Form 10-K for AIR T INC
16-Jun-2008
Annual Report
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Overview
The Company operates in two business segments. The overnight air cargo segment, comprised of its Mountain Air Cargo, Inc. ("MAC") and CSA Air, Inc. ("CSA") subsidiaries, operates in the air express delivery services industry. The ground equipment segment, comprised of its Global Ground Support, LLC ("GGS") and Global Aviation Services, LLC ("GAS") subsidiaries, provides aviation ground support and other specialized equipment products and services to passenger and cargo airlines, airports, the military and industrial customers. Each business segment has separate management teams and infrastructures that offer different products and services.
Following is a table detailing revenues by segment and by major customer category:
Year ended March 31,
2008 2007
Overnight Air Cargo Segment:
FedEx $ 38,918 50 % $ 36,091 54 %
Other Maintenance 358 - - -
$ 39,276 50 % $ 36,091 54 %
Ground Equipment Segment:
Military 15,523 20 % 16,342 24 %
Commercial - Domestic 20,889 27 % 12,709 19 %
Commercial - International 2,711 3 % 2,161 3 %
39,123 50 % 31,212 46 %
$ 78,399 100 % $ 67,303 100 %
MAC and CSA are short-haul express airfreight carriers and provide air cargo services to one primary customer, FedEx Corporation ("FedEx"). MAC will also on occasion provide maintenance services to other airline customers and the military. Under the terms of dry-lease service agreements, which currently cover all of the 89 revenue aircraft, the Company receives a monthly administrative fee based on the number of aircraft operated and passes through to its customer certain cost components of its operations without markup. The cost of fuel, flight crews, landing fees, outside maintenance, parts and certain other direct operating costs are included in operating expenses and billed to the customer as cargo and maintenance revenue, at cost. Pursuant to such agreements, FedEx determines the type of aircraft and schedule of routes to be flown by MAC and CSA, with all other operational decisions made by the Company. These agreements are renewable on two to five-year terms and may be terminated by FedEx at any time upon 30 days' notice. The Company believes that the short term and other provisions of its agreements with FedEx are standard within the airfreight contract delivery service industry. FedEx has been a customer of the Company since 1980. Loss of its contracts with FedEx would have a material adverse effect on the Company.
MAC and CSA's combined revenues increased by $3,185,000 (9%) in fiscal 2008. The increase in revenues was primarily related to flight and maintenance department costs passed through to its customer at cost as well as increased maintenance labor revenue. The air cargo segment's operating income for fiscal 2008 was $2,599,000 compared to $1,717,000 in fiscal 2007, a 53% increase, largely a result of increased maintenance activity and rates.
GGS and GAS manufacture, service and support aircraft deicers and ground support equipment and other specialized industrial equipment on a worldwide basis. The combined GGS and GAS revenues increased by $7,911,000 (25%) in fiscal 2008. In fiscal 2008, GGS and GAS combined revenues were 50% of consolidated revenues compared to 46% in fiscal 2007. This percentage has increased significantly from 30% in fiscal 2003 and this trend shows the increasing significance of the ground equipment segment to the consolidated results of the Company. Revenues in 2008 were affected by a significant increase in the number of deicer units sold in fiscal 2008. The start up of GAS also contributed additional sales revenue of $2,800,000 in fiscal 2008. The ground segment operating income for fiscal 2008 was $5,063,000, a 12% increase over fiscal 2007 segment operating income of $4,506,000.
In June 1999, GGS was awarded a four-year contract to supply deicing equipment to the United States Air Force. In June 2003 GGS was awarded a three-year extension of that contract and a further three-year extension was awarded in June 2006. In fiscal 2008, revenues from sales to the Air Force were down by 5% and accounted for approximately 40% of the ground equipment segment's revenues (as compared to 52% in fiscal 2007).
The following table summarizes the changes and trends in the Company's operating expenses for continuing operations as a percentage of revenue:
Fiscal year ended March 31,
2008 2007
Operating revenue (in thousands) $ 78,399 $ 67,303
Expense as a percent of revenue:
Flight operations 24.42 % 26.55 %
Maintenance 17.99 19.10
Ground Equipment 37.56 33.43
General and Administrative 12.97 14.19
Depreciation and Amortization 0.60 0.99
Total Costs and Expenses 93.54 % 94.26 %
Fiscal 2008 vs. 2007
Consolidated revenue from operations increased $11,095,000 (17%) to $78,399,000 for the fiscal year ended March 31, 2008 compared to the prior fiscal year. The increase in 2008 revenue resulted from an increase in air cargo revenue of $3,184,000 (9%) to $39,276,000 in fiscal 2008, combined with an increase in ground equipment revenue of $7,911,000 (25%) to $39,123,000. The increase in air cargo revenue was primarily the result of an increase in flight and maintenance department costs passed through to its customer at cost as well as increased maintenance labor revenue. Maintenance labor revenue was up as a result of increased maintenance hours due to an increase in scheduled maintenance events in fiscal 2008. In addition, the Company received approval from its customer for an 8.5% increase in its maintenance billable labor rate in June 2007 and an additional 4% increase in January 2008. These rate increases are provided periodically, as a means to offset increases in maintenance operating costs. The increase in ground equipment revenue was the result of a significant increase in the number of commercial deicers sold in fiscal 2008 compared to 2007 (principally in domestic markets), as well as increased parts, service and training income. The start up of GAS also contributed additional revenue of $2,800,000 in fiscal 2008.
