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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ x ] Annual Report pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from ____________ TO _____________
COMMISSION FILE NUMBER: 0-29490
HAWKER PACIFIC AEROSPACE
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3528840
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11240 SHERMAN WAY, SUN VALLEY, CALIFORNIA 91352
(Address of principal executive offices) (Zip code)
(818) 765-6201
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(Title of each 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 that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K 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 this
Form 10-K. [X]
The aggregate market value of the registrant's common stock held by non-
affiliates of the registrant as of March 31, 1999, was approximately
$11,145,000. The number of shares of common stock outstanding on March 31, 1999,
was 5,822,222 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part I and Part II incorporate information by reference to certain portions of
registrant's Annual Report to Shareholders for the fiscal year ended December
31, 1998.
Part III incorporates information by reference to the registrant's definitive
Proxy Statement, to be filed with the Securities and Exchange Commission within
120 days after the close of the fiscal year.
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TABLE OF CONTENTS
Page
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PART I
Item 1 BUSINESS............................................................ 3
Item 2. PROPERTIES.......................................................... 15
Item 3. LEGAL PROCEEDINGS................................................... 15
Item 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS................................................. 15
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER mATTERS.................................. 15
Item 6. SELECTED FINANCIAL DATA............................................. 16
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................... 18
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK............................................... 24
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................... 24
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE........................... 24
PART III OMITTED - (INCORPORATED BY REFERENCE TO PROXY
STATEMENT TO BE FILED NO LATER THAN APRIL 30, 1999)................. 24
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K.......................................... 25
FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS....................................... 25
REPORT OF INDEPENDENT AUDITORS...................................... 28
CONSOLIDATED BALANCE SHEETS......................................... 29
CONSOLIDATED STATEMENTS OF OPERATIONS............................... 31
CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS' EQUITY................................................ 32
CONSOLIDATED STATEMENT OF CASH FLOWS................................ 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.......................... 35
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PART I
ITEM 1 - BUSINESS
General
Hawker Pacific Aerospace ("Hawker Pacific" or the "Company") repairs and
overhauls aircraft and helicopter landing gear, hydromechanical components and
wheels, brakes and braking system components for a diverse international
customer base, including commercial airlines, air cargo operators, domestic
government agencies, aircraft leasing companies, aircraft parts distributors and
original equipment manufacturers ("OEMs"). The Company is a certified Federal
Aviation Administration ("FAA") and Joint Airworthiness Authority ("JAA")
approved repair station, and has also been granted Parts Manufacturer Approvals
by the FAA.
In addition, the Company distributes, manufactures and sells new and
overhauled spare parts and components for both fixed wing aircraft and
helicopters. The Company has long-term service contracts with many customers,
including Federal Express Corporation ("Federal Express"), American Airlines,
Inc. ("American Airlines"), the United States Coast Guard, and US Airways, Inc.
("US Airways").
On February 4, 1998, the Company completed its acquisition (the "BA
Acquisition") of substantially all of the assets of the landing gear repair and
overhaul operations (the "BA Assets") of British Airways plc ("British
Airways"). The Company believes the BA Acquisition will provide it with a base
in the United Kingdom from which to significantly expand its international
repair and overhaul operations, and position itself to become a global leader in
its market.
The Company believes it is well situated to benefit from the following
aviation industry trends that are driving increased demand for third-party
repair, overhaul and spare parts inventory management services: (i) the increase
in worldwide air traffic associated with the addition of new aircraft and more
frequent use of existing aircraft; (ii) the outsourcing by aircraft operators of
services previously handled internally; (iii) the break-up of monopolistic
aircraft maintenance consortiums; and (iv) an increase in regulatory pressure
and customer emphasis on the traceability of aircraft parts and overhaul
processes.
The Company traces its origins back to a hydraulics company formed in 1958.
Hawker Pacific was first incorporated in 1980 in California as a distributor of
aircraft parts and certain other consumer products, and began providing aircraft
repair and overhaul services in 1987. In November 1996, BTR Dunlop, Inc. sold
all of the outstanding capital stock of the Company to certain of the Company's
current shareholders. See "Certain Relationships and Related Transactions".
Unless the context otherwise requires, all references herein to the "Company" or
"Hawker Pacific" shall also include Hawker Pacific Aerospace Limited, a wholly-
owned United Kingdom subsidiary formed in November 1997. The Company's principal
executive offices are located at 11240 Sherman Way, Sun Valley, California
91352, and its telephone number is (818) 765-6201.
Recent Developments
Initial Public Offering. On February 3, 1998, the Company completed an initial
public offering (the "Offering") of 2,766,667 shares of the Company's common
stock through several underwriters represented by EVEREN Securities, Inc. and
The Seidler Companies Incorporated. Of the 2,766,667 shares of common stock sold
in the Offering, 2,600,000 shares were sold by the Company and 166,667 shares
were sold by a principal shareholder of the Company. The principal shareholder
sold 415,000 additional shares of common stock pursuant to the exercise of an
over-allotment option granted to the underwriters by the principal shareholder.
The Registration Statement for the Offering (Registration No. 333-40295) was
declared effective by the Securities and Exchange Commission (the "SEC") on
January 29, 1998. The Company received net proceeds of approximately $18.1
million net of expenses of approximately $2.7 million. The Company used
approximately $9.2 million of the net proceeds to fund a portion of the purchase
price for the BA Assets and approximately $7.6 million to repay a portion of the
revolving and term debt previously outstanding under the Company's credit
facility. The Company used the remaining net proceeds for working capital and
general corporate purposes.
Acquisition of Certain Assets of British Airways. On February 4, 1998, the
Company completed the acquisition of certain assets ("BA Assets") of the British
Airways plc landing gear operation (the "BA Acquisition") for a purchase price
of approximately $19.5 million (including acquisition related expenses)
excluding a 747-400 landing gear rotable asset that was acquired during the
second quarter of fiscal 1998 for approximately $2.9 million. The BA assets
consisted of $1.9
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million of inventory, $4.0 million of machinery and equipment and $13.6 million
of landing gear rotable assets. As part of the BA Acquisition, the Company and
British Airways entered into a seven-year exclusive service agreement for the
Company to provide landing gear and related repair and overhaul services to
substantially all of the aircraft currently operated by British Airways.
Market and Industry Overview
The aviation aftermarket consists principally of the servicing and support of
commercial passenger and cargo aircraft. The Company provides aftermarket
landing gear repair and overhaul services and related spare parts to a variety
of customers in the aviation industry. In March 1997, Dillon Read & Co., Inc.
("Dillon Read") estimated the global aviation aftermarket to be $47 billion
annually and projected that it would grow to $60 billion by the year 2000.
Increased Aviation Activity. Boeing's 1998 Current Market Outlook (the "Boeing
Outlook") projects that global air travel will increase by 55% through the year
2007, with cargo traffic growth projected to increase by 69% through 2007.
Average passenger seat miles flown are also expected to increase significantly
over the next few years. Further, many new airlines are expected to commence
operations in the United States and abroad, especially in China and other Asian
nations where only a small percentage of the population has flown to date. In
order to accommodate growing demand, aircraft operators will be required to
increase the size of their aircraft fleets. The Boeing Outlook projects that the
global fleet of aircraft will grow from 12,300 aircraft at the end of 1997 to
17,700 aircraft in 2007, and 26,200 aircraft in 2017.
Increases in passenger travel, air cargo services and the number of aircraft
in service increase the demand for repair and overhaul services. In addition,
the Federal Aviation Administration (the "FAA") requires aircraft landing gear
to be overhauled every seven to ten years. As a result, the growth in the number
of aircraft over the past 15 years is expected to create increased demand for
landing gear repair and overhaul services, which will most likely continue as
the number of new aircraft in service grows. Further, because start-up airlines
generally do not invest in the infrastructure necessary to service their
aircraft, such airlines outsource all or most of their repair and overhaul
services.
Outsourcing of Repair and Overhaul Services. While the overall air
transportation industry has grown significantly over the past decade, commercial
airlines have not experienced consistent earnings growth over the same period.
As a result, many aircraft operators have recognized outsourcing as an
opportunity to reduce operating costs, working capital investment and turnaround
time. In March 1997, Dillon Read estimated the outsourced military and
government market to be $9 billion and the third party market to be $12 billion.
Outsourcing allows aircraft operators to benefit from the expertise of service
providers like Hawker Pacific who have developed specialized repair techniques
and achieved economies of scale unavailable to individual operators.
Additionally, outsourcing allows aircraft operators to limit their capital
investment in infrastructure and personnel by eliminating the need for the
equipment, sophisticated information systems technology and inventory required
to repair and overhaul landing gear and hydromechanical components. Dillon Read
also estimated in March 1997 that approximately 40%, 35% and 95%, respectively,
of commercial, military and general aviation functions are currently outsourced.
The increasing number of long-term service contracts during 1997 and 1998 from
airlines outsourcing their repair and overhaul services exemplifies this growing
trend. As aircraft operators continue to become more cost and value conscious,
the Company expects the trend toward outsourcing to continue.
Break-Up of Monopolistic Aircraft Maintenance Consortiums. Until recently,
European aircraft operators attempted to realize cost savings by forming repair
consortiums to provide maintenance, repair and overhaul services for their
aircraft. Within these repair consortiums, each member was responsible for
providing the consortium's other members with maintenance, repair and overhaul
services for certain specified aircraft components. Over time, these members
have begun subcontracting their maintenance, repair and overhaul services to
independent service providers through a competitive bidding process. The Company
believes that this trend will provide it with opportunities to expand its
European customer base.
Greater Emphasis on Traceability. As a result of concerns regarding unapproved
aircraft spare parts, regulatory authorities have focused on the level of
documentation which must be maintained on aircraft spare parts. Accordingly,
aircraft operators increasingly demand that third party service providers
provide complete traceability of all parts used in the repair and overhaul
process. The sophistication required to track the parts histories of an
inventory consisting of thousands of aircraft spare parts is considerable. For
example, overhaul of a 747 aircraft shipset requires the handling and tracking
of over 2,500 parts. This has required companies to invest heavily in
information systems technology. The
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Company has developed and maintains a proprietary management information system
that enables it to comply with its customer's contract specifications and
enables its customers to comply with governmental regulations concerning
traceability of spare parts. The Company's proprietary system is well-regarded
in the industry, and the Company considers it to be a competitive advantage.
