILFC guaranteed certain rental revenue.
The Company has an agreement with ILFC related to the December 1995
purchase of an aircraft which provides for recovery of an operating loss, as
defined, in the acquired lease. The Company estimates this loss will be incurred
through 1999. Accordingly, the Company reduced the purchase price of the related
aircraft and recognized a receivable for the present value of the estimated
recovery aggregating $579,000. The amount due from ILFC at December 31, 1998 and
1997 was $61,600 and $238,000, respectively. The loss stems from a stated lease
rate which was less than the market lease rate at the date of acquisition.
Accordingly, the Company allocated additional cost to the purchase price and
recognized deferred rent aggregating $1,747,000 for the present value of the
difference between the market and stated rent. Deferred rent will be amortized
on the straight-line method over the remaining lease term. At December 31, 1998
and 1997, deferred rent from the lease was $1,008,000 and $1,247,000,
respectively.
The Company realized consulting fee revenues of $25,000 and $78,000 during
the years 1997 and 1996, respectively, for services to ILFC. The Company's
Chairman and President collectively own Great Lakes Holdings (GLH), an
affiliated company. From time to time, these officers provide consulting
services to GLH. GLH paid the Company $12,000 during 1997 from Great Lakes. The
Company earned $190,000 of consulting fees in 1996 for providing services in
connection with a sale by ILFC of aircraft equipment to a third party .
38
<PAGE> 39
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(6) RENTAL INCOME
Minimum future rental income on noncancelable operating leases of flight
equipment at December 31, 1998 is as follows:
<TABLE>
<S> <C>
YEAR ENDING DECEMBER 31:
1999............................................... $29,139,000
2000............................................... 24,813,000
2001............................................... 18,015,000
2002............................................... 10,580,000
2003............................................... 4,267,000
Thereafter......................................... 2,507,000
-----------
$89,321,000
===========
</TABLE>
The Company's aircraft are leased under short-term to medium-term leases
with remaining terms expiring within one to six years.
(7) COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases offices from a third party under a noncancelable
operating lease. Future minimum lease payments are:
<TABLE>
<S> <C>
YEAR ENDING DECEMBER 31:
1999......................................... $ 36,667
2000......................................... 59,083
2001......................................... 59,966
2002......................................... 62,688
2003......................................... 64,928
Thereafter................................... 27,220
--------
$310,552
========
</TABLE>
Total rent expense under operating leases for the years ended December 31,
1998, 1997 and 1996 was $33,107, $27,285 and $20,460, respectively.
GOVERNMENT REGULATIONS
The maintenance and operation of aircraft are regulated by the Federal
Aviation Administration (FAA) and foreign aviation authorities which oversee
such matters as aircraft certification, inspection, maintenance, certification
of personnel, and record-keeping. All current leases require the lessee to bear
the costs of complying with governmental regulations. However, in the event a
lessee fails to maintain aircraft in accordance with the terms of a lease, the
Company could be required to repair or recondition the aircraft. Failure of a
lessee to fulfill lease maintenance and operation obligations could have a
material adverse effect on the Company's financial condition and results of
operations.
The FAA and civil aviation authorities of most countries and international
entities issue regulations limiting permitted noise and other emissions from
aircraft. Older non-complying aircraft can be brought into compliance by
modifying the engines. One of the Company's aircraft had noise compliance work
performed at a cost of approximately $2.4 million during 1994 (all of which was
paid by the Company). One of the
39
<PAGE> 40
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
Company's aircraft will be modified to meet noise compliance regulations as a
condition of an existing lease at the lessee's expense. At December 31, 1998,
two of the Company's aircraft were on lease to airlines which operate in
jurisdictions which do not require these modifications. These two aircraft may
require this work to be performed after their leases expire unless the aircraft
are re-leased and operated in an area that does not require the modification.
(8) SHAREHOLDERS' EQUITY
In September 1998, the Company's Board of Directors authorized the
repurchase of up to 449,758 shares of the Company's common stock. During 1998,
the Company repurchased 281,300 shares of its common stock.
In November 1997, the Company issued 2.6 million shares of common stock in
an initial public offering (IPO) at $10.00 per share. In connection with the
IPO, the Company effected a 1-for-4.5 reverse stock split of its common stock
which has been applied retroactively in the accompanying consolidated financial
statements. In accordance with the underwriting agreement, the Company granted
the underwiters warrants to purchase 260,000 shares of common stock at $12 per
share exercisable through November 5, 2000 and an overallotment option
exercisable through December 20, 1997 to purchase 390,000 additional shares of
common stock of which 80,000 shares were exercised. After underwriting discount
and other offering costs, net proceeds to the Company were $23,942,094 for these
issuances. Concurrent with the Company's IPO, all of the outstanding convertible
preferred stock was converted to 1,103,528 shares of common stock.