Operating expenses on a consolidated basis increased $9,901,000 (16%) to $73,345,000 for fiscal 2008 compared to fiscal 2007. The increase in air cargo operating expenses consisted of the following changes: cost of flight operations increased $1,277,000 (7%) primarily as a result of increased direct operating costs, including pilot salaries and related benefits, fuel, airport fees, and costs associated with pilot travel and decreased administrative staffing due to flight schedule changes. Aircraft maintenance expenses increased $1,247,000 (10%) primarily as a result of increases in maintenance costs that are passed through to the customer at cost, the cost of contract services, maintenance personnel, travel, and outside maintenance. Ground equipment costs increased $6,948,000 (31%), which included increased cost of parts and supplies and labor related to the increased customer orders and sales by GGS in fiscal 2008 as well as labor and parts costs attributable to GAS operations which began in fiscal 2008.
General and administrative expense increased $622,000 (7%) to $10,172,000 in fiscal 2008. The most significant portion of this increase was $536,000 of general and administrative expense associated with the start up of the new GAS operations, which began in September 2007. Profit sharing expense also increased by $130,000 in fiscal 2008 in connection with the higher profits generated by the Company. The Company incurred compensation expense related to stock options of $333,000 in fiscal 2008 and $305,000 in fiscal 2007 as a result of adopting SFAS 123(R) Share-Based Payment ("SFAS 123(R)") at the beginning of the fiscal 2007.
Operating income for the year ended March 31, 2008 was $5,054,000, a $1,195,000 (31%) improvement over fiscal 2007. The improvement came from both segments of our business as increased maintenance hours and rates increased our operating income in the air cargo segment and additional sales revenues increased our operating income in the ground equipment segment.
Non-operating income, net for the year ended March 31, 2008 was $123,000, a $79,000 (182%) increase over fiscal 2007. Interest expense decreased by $39,000 due to decreased borrowing levels. This was offset by a $35,000 decrease in investment income, due to decreased rates on investments. Fiscal 2008 also included a $110,000 gain on the sale of investments as the Company divested treasury investments in mutual funds in connection with structuring a more conservative treasury portfolio.
Income tax expense of $1,774,000 in fiscal 2008 represented an effective tax rate of 34.3%, which included the benefit of municipal bond income as well as the full impact of the U.S. production deduction authorized under tax law changes enacted in fiscal 2005. Income tax expense of $1,416,000 in fiscal 2007 represented an effective tax rate of 36.3%, which included similar tax benefits, although the U. S. production deduction was being phased in during that year and provided a lesser benefit.
Net earnings were $3,402,000 or $1.40 per diluted share for the year ended March 31, 2008, a 37% improvement over $2,486,000 or $0.94 per diluted share in fiscal 2007. Of this increase, $0.11 per diluted share is attributable to the decrease in the weighted average shares outstanding from fiscal 2007 to 2008 as a result of the $2,000,000 share repurchase program commenced in November 2006 and completed in August 2007.
Liquidity and Capital Resources
As of March 31, 2008, the Company's working capital amounted to $15,100,000, an increase of $2,370,000 compared to March 31, 2007. The increase resulted from the increased earnings in fiscal 2008. The Company has also experienced a significant increase in accounts receivable at March 31, 2008 as a result of negotiated payment terms with certain commercial customers.
In September 2007, the Company amended its $7,000,000 secured long-term revolving credit line to extend its expiration date to August 31, 2009. The revolving credit line contains customary events of default, a subjective acceleration clause and restrictive covenants that, among other matters, require the Company to maintain certain financial ratios. There is no requirement for the Company to maintain a lock-box arrangement under this agreement. As of March 31, 2008, the Company was in compliance with all of the restrictive covenants. The amount of credit available to the Company under the agreement at any given time is determined by an availability calculation, based on the eligible borrowing base, as defined in the credit agreement, which includes the Company's outstanding receivables, inventories and equipment, with certain exclusions. At March 31, 2008, $7,000,000 was available under the terms of the credit facility. The credit facility is secured by substantially all of the Company's assets. Amounts advanced under the credit facility bear interest at the 30-day "LIBOR" rate plus 137 basis points. The LIBOR rate at March 31, 2008 was 3.11%. At March 31, 2008 and 2007 there were no outstanding balances on the credit line.