Company Operations
Repair and Overhaul. The primary reasons for removing landing gear or
hydromechanical components from an aircraft for servicing are: (i) the number of
takeoffs and landings, or years since a landing gear's last overhaul, has
reached the `time between overhaul' limit, or (ii) the landing gear or
hydromechanical component has been damaged or is not performing optimally. The
cost of servicing landing gear or hydromechanical components that have been
removed varies depending upon the age and type of aircraft and the extent of
repairs required.
Each landing gear overhaul can involve numerous separate parts and work
orders. For example, the Boeing 737 nose landing gear calls for over 290 parts
and related work orders while the Boeing 747-200 nose gear calls for over 650
parts and related work orders. Generally, the Company performs these overhauls
in approximately four to eight weeks. Hydromechanical component overhauls can
involve 200 or more parts and over 25 separate work orders and are generally
performed in approximately two to four weeks. In order to achieve this
throughput, the Company must perform many parallel processes and integrate
numerous components just before final assembly. Completing this complex overhaul
work within the time constraints set by aircraft operators has led the Company
to develop a highly managed systems-driven process, which is facilitated by its
highly specialized management information system. See "Management Information
Systems and Quality Assurance" below. The stages of the overhaul process include
the following:
Disassembly, Cleaning and Inspection. Upon receiving a landing gear shipset or
a hydromechanical component, the Company's technicians disassemble the unit, a
process which requires special tooling and expertise. Each part is completely
cleaned to allow for comprehensive inspection, testing and evaluation of part
size, structural integrity and material tolerances.
The Company uses a detailed checklist and reporting procedure to create a work
order which documents the state of each part inspected, and indicates the extent
of repair or overhaul to be performed. Technicians tag all parts which need to
be replaced or reworked and electronically prepare bills of material and
requisitions to the Company's parts and production departments for inventory and
scheduling purposes. An internal sales order is created concurrently with the
work order for shipping, pricing, billing and delivery purposes. The Company
utilizes its management information system throughout this process to reduce the
amount of detailed inspection time required.
The disassembly and inspection process enables the Company to obtain detailed
information concerning which parts can be reused or repaired and which must be
replaced, as well as the approximate amount of labor needed to complete the job.
The Company's computer system identifies and tracks the parts and associated
work orders from each landing gear or hydromechanical component throughout the
overhaul process in order to maintain the integrity of the landing gear or
hydromechanical component being serviced. Shop travelers provide a complete,
detailed listing of all repair and overhaul work steps and processes. Once a
landing gear is disassembled, the individual parts are washed, visually
inspected for obvious damage and permanently identified using the internal work
order number assigned to that delivery order. Major and minor parts are then
processed for engineering evaluation and disposition of required repair work
steps.
Parts Rework, Replacement and Reassembly. The next phase of an overhaul
involves reworking existing parts to specifications set by the Company's
customers. This entails a combination of machining, plating, heat treatment,
metal reshaping, surface finishing and restoration of organic finish. At this
phase, each part is accompanied by the customized bar-coded traveler which
facilitates the computerized prioritization and tracking of a part through the
rework phase. Tight control is maintained over scheduling for each part,
enabling the Company to remain within its required turnaround time. The Company
performs the majority of the repair and overhaul procedures in its facilities
using proprietary or specialized repair techniques. In addition, the Company
utilizes in-house manufacturing capabilities to fabricate certain parts used in
the overhaul process that are otherwise difficult to obtain. If a part cannot be
reclaimed, the Company may install either a new part or a previously-reworked
part from inventory. The Company maintains an inventory of serviceable parts
that it has reworked for this purpose. Overhauling parts or using serviceable
parts from inventory in lieu of new parts generally lowers customer costs and
increases the Company's margins in comparison to an overhaul that consists of
exclusively new spare parts. In addition, these manufacturing and service
capabilities are integral to the Company's competitive position
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because they enable the Company to maintain or increase the quality of work
performed and reduce cost and turnaround time relative to its competitors.
Inspection and Shipping. After completing the rework phase of the
overhaul/repair process, each part is delivered to the assembly area where the
end unit is assembled, tested and final inspection is completed. Once the end
unit assembly has been accepted through final inspection it is moved to
shipping, where it is packaged and prepared for dispatch.
Pricing. The Company offers its customers different pricing arrangements for
its repair and overhaul services. Pricing generally depends on the volume and
complexity of the work performed, the kind and number of new or remanufactured
spare parts used in the repair or overhaul, and the required turnaround time.
For many of its customers, the Company exchanges a previously overhauled shipset
from its inventory for an as-removed shipset from the customer's aircraft. The
Company charges the customer a fixed overhaul fee, and upon completing the
overhaul of the as-removed shipset, the Company charges the customer an
additional fee for spare parts or extra services required to overhaul the
landing gear to the customer's specifications. The Company typically bills a
substantial portion of the repair and overhaul fee to the customer up-front upon
receiving its as-removed shipset and generally receives payment for this portion
of the overhaul fee before completing the overhaul.
With certain of its customers for whom the Company regularly provides parts
and services on entire fleets or large numbers of aircraft, the Company utilizes
a flat fee fixed price arrangement which it typically sets forth in long-term
service agreements. Pursuant to the Company's service agreements, the Company
performs repair and overhaul services on a scheduled or as-needed basis. Pricing
depends on the volume and type of aircraft landing gear or hydromechanical
component to be serviced and the required turnaround time. Under its long-term
service agreements, the Company is able to plan in advance for equipment and
inventory requirements and can achieve efficiencies in labor hours and materials
usage relative to the estimate on which the contract price was based.
Parts Distribution
General. Aircraft spare parts are classified within the industry as (i)
factory new, (ii) new surplus, (iii) overhauled, (iv) serviceable, and (v) as-
removed. A factory new or new surplus part is one that has never been installed
or used. Factory new parts are purchased from manufacturers or their authorized
distributors. New surplus parts are purchased from excess stock of airlines,
repair facilities or other distributors. An overhauled part has been
disassembled, inspected, repaired, reassembled and tested by a licensed repair
facility. An aircraft spare part is classified serviceable if it is repaired by
a licensed repair facility rather than completely disassembled as in an
overhaul. A part may also be classified serviceable if it is removed by the
operator from an aircraft or engine while operating under an approved
maintenance program and is functional and meets any manufacturer or time and
cycle restrictions applicable to the part. A factory new, new surplus,
overhauled or serviceable part designation indicates that the part can be
immediately utilized on an aircraft. A part in as-removed condition requires
functional testing, repair or overhaul by a licensed facility prior to being
returned to service in an aircraft.
Parts Sales. The Company sells factory new, FAA-approved parts manufactured
by approximately 80 OEMs, including Societe D'Application Des Machines Motrices
("SAMM"), Dunlop Equipment Division, Parker Hannifin Corporation ("Parker
Hannifin") and Messier-Bugatti and overhauled aircraft spare parts to a diverse
base of customers in the aviation industry. The Company believes that it
provides customers with value added parts distribution services by offering
immediate availability, broad product lines, technical assistance and additional
services.
Customers
Commercial. The Company serves a broad base of domestic and international
customers in the aviation industry. The Company's customers include British
Airways, Federal Express, American Airlines, Air France, EVA Airways, US
Airways, Continental Airlines and many other national and regional passenger and
cargo airlines. Approximately 80% of the Company's landing gear business is
derived from long-term contracts, generally of five to seven years in duration,
representing one overhaul cycle for a customer's fleet. The Company believes
that the long-term relationships it has developed with many of its customers
provide the Company with a stable and ongoing base of business, as well as a
source of new business opportunities.
Government Contracts. 1998 and 1997 sales to the United States government and
its agencies represented approximately 4.2% and 6.5%, respectively, of
consolidated revenue. The Company's largest government customer has been the
United States Coast Guard ("USCG"). The Company has an agreement with the USCG
to provide repair and overhaul services and spare parts on an as-needed, fixed
price basis for Dauphin II helicopters. The agreement is for a one-
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year term which the USCG may renew for additional one-year terms through the
year 2000. Because government sales are subject to competitive bidding and
government funding, there can be no assurance that such sales will continue at
previous levels. Although the Company's government contracts are subject to
termination at the election of the government, in the event of such a
termination the Company would be entitled to recover from the government all
allowable costs incurred by the Company through the date of termination.
Material Customers. Customers which have accounted for more than 10% of sales
during the last three years are: (i) in 1998, British Airways (22.3%) and
Federal Express (17.5%); (ii) in 1997, Federal Express (19.3%); and (iii) in
1996, Federal Express (18.4%) and the USCG (11.2%).
Management Information System And Quality Assurance
The Company utilizes its management information system to shorten turnaround
times for customer orders, increase output, improve inventory management and
reduce costs by eliminating duplication of work and reducing errors in ordering
of parts. The system consists of an automated inspection and routing system, a
material resources planning module, a bar-coded shop floor control module, an
inventory control and parts tracing module, a tooling calibration module and a
general accounting module.
The system enables the Company to shorten lead times, increase output and
improve inventory management by allowing the Company to manage and control the
process of detailed parts inspection, materials requisitioning and work order
scheduling and release. The system's database contains much of the information
required to perform landing gear inspection activities, including illustrated
parts catalogues, parts specifications and other technical data. This has
largely eliminated the need to update parts catalogues manually and allows an
inspector using a personal computer located at his workstation to (i) refer to
computer based parts manuals and catalogues to identify needed parts, (ii)
access inventory to check on the availability of needed parts, (iii) requisition
needed parts from inventory, and (iv) create and record an audit trail for all
inspected parts and processes. These features of the system have substantially
reduced total detailed inspection time required in the overhaul process.
Using the system, all materials utilized and labor performed in connection
with a work order are recorded using bar code scanners located throughout the
Company's facility. Work order travelers are generated upon commencement of a
repair or overhaul and accompany the separate parts of each landing gear or
hydromechanical component throughout the overhaul process. After each stage of
the process is completed, the employee who performed the work uses the bar code
system to record the date of completion, his or her employee identification
number, critical dimensions and the quantity processed, accepted or rejected.
For each repair or overhaul that it performs, the Company records: (i) all
essential operations and tests conducted; (ii) inspection data on all components
repaired, overhauled or exchanged for new components; and (iii) the sources of
all materials issued during the course of the work. This function allows the
Company to provide more accurate cost and timing estimates to customers,
facilitates faster and more accurate preparation of customer invoices and forms
the basis of the Company's comprehensive quality assurance program. In addition,
shoploading and material requisition personnel receive more accurate planning
data. Using the system, management can (i) plan for material requirements in
advance so that required materials for a specific unit are on hand in time to
facilitate on-time delivery, and (ii) optimize daily manpower and materials
utilization based upon sales forecasts and actual orders.