Through March 1993, the Company granted options to purchase 647,493 shares
of common stock at management's estimated fair value, $4.50 per share. During
1997, 139,717 options were exercised. Through May 1991, the Company also granted
options to purchase 348,784 shares of convertible preferred stock at
management's estimate of fair value, primarily $5.18 per share. Concurrent with
the Company's IPO, all of these options were exercised and converted to common
stock.
During March 1997, the Company extended the expiration date on 496,664
employee stock options described in the preceding paragraph to March 31, 2007,
which vest 25% in 1997 and 25% in each of the following three years.
Accordingly, the Company will recognize aggregate compensation expense of
approximately $1 million for the difference between the value of the options on
the extension date and the exercise price. The Company recognized $250,000 in
stock compensation during the years ended December 31, 1998 and 1997 related to
the amortization of such cost. If the related employee is terminated, the
respective stock options will vest in full. At December 31, 1998, 485,554
options with an exercise price of $4.50 per share were outstanding and 242,777
were exercisable.
During 1997, the Company adopted the 1997 Employee Stock Option and Award
Plan (the Employee Plan). A maximum of 50,000 shares of common stock (subject to
certain anti-dilutive adjustments) may be issued pursuant to grants and awards
under the Employee Plan. The maximum number of shares that may be subject to
qualifying share-based awards, either individually or in aggregate, that can be
granted under the Employee Plan to any one participant during any calendar year
will not exceed 20,000 (subject to certain anti-dilutive adjustments). During
1998, options to purchase 5,000 shares of the Company's common stock at $5.875
per share had been granted under the Employee Plan. The options are fully vested
at December 31, 1998 and expire December 31, 2003.
During 1997, the Company adopted the 1997 Eligible Directors Stock Option
Plan (the Directors Plan). The Directors Plan provides that annually an Eligible
Director will receive an option to purchase 5,000 shares of common stock at an
exercise price equal to the market price of common stock on the date of grant.
Under the Directors Plan 50,000 shares of common stock are authorized for
issuance. During 1998, options to
40
<PAGE> 41
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
purchase 25,000 shares of the Company's common stock at $10.25 per share had
been granted under the Directors Plan. The options vest through May 21, 2001 and
expire May 21, 2003.
Changes in outstanding options under the Company's stock option plans
during the three years ended December 31, 1998 and options exercisable at
December 31 1998 are as follows:
<TABLE>
<S> <C>
Outstanding at December 31, 1995............................ 974,055
Granted................................................... --
Exercised................................................. --
Canceled or expired....................................... --
--------
Outstanding at December 31, 1996............................ 974,055
Granted at $4.50.......................................... 496,664
Exercised at $4.50 to $5.175.............................. (488,501)
Canceled or expired....................................... (496,664)
--------
Outstanding at December 31, 1997............................ 485,554
Granted at $5.875 to $10.25............................... 30,000
Exercised................................................. --
Canceled or expired....................................... --
--------
Outstanding at December 31, 1998............................ 515,554
========
Exercisable at December 31, 1998............................ 252,891
========
</TABLE>
In November 1997, the convertible note payable was converted to 155,555
shares of common stock.
41
<PAGE> 42
INTERNATIONAL AIRCRAFT INVESTORS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(9) QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
---------- ---------- ------------ -----------
<S> <C> <C> <C> <C>
1998:
Revenues....................................... $6,571,968 $6,610,272 $7,307,570 $8,828,065
Expenses....................................... 5,641,801 5,621,080 6,222,143 7,111,406
---------- ---------- ---------- ----------
Income before income taxes and cumulative
effect of accounting change.................. 930,167 989,192 1,085,427 1,716,659
Income taxes................................... 373,000 397,200 434,000 337,706
---------- ---------- ---------- ----------
Income before cumulative effect of accounting
change....................................... 557,167 591,992 651,427 1,378,953
Cumulative effect of accounting change......... 209,000 -- -- --
---------- ---------- ---------- ----------
Net income................................... $ 766,167 $ 591,992 $ 651,427 $1,378,953
========== ========== ========== ==========
Basic earnings per share:*
Income before cumulative effect of accounting
change.................................... $ .12 $ .13 $ .15 $ .33
Cumulative effect of accounting change....... .05 -- -- --
---------- ---------- ---------- ----------
Net income................................... $ .17 $ .13 $ .15 $ .33
========== ========== ========== ==========
Diluted earnings per share*
Income before cumulative effect of accounting
change.................................... $ .12 $ .13 $ .14 $ .32
Cumulative effect of accounting change....... .05 -- -- --
---------- ---------- ---------- ----------
Net income................................... $ .17 $ .13 $ .14 $ .32
========== ========== ========== ==========
Weighted average number of common shares
outstanding.................................. 4,497,584 4,497,584 4,486,497 4,241,266
Weighted average number of common shares
outstanding-assuming dilution................ 4,627,244 4,679,055 4,634,132 4,287,125
1997:
Revenues....................................... $3,216,574 $3,373,182 $4,151,184 $5,386,533
Expenses....................................... 3,018,416 3,152,153 3,984,587 4,872,621
---------- ---------- ---------- ----------
Income before income taxes..................... 198,158 221,029 166,597 513,912
Income taxes................................... 72,000 88,000 66,600 206,400
---------- ---------- ---------- ----------
Net income..................................... $ 126,158 $ 133,029 $ 99,997 $ 307,512
========== ========== ========== ==========
Basic earnings per share *..................... $ 1.80 $ 1.90 $ 1.23 $ .11
========== ========== ========== ==========
Diluted earnings per share*.................... $ .07 $ .08 $ .06 $ .09
========== ========== ========== ==========
Weighted average number of common shares
outstanding.................................. 70,000 70,000 81,110 2,773,104
Weighted average number of common shares
outstanding-assuming dilution................ 1,780,470 1,720,470 1,755,512 3,509,838
</TABLE>
- ---------------
* Per share data may not always add up to the total for the year since each
figure is independently calculated.