The Company is exposed to changes in interest rates on its line of credit. Although the line had no outstanding balance at March 31, 2008 and 2007, the line of credit did have a weighted average balance outstanding of approximately $508,000 during the year ended March 31, 2008. If the LIBOR interest rate had been increased by one percentage point, based on the weighted average balance outstanding for the year, annual interest expense would have increased by approximately $5,000.
In March 2004, the Company utilized its revolving credit line to acquire a corporate aircraft for $975,000. In April 2004, the Company refinanced the aircraft under a secured 4.35% fixed rate five-year term loan, based on a ten-year amortization with a balloon payment at the end of the fifth year.
Following is a table of changes in cash flow for the respective years ended March 31, 2008 and 2007:
2008 2007
Net Cash Provided by Operating Activities $ 277,000 $ 2,463,000
Net Cash Used In Investing Activities (1,642,000 ) (198,000 )
Net Cash Used in Financing Activities (1,478,000 ) (2,072,000 )
Net (Decrease) Increase in Cash (2,844,000 ) 193,000
Cash provided by operating activities was $2,186,000 less for fiscal 2008 compared to fiscal 2007. Although earnings provided an increase of $916,000, this increase was offset by a significant increase in accounts receivable in fiscal 2008. Accounts receivable have increased at March 31, 2008 as a result of increased sales in the fourth quarter as well as negotiated payment terms with certain commercial customers. Cash used in investing activities for fiscal 2008 was approximately $1,444,000 more than fiscal 2007, due to increased capital expenditures in the current year largely due to the start-up of GAS as well as the purchase of short-term investments with available cash, offset partially by the sale of investments. Cash used by financing activities was $594,000 less in fiscal 2008 compared to fiscal 2007 principally due to less cash outlay under the stock repurchase plan. During the fiscal years ended March 31, 2008 and 2007 the Company repurchased shares of its common stock for $713,000 and $1,287,000, respectively.
There are currently no commitments for significant capital expenditures. The Company's Board of Directors, on August 7, 1997, adopted the policy to pay an annual cash dividend in the first quarter of each fiscal year, in an amount to be determined by the board. On May 20, 2008 the Company declared a $.30 per share cash dividend, to be paid on June 27, 2008 to shareholders of record June 6, 2008. On May 22, 2007 the Company declared a $.25 per share cash dividend, to be paid on June 29, 2007 to shareholders of record June 8, 2007.
Off-Balance Sheet Arrangements
The Company defines an off-balance sheet arrangement as any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a Company has (1) made guarantees, (2) a retained or a contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity, or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or that engages in leasing, hedging, or research and development arrangements with the Company. The Company is not currently engaged in the use of any of these arrangements.
Impact of Inflation
The Company believes that the recent increases in inflation have not had a material effect on its manufacturing operations, because increased costs to date have been passed on to its customers. Under the terms of its air cargo business contracts the major cost components of its operations, consisting principally of fuel, crew and other direct operating costs, and certain maintenance costs are reimbursed, without markup by its customer. Significant increases in inflation rates could, however, have a material impact on future revenue and operating income.
Seasonality
GGS's business has historically been seasonal. The Company has continued its efforts to reduce GGS's seasonal fluctuation in revenues and earnings by increasing military and international sales and broadening its product line to increase revenues and earnings throughout the year. In June 1999, GGS was awarded a four-year contract to supply deicing equipment to the United States Air Force, and GGS has been awarded two three-year extensions on the contract. Although sales remain somewhat seasonal, this diversification has lessened the seasonal impacts and allowed the Company to be more efficient in its planning and production. The air cargo segment of business is not susceptible to seasonal trends.
Critical Accounting Policies and Estimates
The Company's significant accounting policies are more fully described in Note 1 of Notes to the Consolidated Financial Statements in Item 8. The preparation of the Company's financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions to determine certain assets, liabilities, revenues and expenses. Management bases these estimates and assumptions upon the best information available at the time of the estimates or assumptions. The Company's estimates and assumptions could change materially as conditions within and beyond our control change. Accordingly, actual results could differ materially from estimates. The Company believes that the following are its most significant accounting policies:
Allowance for Doubtful Accounts. An allowance for doubtful accounts receivable in the amount of $268,000 and $413,000, respectively, in fiscal 2008 and 2007, was established based on management's estimates of the collectability of accounts receivable. The required allowance is determined using information such as customer credit history, industry information, credit reports, customer financial condition and the collectability of outstanding accounts receivables. The estimates can be affected by changes in the financial strength of the aviation industry, customer credit issues or general economic conditions.