Equipment Maintenance and Tooling
The Company performs all of the maintenance and repair on the equipment used
in the repair and overhaul process. The Company's maintenance personnel perform
various regularly scheduled maintenance procedures on the Company's equipment on
a weekly, monthly and annual basis, and shift operators perform daily preventive
maintenance. Precision measurement accessories installed on certain machines,
which require periodic calibration, are maintained and serviced by approved
vendors and closely monitored by the Company.
The Company invests significant material and resources to design and construct
tooling and fixtures to support its current product line and improve the
efficiency of the repair and overhaul process. Manufacturer-designed tooling is
typically limited to specialized tools to aid in the disassembly, assembly and
testing of landing gear components, such as spanner wrenches and seal
installation tools. From time to time, the Company's employees may develop
modifications to existing tooling or ideas for new tooling and fixtures in order
to accomplish a specific machining or testing operation or to
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improve the performance of the overhaul process. Tooling and fixtures used in
machining and plating operations are conceived, designed and fabricated in-house
by the technical personnel involved in the Company's daily operations to improve
the labor efficiency of a process and reduce the cost of performing a repetitive
process. The Company believes that its ability to design and fabricate tooling
used in its operations allows it to maximize efficiencies and enables its
customers to realize cost savings and improved turnaround time.
Suppliers And Procurement Practices
The primary sources of parts and components for the Company's overhaul
operations and parts distribution business are domestic and foreign airlines,
OEMs and aircraft leasing companies. The supply of parts and components for the
Company's aftermarket sales is affected by the availability of excess
inventories that typically become available for purchase as a result of new
aircraft purchases by commercial airlines. These new aircraft purchases reduce
the airline's need for spares supporting the aircraft that have been replaced.
Aftermarket supply is also affected by the availability of new parts from OEMs
and the availability of older, surplus aircraft that can be purchased for the
value of the major parts and components.
Although the Company does not have fixed agreements with the majority of its
suppliers, it has frequently been able to obtain price discounts from suppliers
because of the volume and regularity of its purchases. The Company has ten-year
agreements with Dunlop Limited, Aviation Division and Dunlop Equipment Division
(collectively, "Dunlop") that enable it to purchase Dunlop parts at a discount
from list price for resale and for use in the repair and overhaul of a variety
of fixed wing aircraft and helicopters. Dunlop has been the largest single
supplier of materials to the Company in 1997 and 1998.
The Company also has agreements with Messier-Bugatti, SAMM and Eurocopter
France that enable the Company to purchase new aircraft parts at discounts from
list price. Although the Company does not have agreements with many of its
suppliers, and competes with other parts distributors for production capacity,
the Company believes that its sources of supply and its relationships with its
suppliers are satisfactory.
The Company has developed procurement practices to ensure that all supplies
received conform to contract specifications. For cost, quality control and
efficiency reasons, the Company generally purchases supplies only from vendors
with whom the Company has an on-going relationship and/or whom the Company's
customers have previously approved. The Company has qualified second sources or
has identified alternate sources for all of its supplies. The Company chooses
its vendors primarily on the quality of the parts supplied and the vendor's
record for on-time performance. The Company regularly evaluates and audits the
performance of its approved vendors. Repeated failure to comply with the
Company's quality and delivery requirements may cause the Company to remove a
vendor from its approved vendor list.
Sales And Marketing
The Company's sales and marketing strategy targets commercial and government
customers with large fleets of aircraft that require regular repair and overhaul
of landing gear parts and components. In recent years, the Company has
significantly expanded its direct sales efforts, with the dual goals of
increasing sales from the Company's existing customer base as well as attracting
new customers. In particular, the Company focuses its sales efforts on
encouraging its existing and prospective customers to enter into long-term
agreements with the Company for the repair and overhaul of landing gear on all
aircraft within a fleet, or alternatively, to engage the Company to perform
repair and overhaul services on several aircraft at one time. In its sales and
marketing efforts, the Company emphasizes its competitive strengths, including
its superior quality of service, competitive pricing, rapid turnaround time and
extensive industry experience.
The Company markets and sells its products and services worldwide both
directly through an in-house sales staff and indirectly through a network of
independent sales representatives. Air Resources, Inc., an aviation sales
representative agency ("Air Resources"), markets and sells the Company's
products and services to a number of domestic airlines in return for a
commission on sales made through Air Resources' efforts. The Company's domestic
sales are conducted primarily by Air Resources, which focuses its efforts on
major domestic commercial carriers, as well as the Company's in-house sales
force.
The Company conducts its international sales and marketing through a number of
independent agencies based worldwide in such countries as France, Sweden, Mexico
and India. Additionally, senior management plays an active role in marketing the
Company's product lines. The Company's president and chief executive officer,
Dave Lokken, oversees all sales
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activities. Brian Carr, managing director of Sun Valley operations, supervises
landing gear sales, and Michael Riley, vice president of the hydromechanical
business unit, supervises hydromechanical component sales. The Company's sales
staff works closely with engineering and customer support personnel to provide
cost effective solutions to maintaining landing gear and hydromechanical
systems, stressing the Company's repair and overhaul engineering expertise,
turnaround times and component overhauling capabilities.
In addition, the Company actively participates in many of the major aviation
industry gatherings and air shows and hosts groups of aircraft operators at
technical and other meetings. In certain instances, the Company bids on
government contracts through its government contracts department, which
coordinates with the Company's sales and marketing team.
Growth Strategy
Pursue Additional International Growth Opportunities. The Company believes
that the international aviation aftermarket presents the greatest potential for
substantial growth. With the large air transport repair and overhaul operations
that it has established through the recent BA Acquisition, and the
hydromechanical repair and overhaul services that it performs from its
Netherlands facility, the Company believes it will be able to provide customers
with a full range of repair and overhaul services in Europe. In addition, the
Company believes that the break-up of aircraft maintenance consortiums will
create opportunities for the Company to expand its European, Middle Eastern and
Asian customer bases. With facilities located in the United Kingdom and
California, the Company believes that it is geographically positioned to pursue
additional growth opportunities in both the European and Asian aviation
aftermarkets.
Focus on Long-Term Service Agreements. Through increased sales and marketing
efforts, the Company is actively seeking to enter into long-term service
agreements with its existing and potential customers to provide its services for
all of their respective aircraft. A recent example of the Company's success in
this area includes the Company's five-year service agreement with EVA Airways,
based in Taiwan, Republic of China. The Company had previously entered into a
contract to provide overhaul services for all of EVA's B767 aircraft. Based on
the Company's performance in servicing this fleet, EVA recently awarded the
Company another contract for its entire fleet of B747-400's. The Company
believes that long-term service agreements provide it with a more predictable
and consistent flow of business. Approximately 80% of the Company's landing gear
business, and approximately 64% of the Company's consolidated revenue, are
currently derived from long-term service contracts.
Expand Existing Operations. Hawker Pacific seeks to increase sales and
operating income by marketing its landing gear repair and overhaul services to
new and existing customers, and by expanding its hydromechanical component
product lines. The Boeing Outlook projects that the global fleet of aircraft
will grow from 12,300 aircraft at the end of 1997 to 17,700 aircraft in 2007,
and 26,200 aircraft in 2017. The Company plans to expand its landing gear repair
and overhaul operations to capitalize on this growth trend. Because the Company
believes that improved profit margins in fixed wing operations are primarily a
function of increased volume, it plans to expand its capacity to perform fixed
wing landing gear repair and overhaul services. The Company also intends to
expand its hydromechanical component service offerings. The Company recently
began to offer repair and overhaul of constant speed drive-integrated drive
generators.
Accelerate Growth through Acquisition. At such times as its financial
condition and resources permit, the Company will pursue strategically located
companies with technology, equipment and inventory that complement or expand the
Company's existing operations and that may enable it to expand into new
geographic or product markets. In particular, the Company seeks to acquire
companies that will enable it to expand its international operations or
horizontally increase its product offerings within the aviation repair and
maintenance industry.
Competition
Numerous companies compete with Hawker Pacific in the aviation services
industry. The Company primarily competes with various repair and overhaul
organizations, which include the service arms of OEMs, the maintenance
departments or divisions of large air carriers (some of which also offer
maintenance services to third parties) and independent organizations such as the
Aerospace Division of B.F. Goodrich Company, the Landing Gear Division of AAR
Corporation ("AAR"), Revima, a company organized and operating under the laws of
France, and Dowty Aerospace Aviation Services. The Company's major competitors
in its hydromechanical components business include AAR and OEMs such as
Sunstrand, Aeroquip Vickers, Inc., Parker-Hannifin Corporation, Messier-Bugatti
and Lucas.
-9-
Government Regulation
The Company is highly regulated worldwide by the FAA, the JAA (a consortium of
European regulatory authorities), and various other foreign regulatory
authorities, including the Dutch Air Agency, which regulates the Company's
Netherlands' operations, and the Civil Aviation Authority, which regulates the
Company's United Kingdom operations. These regulatory authorities require all
aircraft to be maintained under continuous condition monitoring programs and
periodically to undergo thorough inspection. In addition, all parts must be
certified by the FAA and equivalent regulatory agencies in foreign countries and
conformed to regulatory standards before installation on an aircraft.
The Company is a certified FAA and JAA approved repair station, and has been
granted Parts Manufacturer Approvals by the FAA Manufacturing Inspectors
District Office. In addition, the Company's operations are regularly audited and
accredited by the Coordinating Agency for Supplier Evaluation, formed by
commercial airlines to approve FAA approved repair stations and aviation parts
suppliers.
Environmental Matters and Proceedings
The Company's operations are subject to extensive and frequently changing
federal, state and local environmental laws and substantial related regulation
by government agencies, including the United States Environmental Protection
Agency (the "EPA"), the California Environmental Protection Agency, and the
United States Occupational Safety and Health Administration. Among other
matters, these regulatory authorities impose requirements that regulate the
operation, handling, transportation and disposal of hazardous materials
generated by the Company during the normal course of its operations, govern the
health and safety of the Company's employees and require the Company to obtain
and maintain permits in connection with its operations. See "Risk Factors--
Environmental Regulations".