42
<PAGE> 43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INTERNATIONAL AIRCRAFT INVESTORS
Date: March 29, 1999 By: /s/ MICHAEL P. GRELLA
------------------------------------
Michael P. Grella
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ WILLIAM E. LINDSEY Chairman of the Board, Chief March 29, 1999
- ----------------------------------------------------- Executive Officer and Director
William E. Lindsey (Principal Executive Officer)
/s/ MICHAEL P. GRELLA President, Chief Operating March 29, 1999
- ----------------------------------------------------- Officer and Director
Michael P. Grella (Principal Operating Officer)
/s/ RICK O. HAMMOND Vice President -- Finance, March 29, 1999
- ----------------------------------------------------- Chief Financial Officer
Rick O. Hammond (Principal Financial Officer)
/s/ ALAN G. STANFORD, JR. Vice President -- Controller March 29, 1999
- ----------------------------------------------------- (Principal Accounting Officer)
Alan G. Stanford, Jr.
/s/ MAGNUS GUNNARSSON Director March 29, 1999
- -----------------------------------------------------
Magnus Gunnarsson
/s/ RALPH O. HELLMOLD Director March 29, 1999
- -----------------------------------------------------
Ralph O. Hellmold
/s/ AARON MENDELSOHN Director March 29, 1999
- -----------------------------------------------------
Aaron Mendelsohn
/s/ CHRISTER SALEN Director March 29, 1999
- -----------------------------------------------------
Christer Salen
/s/ KENNETH TAYLOR Director March 29, 1999
- -----------------------------------------------------
Kenneth Taylor
/s/ STUART M. WARREN Director March 29, 1999
- -----------------------------------------------------
Stuart M. Warren
</TABLE>
43
<PAGE> 1
EXHIBIT 23.1
ACCOUNTANTS' CONSENT
Board of Directors
International Aircraft Investors:
We consent to incorporation by reference in the registration statements
(No. 333-46411 and 333-46413) on Form S-8 of International Aircraft Investors
and subsidiaries of our report dated January 19, 1999 relating to the
consolidated balance sheets of International Aircraft Investors and subsidiaries
as of December 31, 1998 and 1997 and the related consolidated statements of
earnings, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1998, which report appears in the 1998
report on Form 10-K of International Aircraft Investors and subsidiaries.
KPMG LLP
Los Angeles, California
March 26, 1999
44
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 15,923,982
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 273,008,257
<DEPRECIATION> 36,099,484
<TOTAL-ASSETS> 267,891,016
<CURRENT-LIABILITIES> 0
<BONDS> 208,001,908
0
0
<COMMON> 42,163
<OTHER-SE> 34,708,442
<TOTAL-LIABILITY-AND-EQUITY> 267,891,016
<SALES> 0
<TOTAL-REVENUES> 29,317,875
<CGS> 0
<TOTAL-COSTS> 12,476,684
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12,119,746
<INCOME-PRETAX> 4,721,445
<INCOME-TAX> 1,541,906
<INCOME-CONTINUING> 3,179,539
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 209,000
<NET-INCOME> 3,388,539
<EPS-PRIMARY> .76
<EPS-DILUTED> .75
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 23,838,306
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 197,908,257
<DEPRECIATION> 25,402,000
<TOTAL-ASSETS> 204,552,126
<CURRENT-LIABILITIES> 0
<BONDS> 154,719,546
0
0
<COMMON> 44,976
<OTHER-SE> 33,050,014
<TOTAL-LIABILITY-AND-EQUITY> 204,552,126
<SALES> 0
<TOTAL-REVENUES> 16,127,473
<CGS> 0
<TOTAL-COSTS> 7,547,287
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,480,490
<INCOME-PRETAX> 1,099,696
<INCOME-TAX> 433,000
<INCOME-CONTINUING> 666,696
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 666,696
<EPS-PRIMARY> .88
<EPS-DILUTED> .30
</TABLE>