Inventories. The Company's parts inventories are valued at the lower of cost or market. Provisions for excess and obsolete inventories in the amount of $908,000 and $664,000, respectively, in fiscal 2008 and 2007, are based on assessment of the marketability of slow-moving and obsolete inventories. Historical parts usage, current period sales, estimated future demand and anticipated transactions between willing buyers and sellers provide the basis for estimates. Estimates are subject to volatility and can be affected by reduced equipment utilization, existing supplies of used inventory available for sale, the retirement of aircraft or ground equipment and changes in the financial strength of the aviation industry.
Warranty reserves. The Company warranties its ground equipment products for up to a three-year period from date of sale. Product warranty reserves are recorded at time of sale based on the historical average warranty cost and are adjusted as actual warranty cost becomes known. As of March 31, 2008 and 2007, the Company's warranty reserve amounted to $144,000 and $196,000, respectively.
Deferred Taxes. Deferred tax assets and liabilities, net of valuation allowance in the amount of $20,000 and $62,000, respectively, in fiscal 2008 and 2007, reflect the likelihood of the recoverability of these assets. Company judgment of the recoverability of these assets is based primarily on estimates of current and expected future earnings and tax planning.
Stock Based Compensation. The Company adopted Statement of Financial Accounting Standards No. 123(R), Accounting for Stock-Based Compensation ("SFAS 123(R)") as of April 1, 2006, using the modified prospective method of adoption, which requires all share-based payments, including grants of stock options, to be recognized in the income statement as an operating expense, based on their fair values over the requisite service period. The compensation cost we record for these awards is based on their fair value on the date of grant. The Company continues to use the Black Scholes option-pricing model as its method for valuing stock options. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate and dividend yield.
Retirement Benefits Obligation. The Company currently determines the value of retirement benefits assets and liabilities on an actuarial basis using a 4.0% discount rate (reduced from 5.75% in the prior year). Values are affected by current independent indices, which estimate the expected return on insurance policies and the discount rates used. Changes in the discount rate used will affect the amount of pension liability as well as pension gain or loss recognized in other comprehensive income.
Revenue Recognition. Cargo revenue is recognized upon completion of contract terms and maintenance revenue is recognized when the service has been performed. Revenue from product sales is recognized when contract terms are completed and ownership has passed to the customer.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 establishes a framework for measuring fair value within generally accepted accounting principles, clarifies the definition of fair value within the framework, and expands disclosures about the use of fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, and is effective for the Company April 1, 2008. The Company does not expect the adoption of SFAS 157 to have a material effect on its consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Liabilities ("SFAS 159"). SFAS 159 is effective as of the beginning of the first fiscal year beginning after November 15, 2007, and is effective for the Company April 1, 2008. SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value that are not currently required to be measured at fair value. Accordingly, companies would then be required to report unrealized gains and losses on these items in earnings at each subsequent reporting date. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Company does not expect the adoption of SFAS 159 to have a material effect on its consolidated financial statements.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(revised 2007), Business Combinations ("SFAS 141R"). SFAS 141R will significantly change the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, acquisition costs and restructuring costs. In addition, under SFAS 141R, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income tax expense. SFAS 141R is effective for fiscal years beginning after December 15, 2008 (our 2010 fiscal year). This statement will impact the Company if we complete an acquisition after the effective date.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 ("SFAS 160"). SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method will significantly change the accounting for transactions with minority interest holders. SFAS 160 is effective for fiscal years beginning after December 15, 2008 (our 2010 fiscal year). This statement will not impact the Company's current financial statements.
Forward Looking Statements
Certain statements in this Report, including those contained in "Overview," are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the Company's financial condition, results of operations, plans, objectives, future performance and business. Forward-looking statements include those preceded by, followed by or that include the words "believes", "pending", "future", "expects," "anticipates," "estimates," "depends" or similar expressions. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated by such forward-looking statements, because of, among other things, potential risks and uncertainties, such as:
* Economic conditions in the Company's markets;
* The risk that contracts with FedEx could be terminated or that the U.S. Air Force will defer orders under its contract with GGS or that this contract will not be extended;
* The impact of any terrorist activities on United States soil or abroad;
* The Company's ability to manage its cost structure for operating expenses, or unanticipated capital requirements, and match them to shifting customer service requirements and production volume levels;
* The risk of injury or other damage arising from accidents involving the Company's air cargo operations, equipment sold by GGS or services provided by GGS or GAS;
* Market acceptance of the Company's new commercial and military equipment and services;
* Competition from other providers of similar equipment and services;
* Changes in government regulation and technology;
* Mild winter weather conditions reducing the demand for deicing equipment.
A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. We are under no obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.
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