Environmental Proceedings. In October 1993, the United States of America and
the State of California each filed lawsuits in the United States District Court
for the Central District of California, against the Company and the owners (the
"Owners") of one of the Company's facilities (the "Site"). The lawsuits (the
"SFVB Actions") alleged that the groundwater in the San Fernando Valley Basin
("SFVB") had been contaminated with volatile organic compounds and other
hazardous substances released from the Site, requiring costly investigation,
evaluation and remediation efforts for which the Company and the Owners were
liable. In February and June 1997, the Company entered into settlements with the
United States of America and State of California pursuant to which the Company
paid the EPA $382,500 and the State of California $40,950, respectively. The
Company believes that it will not be liable to the United States government or
the State of California for any future costs related to this matter, and the
California Regional Water Quality Control Board recently notified the Company of
its conclusion that soil contamination at the Site does not represent a
significant threat to groundwater quality. BTR Dunlop, Inc., the former owner of
the Company ("BTR"), has agreed to indemnify the Company against any future
amounts for which the Company may be responsible in connection with the SFVB
Actions. See "Certain Transactions--Acquisition of the Company from BTR."
From August 1997 through December 1998, several lawsuits were filed by various
individuals against Lockheed Martin Corporation and various other parties,
including the Company, in the Los Angeles Superior Court pleading various causes
of action in connection with certain alleged injuries caused by toxic and
carcinogenic chemicals allegedly released by the defendants in the Burbank and
Glendale areas of Los Angeles County, California. The individual plaintiffs seek
unspecified compensatory and punitive damages. The Company does not believe that
it caused the release of toxic and carcinogenic chemicals alleged in the
complaints and believes that it is entitled to indemnification from BTR in the
event it is held responsible for any damages in these lawsuits. The Company
recently reached agreement to settle all liability associated with said lawsuits
for a nominal payment. The settlement documents are in the process of being
finalized.
Employees and Employee Training
As of March 31, 1999, the Company had 453 full-time employees, of whom 284 are
employed at the Company's Sun Valley headquarters and repair facility, 156 are
employed with the Company's United Kingdom subsidiary, and 13 are employed at
the Company's repair facility in the Netherlands. In the United Kingdom, 83
former British Airways employees, representing 18% of the Company's work force,
are covered by a collective bargaining agreement.
Each of the Company's technical employees receives specific training in the
individual repair and overhaul functions that he or she performs, in addition to
comprehensive general training in total quality management procedures,
statistical process control and material resource planning. The Company also
regularly conducts in-house training programs, which the Company's management
designs using standard industry practice manuals. In-house training is provided
for the
-10-
Company's technical and engineering employees on a number of subjects, including
materials handling, corrosion prevention and control, surface tension etch
inspection and shot peening.
Risk Factors
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995.
THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995, SUCH AS STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND
INTENTIONS, THAT INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN SUCH FORWARD-LOOKING STATEMENTS.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT
LIMITED TO, THOSE DISCUSSED IN THIS SECTION ENTITLED "RISK FACTORS" AS WELL AS
THOSE DISCUSSED ELSEWHERE IN THIS ANNUAL REPORT. IN ADDITION TO THE OTHER
INFORMATION SET FORTH IN THIS ANNUAL REPORT, PERSONS WHO MAY OWN OR INTEND TO
OWN SECURITIES OF THE COMPANY SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK
FACTORS.
Aviation Industry Risks
The Company derives all of its sales and operating income from the services
and parts that it provides to its customers in the aviation industry. Therefore,
the Company's business is directly affected by economic factors and other trends
that affect its customers in the aviation industry, including a possible
decrease in aviation activity, a decrease in outsourcing by aircraft operators
or the failure of projected market growth to materialize or continue. When such
economic and other factors adversely affect the aviation industry, they tend to
reduce the overall demand for the Company's products and services, thereby
decreasing the Company's sales and operating income.
Fluctuations in Results of Operations
The Company's operating results are affected by a number of factors, including
the timing of orders for the repair and overhaul of landing gear and fulfillment
of such contracts, the timing of expenditures to manufacture parts and purchase
inventory in anticipation of future services and sales, parts shortages that
delay work in progress, general economic conditions and other factors. Although
the Company has secured several long-term agreements to service multiple
aircraft, the Company receives sales under these agreements only when it
actually performs a repair or overhaul. Because the average time between landing
gear overhauls is seven years, the work orders that the Company receives and the
number of repairs or overhauls that the Company performs in particular periods
may vary significantly causing the Company's quarterly sales and results of
operations to fluctuate substantially. The Company is unable to predict the
timing of the actual receipt of such orders and, as a result, significant
variations between forecasts and actual orders will often occur. In addition,
the Company's need to make significant expenditures to support new aircraft in
advance of generating revenues from repairing or overhauling such aircraft may
cause the Company's quarterly operating results to fluctuate. Furthermore, the
rescheduling of the shipment of any large order, or portion thereof, or any
production difficulties or delays by the Company, could have a material adverse
effect on the Company's quarterly operating results.
Risks Relating to Acquisition Strategy; Establishment of United Kingdom
Operations
The Company may attempt to grow by acquiring service and parts providers whose
operations or inventories complement or expand the Company's existing repair and
overhaul businesses, or whose strategic locations enable the Company to expand
into new geographic markets. The Company's ability to grow by acquisition
depends upon, and may be limited by, the availability of suitable acquisition
candidates and the Company's capital resources. See "Liquidity and Capital
Resources" in Item 1.
Acquisitions involve risks that could adversely affect the Company's operating
results, including the assimilation of the operations and personnel of acquired
companies, the amortization of acquired intangible assets and the loss of key
employees of acquired companies. Although the Company investigates the
operations and assets that it acquires, there may be liabilities that the
Company fails or is unable to discover, and for which the Company as a successor
owner or operator may be liable. In addition, costs and charges, including legal
and accounting fees and reserves and write-downs relating to an acquisition, may
be incurred by the Company or may be reported in connection with any such
acquisition. The Company evaluates acquisition opportunities from time to time,
but the Company has not entered into any commitments or binding agreements to
date, except with respect to the BA Acquisition. There can be no assurance that
the Company will be able to consummate acquisitions on satisfactory terms, or at
all, or that it will be successful in integrating any such acquisitions,
including the BA Acquisition, into its operations. The Company had no history or
experience operating in the United Kingdom prior to the BA acquisition. The
likelihood of the success of the Company's United Kingdom operations
-11-
must be considered in light of the problems, expenses, difficulties,
complications and delays frequently encountered in connection with a new
business. These include, without limitation, the need to establish operating,
marketing and administrative capabilities, the need to implement the Company's
management information system in its new location, the need to locate and move
into a new facility, unanticipated marketing problems, new competitive
pressures, and increased expenses.
Risks Associated With Expansion Of International Operations
The Company's growth strategy is based in large part on the Company's ability
to expand its international operations, which will require significant
management attention and financial resources. The Company currently has a
subsidiary in the United Kingdom and a division in the Netherlands. There can be
no assurance that the Company's efforts to expand operations internationally
will be successful. In addition, international operations are subject to a
number of risks, including longer accounts receivable collection periods and
greater difficulty in accounts receivable collections, unexpected changes in
regulatory requirements, foreign currency fluctuations, import and export
restrictions and tariffs, difficulties and costs of staffing and managing
foreign operations, potentially adverse tax consequences, political instability,
the burdens of complying with multiple, potentially conflicting laws and the
impact of business cycles and economic instability outside the United States.
The Company's sales are principally denominated in United States dollars and
British pounds, and to a lesser extent in Dutch guilders. The Company makes
substantial inventory purchases in French francs from such suppliers as Messier-
Bugatti, Societe D'Applications Des Machines Motrices and Eurocopter France. The
Company's Netherlands facility's inventory purchases are primarily United States
dollar denominated, while sales and operating expenses are partially denominated
in Dutch guilders. To date, the Company's business has not been significantly
affected by currency fluctuations or inflation. Fluctuations in currency
exchange rates could cause the Company's products to become relatively more
expensive in particular countries, leading to a reduction in sales in that
country.
Substantial Competition
Numerous companies compete with the Company in the aviation services industry.
The Company expects that competition in its industry will increase substantially
as a result of industry consolidations and alliances in response to the trend in
the aviation industry toward outsourcing of repair and overhaul services. In
addition, as the Company moves into new geographic or product markets it will
encounter new competition.
The Company believes that the primary competitive factors in its marketplace
are quality, price, rapid turnaround time and industry experience. Certain of
the Company's competitors have substantially greater financial, technical,
marketing and other resources than the Company. These competitors may have the
ability to adapt more quickly to changes in customer requirements, may have
stronger customer relationships and greater name recognition and may devote
greater resources to the development, promotion and sale of their products than
the Company. There can be no assurance that competitive pressures will not
materially and adversely affect the Company's business, financial condition or
results of operations. See "Business--Competition."
Government Regulation
The Company's operations are regularly audited and accredited by the
Coordinating Agency for Supplier Evaluation, formed by commercial airlines to
approve FAA approved repair stations and aviation parts suppliers. If material
authorizations or approvals are revoked or suspended, the Company's operations
will be materially and adversely affected. As the Company attempts to commence
operations in countries in which it has not previously operated, it will need to
obtain new certifications and approvals. In addition, if new and more stringent
regulations are adopted by foreign or domestic regulatory agencies, or oversight
of the aviation industry is increased in the future, the Company's business may
be adversely affected.
Dependence On Key Suppliers
The Company purchases landing gear spare parts and components for a variety of
fixed wing aircraft and helicopters. The Company has separate 10-year agreements
that each expire in October 2006 with: (i) Dunlop Limited, Aviation Division;
(ii) Dunlop Limited, Precision Rubber; and (iii) Dunlop Equipment Division.
Under two of these agreements, the Company purchases discounted parts for resale
and repair from Dunlop. For the years ended December 31, 1998 and 1997, Dunlop
accounted for approximately $4,513,000 and $4,301,000, respectively, of the
spare parts and components that the Company purchased in such periods. Failure
by any one of these divisions of Dunlop to renew its agreement on
-12-
similar terms when it expires could have a material adverse affect on the
Company's business. The Company's single largest supplier during 1998 was
Boeing, who provided the Company $13,000,000 of spares parts and components.
In addition, the Company has agreements with Messier-Bugatti, SAMM and
Eurocopter France that enable the Company to purchase new aircraft parts at
discounts from list price. Many of the Company's supplier agreements, other than
its agreements with Dunlop, are short-term and can be terminated by the supplier
upon providing ninety days prior written notice. A decision by any of these
suppliers to terminate their agreements would reduce the competitive advantage
the Company derives therefrom.
Customer Concentration
British Airways, Federal Express and the USCG have been the only customers
accounting for more than 10% of sales during the last three years. For
additional detail please see "Business--Material Customers".
Concentration of Credit Risk
At December 31, 1998, 25.7% and 19.4% of the Company's total accounts
receivable were associated with British Airways and Federal Express,
respectively. At December 31, 1997, 18.9% and 6.1% of the Company's total
accounts receivable were associated with Federal Express and British Airways,
respectively. At December 31, 1996, 7.4% and 9.3% of the Company's total
accounts receivable were associated with Federal Express and the USCG,
respectively.
Write-offs against accounts receivable have been one-twentieth of one percent
in 1998, and two-tenths of one percent in 1997. The Company can not provide any
assurance that such favorable bad debt experience will continue.
Environmental Regulations
The Company's operations are subject to extensive and frequently changing
federal, state and local environmental laws and substantial related regulation
by government agencies, including the EPA, the California Environmental
Protection Agency and the United States Occupational Safety and Health
Administration. Among other matters, these regulatory authorities impose
requirements that regulate the operation, handling, transportation and disposal
of hazardous materials generated by the Company during the normal course of its
operations, govern the health and safety of the Company's employees and require
the Company to obtain and maintain permits in connection with its operations.
This extensive regulatory framework imposes significant compliance burdens and
risks on the Company and, as a result, substantially affects its operational
costs. In addition, the Company may become liable for the cost of removal or
remediation of certain hazardous substances released on or in its facilities
without regard to whether the Company knew of, or caused, the release of such
substances. The Company believes that it currently is in material compliance
with applicable laws and regulations and is not aware of any material
environmental problem at any of its current or former facilities. There can be
no assurance, however, that its prior activities did not create a material
problem for which the Company could be responsible or that future uses or
conditions (including, without limitation, changes in applicable environmental
laws and regulation, or an increase in the amount of hazardous substances
generated by the Company's operations) will not result in material environmental
liability to the Company and materially and adversely affect the Company's
financial condition and results of operations. The Company's plating operations,
which use a number of hazardous materials and generate a significant volume of
hazardous waste, increase the Company's regulatory compliance burden and
compound the risk that the Company may encounter a material environmental
problem in the future. Furthermore, compliance with laws and regulations in
foreign countries in which the Company locates its operations may cause future
increases in the Company's operating costs or otherwise adversely affect the
Company's results of operations or financial condition. See also "Business--
Environmental Matters and Proceedings".
Product Liability Risks
The Company's business exposes it to possible claims for personal injury,
death or property damage which may result from the failure or malfunction of
landing gears, hydromechanical components or aircraft spare parts repaired or
overhauled by the Company. Many factors beyond the Company's control could lead
to liability claims, including the failure of the aircraft on which landing gear
or hydromechanical components overhauled by the Company is installed, the
reliability of the customer's operators of the aircraft and the maintenance of
the aircraft by the customer. The Company currently has in force aviation
products liability and premises insurance, which the Company believes provides
coverage in amounts and on terms that are generally consistent with industry
practice. The Company has not experienced any material product liability claims
related to its products. There can be no assurance that the amount of product
liability insurance that the Company carries at the time a product liability
claim is be made will be sufficient to protect the Company.
-13-
Dependence On Key Personnel
The continued success of the Company depends to a large degree upon the
services of certain of its executive officers and upon the Company's ability to
attract and retain qualified managerial and technical personnel experienced in
the various operations of the Company's business. Loss of the services of such
employees, particularly David Lokken, President and Chief Executive Officer;
Philip Panzera, Vice President and Chief Financial Officer; Dennis Biety,
Managing Director of Hawker Pacific Aerospace Ltd.; Brian Carr, Managing
Director of Sun Valley Operations; or Michael Riley, Vice President-
Hydromechanical Operations, could adversely affect the operations of the
Company.
The Company has entered into employment agreements expiring in 2001 with
Messrs. Lokken and Panzera, and 2003 with Mr. Biety. Messrs. Carr and Riley have
employment agreements with the Company which expire on October 31, 1999.
Risk Associated with Facilities Reorganization
The Company's UK subsidiary will relocate to a new facility in mid-1999. See
"Item 2--Properties". This relocation has been planned for over one year, and
the Company believes it has an effective strategy to move the facility with a
minimum of disruption. The UK operation does, however, have a large amount of
heavy machinery and equipment. Moving these items could present unforeseen
problems. It is also difficult to predict to what extent the Company's principal
operations will be affected by the move. Deliveries to key customers might be
missed, with any delays causing additional fees to the subsidiary or potentially
the loss of the customer.
There is also the risk that machinery or equipment may be lost, damaged or
stolen during the relocation. The Company has theft, casualty and business
interruption insurance, but no assurance can be given that the proceeds from
such insurance will be sufficient to reimburse the Company for any damages it
may suffer.
The Company is in the process of expanding its plating operations at its Sun
Valley facility. This expansion is not expected to be completed until sometime
in 2000. The plating shop of the UK operation is not scheduled to move to the
new facility until sometime in early 2000. Any failure or delay in the expansion
or relocation of these plating operations could impair the Company's ability to
service its customers.
Control By Existing Shareholders And Anti-Takeover Provisions
As of March 26, 1999, the five shareholders (the "Unique Shareholders") of
Unique Investment Corporation ("Unique") beneficially owned in the aggregate
approximately 40.4% of the Company's outstanding common stock, and by virtue of
such ownership, have effective control over all matters requiring a vote of
shareholders, including the election of a majority of directors. See "Security
Ownership of Certain Beneficial Owners and Management".
On March 25, 1999, the Company declared a dividend distribution of one
Preferred Share Purchase Right (the "Rights") on each outstanding share of its
common stock, payable to shareholders of record as of that date. The Rights
attached to the Company's common stock and will be traded separately and be
exercisable only in the event that a person or group acquires or announces the
intent to acquire 20% or more of the Company's common stock. Each Right will
entitle the holder to buy one one-hundredth of a share of a new series of junior
participating preferred stock at an exercise price of $15. The Rights are
designed to insure that all shareholders receive fair and equal treatment in the
event of any proposed takeover of the Company, and to guard against partial
tender offers, squeeze-outs, open market accumulations and other abusive tactics
to gain control of the Company without paying all shareholders a control
premium. The Rights will not prevent a takeover, but should encourage anyone
seeking to acquire the Company to negotiate with the Board of Directors prior to
attempting a takeover. For additional information, please refer to Note 14--
Subsequent Events to the Consolidated Financial Statements.
Stock Price Volatility
In recent years, the stock market has experienced significant price and volume
fluctuations. These fluctuations, which are often unrelated to the operating
performances of specific companies, have had a substantial effect on the market
price of stocks, particularly for many small capitalization companies. The
Company's common stock is also thinly traded, which frequently causes relatively
small trades to have a disproportionate effect on the Company's market price.
-14-
ITEM 2. PROPERTIES
The Company's principal executive offices and production facilities are
located in Sun Valley, California, near the Burbank Airport in Los Angeles. The
Company occupies the premises, comprising approximately 193,000 square feet and
nine buildings, pursuant to various long-term leases that expire on dates
ranging between 2004 and 2010.
Hawker Pacific Aerospace Ltd. operates the Company's second major repair
facility. This operation is currently located in a British Airways building on
Heathrow Airport in London. Pursuant to the BA acquisition agreement, the UK
subsidiary must relocate from this 125,000 square foot facility during 1999. The
Company intends to move the operation to a new 140,000 square foot facility in
Hayes, about four miles from Heathrow. The relocation will take place from May
1999 to July 1999. The relocation will increase the subsidiary's capacity and
capability, and is expected to significantly improve the Company's ability to
serve current and future European customers, and compete effectively for new
business.
During 1998 the Company's Holland operation relocated to a 11,700 square foot
facility near Schiphol Airport in Amsterdam. The lease for the facility expires
in 2008.
ITEM 3. LEGAL PROCEEDINGS
From August 1997 through December 1998, several lawsuits were filed by various
individuals against Lockheed Martin Corporation and various other parties,
including the Company, in the Los Angeles Superior Court pleading various causes
of action in connection with certain alleged injuries caused by toxic and
carcinogenic chemicals allegedly released by the defendants in the Burbank and
Glendale area of Los Angeles County, California. The individual plaintiffs seek
unspecified compensatory and punitive damages. The Company does not believe that
it caused the release of toxic and carcinogenic chemicals alleged in the
complaints and believes that it is entitled to indemnification from BTR in the
event the Company is held responsible for any damages in these lawsuits. The
Company recently reached agreement to settle all liability associated with said
lawsuits for a nominal payment. The settlement documents are in the process of
being finalized. See also "Business--Environmental Matters and Proceedings".
The Company is sued from time to time in the ordinary course of business. At
the present time, there are no material legal proceedings against the Company,
its subsidiary, or any officer, director, affiliate or five percent shareholder.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's common stock is quoted on the NASDAQ National Market under
the symbol "HPAC". The following table sets forth the high and low sale prices
as reported by NASDAQ from January 29, 1998, the date public trading of the
Company's common stock commenced. Such over-the-counter market quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
may not necessarily represent actual transactions.
Sale Price
---------------
Low High
--- ----
1998
From January 29, 1998 $8.00 $11.25
2nd Quarter 10.00 14.125
3rd Quarter 1.875 13.50
4th Quarter 2.5625 4.875
1999
1st Quarter 2.50 5.25
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As of March 31, 1999, the Company's common stock was held by 29 shareholders
of record, and owned beneficially by an estimated 1,371 shareholders.
The Company has not paid cash dividends on its common stock since its
inception and has no plans to pay dividends on its common stock in the
foreseeable future. The Company's current bank credit facility prohibits the
payment of dividends. The Company intends to reinvest future earnings, if any,
in the development and expansion of its business.
Included in the totals of options granted and options cancelled were 144,207
options that were repriced from $8.00 to $3.56. These options included all
115,365 options granted to senior management in November 1997, and 28,842
options granted to senior management under the 1997 Plan. These newly issued
options were repriced to be consistent with options granted to certain members
of middle management in October 1998, and were issued pursuant to exemptions
available under Section 3(9) of the Securities Act of 1933, as amended.. The
strike price for these options was established at the $3.56 closing price of the
Company's common stock on the date issued.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth for the periods and the dates indicated certain
financial data which should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the financial
statements and notes thereto included in this Annual Report. For the years ended
December 31, 1994, 1995 and the ten months ended October 31, 1996, the Company
was a wholly owned subsidiary of BTR Dunlop Holdings, Inc., and financial data
related to those periods is presented under columns marked "Predecessor".
Effective November 1, 1996, the Company was acquired by the Unique Shareholders
and the Company's then current executive officers. All financial data subsequent
to October 31, 1996, is presented below under columns marked "Successor".
The balance sheet data as of December 31, 1995, 1996, 1997 and 1998, and the
statement of operations data for the fiscal year ended December 31, 1995, the
ten months ended October 31, 1996, the two months ended December 31, 1996, and
the years ended December 31, 1997 and 1998, are derived from the financial
statements of the Company which have been audited by Ernest & Young LLP,
independent accountants.
The balance sheet and statement of operations data as of December 31, 1994,
are derived from unaudited financial statements. The pro forma statement of
operations data for the year ended December 31, 1996, is derived from unaudited
pro forma adjustments which were made to estimate the results of operations for
fiscal year 1996 as if the purchase had occurred on January 1, 1996. For
additional detail on these pro forma adjustments, please refer to the
"Organization and Basis of Presentation" in Note 1 to the Consolidated Financial
Statements. The unaudited financial statements have been prepared by the Company
on a basis consistent with the Company's audited financial statements and, in
the opinion of management, include all adjustments, consisting only of normal
recurring accruals, necessary for a fair presentation of the Company's results
of operations for the period.
Successor Predecessor
--------------------------------------------------- -------------------------------------
Year Ended December 31, Two Months Ten Months Year ended
----------------------------------- Ended Ended December 31,
(pro forma) December 31, -----------------------
(In thousands, except per share data) 1998 1997 1996 1996 1996 1995 1994
- ------------------------------------ ---- ---- ---- ---- ---- ---- ----
Revenue $65,151 $41,042 $39,004 $ 6,705 $32,299 $35,012 $31,743
Net income (loss) (2,198) 788 (1,523) 469 (1,606) 265 1,050
Net income (loss) per share (0.39) 0.25 (0.48) 0.15 -- -- --
Total assets 87,237 40,898 35,178 -- -- 35,455 25,865
Total long-term debt
(excluding current portion) 2,500 17,700 19,150 -- -- 27,310 21,404
On February 4, 1998, the Company acquired the British Airways repair and
overhaul operation in the United Kingdom. See "Organization and Basis of
Presentation" in Note 1 to the Consolidated Financial Statements.
-16-
Income tax expenses for the two months ended December 31, 1996, and the year
ended December 31, 1997, include provisions of $382,000 and $467,000,
respectively, primarily due to changes in deferred tax assets. No tax was
actually payable for such provisions. See Note 4 to the Consolidated Financial
Statements.
Restructuring charges of $1,196,000 are included during the ten months ended
October 31, 1996, and the pro forma year ended December 31, 1996, related to
costs incurred to shut down discontinued operations of Dunlop Miami. See Note 10
to the Consolidated Financial Statements.
Included in selling, general and administrative expenses for the ten months
ended October 31, 1996, and the pro forma year ended December 31, 1996, are
expenditures related to an EPA Claim of approximately $947,000. For the years
ended December 31, 1993 and 1994, selling, general and administrative expenses
included $122,000 and $410,000, respectively, for expenditures related to the
EPA Claim. No such costs were incurred during the two months ended December 31,
1996, or the year ended December 31, 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Results of
Operations".
Fiscal 1995 includes a non-recurring charge to cost of revenues of $927,000
for disposal of inventory related to the Dunlop Merger which had operations in
Chatsworth, CA and Miami, FL. Fiscal 1995 also includes a net gain of
approximately $300,000 included in selling, general and administrative expenses,
which represents an operating expense of $700,000 offset by an insurance
reimbursement of $1,000,000 related to the EPA Claim for which the Company has
been fully indemnified by BTR. The estimated total net cost of the EPA Claim
recorded in fiscal 1995 was based on the information available at that time. See
"Environmental Matters and Proceedings" in Note 1.
Effective January 1, 1994, certain assets, liabilities and operations of
Dunlop Aviation were merged into the Company. The merger was treated similarly
to a pooling of interest for accounting purposes and accordingly, the financial
data as of and for the year ended December 31, 1993 includes those assets,
liabilities and operations as if the merger occurred on January 1, 1993.
Included in selling, general and administrative expenses for the year ended
December 31, 1994, are approximately $501,000 of merger related expenses.
-17-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE COMPANY'S
FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO AND THE OTHER FINANCIAL
INFORMATION INCLUDED ELSEWHERE IN THIS ANNUAL REPORT. WHEN USED IN THE FOLLOWING
DISCUSSIONS, THE WORDS "BELIEVES", "ANTICIPATES", "INTENDS", "EXPECTS" AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, WHICH COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED, INCLUDING, BUT NOT
LIMITED TO, THOSE SET FORTH IN "BUSINESS--RISK FACTORS." READERS ARE CAUTIONED
NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS
OF THE DATE HEREOF.
Results Of Operations
The following table sets forth certain statement of operations data for the
periods indicated. Fiscal year 1996 represents an unaudited pro forma
combination of the Successor and Predecessor
1998 1997 1996
----- ----- -----
(Dollars in thousands) $ % $ % $ %
Revenue $ 65,151 100.0% $41,042 100.0% $ 39,004 100.0%
Cost of revenue 55,059 84.5% 31,430 76.6% 31,799 81.5%
-------- ----- ------- ----- -------- -----
Gross margin 10,092 15.5% 9,612 23.4% 7,205 18.5%
Selling general and administrative
expense 9,764 15.0% 5,897 14.4% 6,161 15.8%
Restructuring charges -- -- -- -- 1,196 3.1%
-------- ----- ------- ----- -------- -----
Operating income (loss) 328 -0.5% 3,715 9.1% (152) 0.4%
Interest expense (3,402) -5.2% (2,431) -5.9% (2,312) -5.9%
Interest income 74 -- 3 -- 7 --
Other expense, net -- -- (32) -0.1% -- --
-------- ----- ------- ----- -------- -----
Income (loss) before income taxes
and extraordinary item (3,000) -4.6% 1,255 3.1% (2,457) -6.3%
Income tax provision (benefit) (1,402) -2.2% 467 1.1% (934) -2.4%
-------- ----- ------- ----- -------- -----
Income (loss) before extraordinary
item (1,598) -2.5% 788 2.0% (1,523) -3.9%
Extraordinary loss (600) -0.9% -- -- -- --
-------- ----- ------- ----- -------- -----
Net income (loss) ($2,198) -3.4% $ 788 2.0% ($1,523) -3.9%
======== ===== ======= ===== ======== =====
Year Ended December 31, 1998 Compared To Year Ended December 31, 1997
Revenue. Revenue for the year ended December 31, 1998, increased by
$24,109,000, or 59%, from the year ended December 31, 1997. Revenue comparisons
were favorably affected by the Company's acquisition of the British Airways
landing gear repair and overhaul operation in February 1998. Without the effect
of the British Airways acquisition, the Company's other operations recorded
revenue growth of 25% as compared with 1997.
Landing gear repair and overhaul revenue increased $7,753,000 (41%) to
$26,680,000. The increase in landing gear repair and overhaul revenue was
primarily attributable to increased business from Federal Express and American
Airlines at the Company's Sun Valley facility, along with increased business
from British Airways generated by the addition of the Company's United Kingdom
("UK") operation.
-18-
Fixed wing and helicopter repair and overhaul increased to $14,245,000 from
$13,195,000 in 1997 or 8%. Wheels, brakes and braking system components repair
and overhaul declined 5% to $5,135,000 from $5,393,000 in 1997.
Cost of Revenue and Gross Margin. Cost of revenue as a percentage of sales in
1998 increased to 84.5%, as compared with 76.6% in 1997. Cost of revenue was
higher proportionally during 1998 primarily because the Company's UK subsidiary
was restructuring its operations, implementing new procedures and controls, and
hiring and training personnel throughout 1998. The UK operation therefore
required increased labor, material and overhead costs as compared with the
Company's long-established Sun Valley facility. As the prior comparable period
included only Sun Valley results, the gross margin percentage decreased
accordingly during 1998. Also adversely affecting gross margin was a $750,000
writedown of certain slow-moving inventory.
Selling, General and Administrative Expense. Selling, general and
administrative expense for the year ended December 31, 1998, increased
significantly from the prior comparable period as a direct result of the added
facility in the United Kingdom. Additional expense was also incurred from the
cancellation of a convertible debt offering, foreign currency adjustments, and
an increase to a reserve for doubtful accounts. Although the dollar amount
increased primarily because of the new facility and the significant charges
above, selling, general and administrative expense as a percent of revenue
increased only slightly for the year.
Interest Expense. Interest expense increased by $971,000 during 1998 as a
result of increased borrowings on the Company's senior credit facility.
Income Taxes. During 1998 the Company recorded an income tax benefit of
$1,402,000, as compared to income tax expense of $467,000 in 1997. A valuation
allowance of $225,000 was recorded against the related deferred tax assets for
state net operating loss carryforwards that expire in the near term.
Extraordinary Item. In December 1998 the Company obtained a new senior credit
facility which provided an additional $20,800,000 of availability. The Company
incurred $954,000 of costs in deferred loan fees and prepayment charges to
retire the Company's previous credit facility. These charges were recorded as an
extraordinary item, and presented net of tax of $354,000.
Net Loss. The net loss for fiscal year 1998 was $2,198,000, or $0.39, as
compared with net income of $788,000, or $0.25, for fiscal year 1997.
Quarter Ended December 31, 1998, Compared to Quarter Ended December 31, 1997
Revenue. Revenue for the fourth quarter of 1998 increased by 60% to
$17,618,000 from $10,982,000 for the comparable period of 1997.
Cost of Revenue and Gross Margin. Cost of revenue as a percentage of sales
increased significantly during the fourth quarter of 1998 because of the
addition of the new operation in the United Kingdom. The UK subsidiary was still
establishing its operations, implementing new procedures and controls, and
working to cope with massive personnel turnover issues. The UK operation
therefore required increased labor, material and overhead costs, which
management estimates exceeded $1 million in additional costs, as compared with
the Company's long-established Sun Valley facility. As the prior comparable
period included only Sun Valley results, the gross margin percentage decreased
accordingly during the fourth quarter of 1998.
Extraordinary, Unusual or Infrequently Occurring Items. Fourth quarter charges
totaled $3,421,000, or $0.59. This amount includes an extraordinary expense of
$954,000, and unusual or infrequently occurring charges of $2,467,000. The
extraordinary expense of $954,000 consisted of costs related to retiring the
Company's previous senior credit facility. Unusual or infrequently occurring
charges included: (i) $241,000 for the cancellation of a convertible debt
offering; (ii) $825,000 for restructuring expenses in the UK operation,
including costs related to replacing management and restructuring operations;
(iii) $750,000 to writedown slow-moving inventory; (iv) $326,000 of foreign
exchange adjustments; (v) $225,000 to establish a valuation allowance against
California net operating loss carryforwards which imminently expire; and (vi)
$100,000 to increase the allowance for bad debt.
-19-
Net Loss. The Company posted a fourth quarter loss of $3,622,000, or $0.62, as
compared with net income of $123,000, or $0.02 in the comparable period of 1997.
Without the effect of the charges above, the Company would have recorded a net
loss of $201,000, or $0.03.
Year Ended December 31, 1997 Compared To Pro Forma Year Ended December 31, 1996
Revenue. Revenue for the year ended December 31, 1997, increased $2,038,000
or 5.2% to $41,042,000 from $39,004,000 for the year ended December 31, 1996.
The increase was a result of a 20.2% increase in landing gear repair and
overhaul services offset by reductions resulting from the Company's closure of
the Dunlop Miami operations and rationalization of unprofitable product lines.
Landing gear repair and overhaul revenues increased to $18,927,000 and accounted
for 46.1% of total revenues for 1997, as compared to $15,745,000 or 40.4% of
total revenues for 1996. The increase in landing gear repair and overhaul
revenues was attributable to increases in business from Federal Express's MD10
freighter conversion program and new wide-body repair and overhaul business from
British Airways and American Airlines.
Fixed wing aircraft and helicopter repair and overhaul declined 0.9% to
$13,195,000 or 32.1% of total revenues for 1997 from $13,310,000 or 34.1% of
total revenues for 1996. This decline was attributable to a reduction in
helicopter repair and overhaul business from the USCG, in part due to the
modifications performed by the Company in 1996 and 1997 to extend the time
between overhauls for the USCG fleet of Dauphin II helicopters. Wheels, brakes
and braking system component repair and overhaul increased 9.8% to $5,393,000 or
13.1% of total revenues for 1997 from $4,913,000 or 12.6% of total revenues for
1996.
For the year ended December 31, 1997, repair and overhaul services accounted
for 92.5% of total revenues, as compared to 90.2% for 1996. Revenues from spare
parts distribution and sales accounted for 7.5% of total revenues for 1997, as
compared to 8.6% for 1996. This decline was a result of the Company's decision
to close the Dunlop Miami operations and discontinue the low margin Dunlop
aircraft tire distribution business, which contributed to improvements in
operating profits.
Gross Margin. Gross margin for the year ended December 31, 1997, increased
33.4% to $9,612,000 from $7,205,000 for 1996. Gross margin as a percent of
revenue increased to 23.4% for the year ended December 31, 1997, compared to
18.5% for 1996. This increase was primarily due to: (i) improved throughput and
economies of scale achieved from increased revenue in wide-body landing gear
repair and overhaul services; (ii) development of the Company's higher margin
fixed wing aircraft and helicopter hydromechanics products; and (iii)
discontinuing the unprofitable Dunlop Miami operation, which adversely impacted
gross profit in 1996 as a result of charges to cost of revenue for non-
productive inventory.
Gross profit for the year ended December 31, 1996, included a nonrecurring
charge of $489,000 to dispose of certain obsolete and non-productive inventory
related to closing Dunlop Miami and a charge of $574,000 primarily related to
other non-productive inventory at the Company's Sun Valley operations, including
inventory related to Dunlop Aviation. Excluding these charges, gross profit
would have been $8,268,000 or 21.2% of revenues for the year ended December 31,
1996.
Selling, General And Administrative Expense. Selling, general and
administrative expense for the year ended December 31, 1997 decreased $264,000
or 4.3% to $5,897,000 from $6,161,000 for the year ended December 31, 1996.
Selling, general and administrative expense decreased as a percent of revenues
to 14.4% from 15.8% for the prior year. This decrease was due to $947,000 of
costs related to the EPA Claim in 1996 that were not incurred in 1997. BTR
indemnified the Company for costs incurred in connection with the EPA Claim.
This decrease was offset by additional costs incurred in 1997 resulting from:
(i) the Company's efforts to expand its international market presence through
sales representatives located in Europe, the Middle East and China; (ii)
management fees paid to Unique Investment Corporation; and (iii) expenses
incurred in connection with developing the Company's relationship with British
Airways. Excluding the $947,000 charge, selling, general and administrative
expenses would have been $5,214,000 or 13.4% of revenue for the year ended
December 31, 1996.
Operating Income. Operating income for the year ended December 31, 1997,
increased $3,867,000 to $3,715,000 or 9.1% of total revenues compared to an
operating loss of $152,000 for 1996. Operating income for the year ended
December 31, 1996, was negatively impacted by nonrecurring restructuring charges
of $1,196,000 and charges to cost of
-20-
revenues of $1,063,000 related to the closure of the Dunlop Miami and $947,000
in costs related to the EPA claim. Excluding these charges, pro forma operating
income for the year ended December 31, 1996, would have been $3,054,000 or 7.8%
of revenues.
Income Taxes. Income taxes for the year ended December 31, 1997, were
$467,000 compared to an income tax benefit of $934,000 for the year ended
December 31, 1996. The effective tax rate for the year ended December 31, 1997,
was 37.2% compared to 38.0% for 1996. The effective tax rate for the periods
differs from the federal statutory rate of 34.0% due to certain nondeductible
expenses. At December 31, 1997, the Company had net operating loss carryforwards
of $7,892,000. The utilization of these operating loss carryforwards is limited
due to changes in the Company's ownership in November 1996. At December 31,
1997, the Company had a valuation reserve of $659,000 for the deferred tax
assets.
Net Income. As a result of the factors described above, net income for the
year ended December 31, 1997, of $788,000 represents an increase of $2,311,000
from the net loss of $1,523,000 for the year ended December 31, 1996.
Liquidity And Capital Resources
Since the Company was acquired from BTR in November 1996, the Company's
working capital and funds for capital expenditures have been provided by cash
generated from operations, borrowings under the Company's working capital credit
facilities and cash received from the sale of common stock. In November 1996,
the Company entered into a loan agreement with Bank of America National Trust
and Savings Association ("Bank of America") for a $10.0 million revolving line
of credit, a $13.5 million term loan and a $3.0 million capital expenditures
facility.
On January 23, 1998, the Company and Bank of America entered into an Amended
and Restated Business Loan Agreement (the "Amended Loan Agreement"), as a result
of which the maximum amount of credit available to the Company was increased
from $26.5 million to $45.5 million. The credit facilities of the Amended Loan
Agreement became available upon the completion of the Company's initial public
offering and consummation of the acquisition of the British Airways ("BA")
repair operation. The Company used approximately $9.2 million of the proceeds
available under the Amended Loan Agreement to fund a portion of the purchase
price of the BA assets. The Amended Loan Agreement provided the Company with a
$15.0 million revolving line of credit, a $24.5 million term loan, and a $6.0
million capital expenditure facility.
Cash used by the Company for operating activities during 1998 amounted to $3.1
million. This amount resulted primarily from increases in accounts receivable
and inventory related to the new UK subsidiary.
The Company has scheduled capital expenditures in 1999 of approximately $8.7
million. Included in this amount are $3.9 million for rotable assets, and $4.8
million for other capital expenditures. Other capital expenditures consist
primarily of $4.2 million for the relocation of the UK subsidiary. The $45.5
million Bank of America line was not adequate to fund these capital
requirements.
Accordingly, on December 22, 1998, the Company secured a $66.3 million senior
credit facility from Heller Financial, Inc., and NMB-Heller Limited
(collectively, "Heller"). Upon closing, $41.5 million of the proceeds were used
to retire the Bank of America facility, and a $2.5 million principal payment was
made on a $5 million subordinated debt agreement between the Company and Unique
Investment Corporation ("Unique"), an entity controlled by several shareholders
of the Company.
The Loan and Security Agreement with Heller (the "Heller Agreement") provided
a $55 million revolving line of credit, a Term Loan A in the amount of $4.3
million, and a Term Loan B in the amount of $7.0 million. The revolver and both
term loans expire in five years, and carried interest at a base rate of 7.75%.
In January 1999 the Company elected a LIBOR rate option, which changed the rate
of interest on the line of credit, Term Loan A and Term Loan B to 7.0%, 7.25%
and 7.5%, respectively. At March 26, 1999, the weighted average interest rate
for all three loans was 7.1%.
Availability on the $55 million revolving line of credit may be limited by
borrowing base criteria related to levels of accounts receivable, inventory and
exchange assets. At December 31, 1998, the Company's borrowing base was $50.4
million, of which $37.3 million had been advanced, leaving remaining
availability of $13.1 million.
On February 19, 1999, Heller established a $5 million reserve against the
Company's line of credit as a result of the Company being in default on certain
financial covenants. On March 26, 1999, certain exchange gears were temporarily
-21-
excluded from the borrowing base as they were located in ineligible foreign
countries. At March 26, 1999, excluding the $4.0 million unavailable as a result
of the foreign location of these exchange gears, the Company's borrowing base
was $51.2 million, of which $43.0 million had been advanced, leaving remaining
availability (after the $5 million reserve) of $3.2 million.
The $5 million reserve removed important availability that the Company had
planned on in meeting its capital budget for 1999. As a result of the large
lump-sum payments required for the UK relocation from May through July 1999, and
the decreased level of availability from the reserve, management anticipates
that the Company will undergo a temporary period of cash tightness for the next
few quarters. Management believes this condition will be temporary since cash
flow from operations is anticipated to improve significantly commencing in the
third quarter when the relocation is completed, and the UK subsidiary has
substantially eliminated transition issues which have adversely affected its
operating results.
On March 10, 1999, the Company and Heller entered into a Forbearance Agreement
with regard to certain violations of financial covenants in the Heller
Agreement. In consideration therefor, the Company agreed to: (i) accept certain
stricter financial controls; (ii) provide a consolidated business plan, and an
operational improvements plan for the UK subsidiary; (iii) pay a $75,000 fee;
and (iv) hire a third party consultant to evaluate improvement plans underway
with respect to the UK subsidiary.
The Forbearance Agreement was extended in a Second Forbearance Agreement with
an effective date of April 13, 1999. In exchange for Heller's continued
forbearance, the Company agreed to: (i) continue the tighter financial controls
and retain a consultant as required in the Forbearance Agreement; (ii) accept a
1.5% interest rate increase on the revolving line; (iii) forego the ability to
elect the LIBOR interest rate option; (iv) forego the benefit of future interest
rate reductions if the Company's fixed charge coverage improves; and (v) provide
supplemental financial statements for 1998 conforming to certain financial
criteria.
As additional consideration for the Second Forbearance Agreement, Unique (or a
shareholder of Unique) has agreed to provide Heller by April 23, 1999, a $2.5
million guarantee and stand-by letter of credit securing the Company's
obligations to Heller related to Term Loan B. Upon delivery of this guarantee
and letter of credit, the $5.0 million reserve against the line of credit shall
be released, and the Company will pay, to the extent available on the line of
credit, up to $4.15 million to reduce the outstanding principal balance on Term
Loan B to $2.5 million. At such time as the balance on Term Loan B is reduced to
$2.5 million, all remaining principal payments shall be deferred until the
expiration of Term Loan B on December 31, 2003.
The Second Forbearance Agreement expires on April 30, 1999, and the Company is
presently negotiating with Heller to restructure the facility. Management is
confident that it will be able to successfully restructure the facility with
Heller before the Second Forbearance Agreement expires. The Company intends to
take whatever actions are necessary to insure that it has sufficient liquidity
to meet its cash requirements. The Company is currently considering and
implementing many options to improve liquidity, including eliminating or
deferring selected capital expenditures, selling off lower-performing assets,
and reducing internal costs. In addition, the Company is considering options to
raise capital through external sources.
The Company believes that funds generated from operations, supplemented by
available borrowings under the Heller facility, and, if necessary, additional
capital from external sources, will provide sufficient liquidity to meet the
Company's cash requirements for the year ending December 31, 1999.
Foreign Exchange
The Company has operating units located in the United Kingdom and the
Netherlands, and also conducts business in many other countries worldwide.
Foreign currency exchange rates could cause the Company's products to become
relatively more expensive in particular countries, leading to a reduction in
revenues in that country. However, to date, the Company's business has not been
significantly affected by currency fluctuations.
The Company makes substantial inventory purchases in French francs from such
suppliers as Messier-Dowty, SAMM and Eurocopter France. In the last few years,
the United States dollar has strengthened against the French franc, creating a
favorable exchange rate variance for the Company. Transactions related to the
Company's Netherlands facility are primarily denominated in United States
dollars for inventory purchases, while revenue and operating expenses are
partially denominated in Dutch guilders. The Company anticipates as much as 35%
of its 1999 consolidated revenue may be received by the Company's UK subsidiary
in British pounds sterling.
-22-
The Company's payment of the purchase price for the BA Acquisition was
denominated in pounds. To hedge against the fluctuation of pounds to dollars,
the Company entered into a transaction which permitted it to purchase
approximately $17 million of pounds at a rate of 1.6373 dollars per pound. The
balance of the purchase price was not hedged, although the spot rate when the BA
Acquisition was completed was similar to the forward hedge rate. The Company
will continue to evaluate hedging options in the future. The Company's business
will require it to continue engaging in foreign currency denominated sales, and
to incur material amounts of expense in foreign currencies. These activities may
generate gains and losses as a result of currency fluctuations.
Quarterly Revenue Fluctuations
The Company's operating results are affected by a number of factors, including
the timing of orders for repair and overhaul work, the timing of expenditures to
manufacture parts and purchase inventory in anticipation of future services and
sales, parts shortages that delay work in progress, general economic conditions
and other factors. As a result, the Company may experience significant
fluctuations in operating results from quarter to quarter. See Risk Factors--
Fluctuations in Results of Operations in Item 1 for additional detail.
Inflation
Although the Company cannot accurately anticipate the effect of inflation on
its operations, the Company does not believe that inflation has had, or is
likely to have in the foreseeable future, a material effect on its results of
operations or financial condition.
Year 2000 Issue
Description. The Company is currently working to resolve the potential impact
of the year 2000 on the processing of date-sensitive information by the
Company's computerized information systems. The year 2000 problem is the result
of computer programs being written using two digits (rather than four) to define
the applicable year. Any of the Company's programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculation or system failures.
Assessment. The Company's plan to resolve the Year 2000 issue involves the
following four phases: assessment, remediation, testing and implementation. To
date, the Company has fully completed its assessment of all systems that could
be significantly affected by the Year 2000 issue. The completed assessment
indicated that some of the Company's internal software would have to be
rewritten or upgraded, and that the Company's telephone system at Sun Valley
would have to be replaced.
Based on a review of its product lines, the Company has determined that its
products and services do not require remediation to be Year 2000 compliant.
Accordingly, the Company does not believe that the Year 2000 issue presents a
material exposure as it relates to the Company's products and services.
The Company is currently in the process of gathering information and
evaluating the Year 2000 compliance status of its significant suppliers and
subcontractors. To date the Company is not aware of any problems with its
suppliers or subcontractors that would affect the Company's operations. This
assessment is scheduled to be completed by June 15, 1999.
Remediation. The Company has completed approximately 40% of the software
reprogramming and replacement required, and expects to complete the remaining
remedial work required no later than June 15, 1999. Once software has been
reprogrammed or replaced, the Company will begin testing and implementation.
These phases run concurrently for different systems. Testing and implementation
have been completed on the remediation work already accomplished.
The Company has replaced its telephone system in Sun Valley with a Year 2000
compliant system. When a new telephone system is installed in the new UK
facility in May 1999, all communication systems within the Company will be Year
2000 compliant.
Costs. As of March 31, 1999, the total costs incurred to address the
Company's year 2000 issues approximate $120,000. The Company estimates that
another $75,000 of costs may be required to complete remediation efforts on the
year 2000 issue. Given the nature of the Company's repair and overhaul
operations, management does not believe such impact, if any, will be material.
The Company does plan, however, to devote the necessary resources to becoming
Year
-23-
2000 compliant in a timely manner. The Company believes it has an effective
program in place to resolve this issue prior to the end of the third quarter.
Contingency Plan. The Company is currently developing a contingency plan to
handle any unanticipated year 2000 problems. The Company's contingency plan is
scheduled to be completed by July 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk refers to the potential effects of unfavorable changes in certain
prices and rates on the Company's financial results and condition, primarily
foreign currency exchange rates and interest rates on borrowings. The Company
does not utilize derivative instruments in managing its exposure to such
changes.
Foreign Currency Risk. The Company has operations in the United Kingdom and
the Netherlands. The currencies of these two countries have been relatively
stable as compared with the U.S. dollar. The Company manages foreign currency
risk, in part, by generally requiring that customers pay for the services of the
Company's foreign operating units in the currency of the country where the
operating unit is located. The Company also does not routinely exchange material
sums of money between the operating units. The Company has not to date seen the
need for currency hedging transactions in the ordinary course of business. For
additional discussion on foreign currency exchange risk as it relates to the
Company's operations, please refer to: (i) Item 7--Foreign Exchange; (ii) Item
1--Risks Associated with International Expansion; and (iii) Note 1 to the
Consolidated Financial Statements--Foreign Currency Translation.
Interest Rate Risk. The Company's senior credit facility is comprised of two
notes payable and a revolving line of credit, each of which carries an interest
rate which varies in accordance with a Base Rate equal to the higher of the
Federal Reserve prime rate, or the Federal Funds Effective Rate. The Company is
subject to potentially material fluctuations in its debt service as the Base
Rate changes. The extent of this risk is not quantifiable or predictable. For
additional information, please refer to Note 1 to the Consolidated Financial
Statements--Fair Value of Financial Instruments.
In February 1998, to reduce the impact of changes in interest rates on the
Company's debt facility, the Company entered into an interest rate swap
agreement. The swap agreement reduced interest rate exposure to a fixed amount.
For additional information, please refer to Note 5 to the Consolidated Financial
Statements--Successor Lines of Credit and Notes Payable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to Part IV, Item 14 of this Form 10-K for the information
required by Item 8.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEMS 10-13. The information required by Items 10-13 of Part III is omitted and
incorporated by reference to the Company's definitive Proxy Statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A
within 120 days after the close of the Company's fiscal year.
-24-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Schedules
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
-------------------------------------------
Page
----
Report of Independent Auditors.......................................................................... 28
Consolidated Balance Sheets as of December 31, 1997 and 1998............................................ 29
Consolidated Statements of Operations for the ten months ended October 31, 1996,
two months ended December 31, 1996, the year ended December 31, 1997,
and the year ended December 31, 1998.............................................................. 31
Consolidated Statements of Changes in Shareholders' Equity for the ten months ended October 31, 1996,
two months ended December 31, 1996, the year ended December 31, 1997,
and the year ended December 31, 1998.............................................................. 32
Consolidated Statements of Cash Flows for the ten months ended October 31, 1996,
two months ended December 31, 1996, the year ended December 31, 1997,
and the year ended December 31, 1998.............................................................. 33
Notes to Consolidated Financial Statements.............................................................. 35
Note 1 - Summary of Significant Accounting Policies.................................................. 35
Note 2 - Inventories................................................................................. 39
Note 3 - Equipment and Leasehold Improvements........................................................ 40
Note 4 - Income Taxes................................................................................ 40
Note 5 - Successor Lines of Credit and Notes Payable................................................. 42
Note 6 - Commitments and Contingencies............................................................... 44
Note 7 - Related Party Transactions.................................................................. 45
Note 8 - Stock Option Plan........................................................................... 46
Note 9 - Employee Benefit Plans...................................................................... 48
Note 10 - Restructuring Charges...................................................................... 49
Note 11 - Shareholders' Equity....................................................................... 49
Note 12 - Non-monetary Exchange Transaction.......................................................... 50
Note 13 - Segment Information........................................................................ 50
Note 14 - Subsequent Events (unaudited).............................................................. 50
Schedule II. Valuation and qualifying accounts......................................................... 51
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the fourth
quarter of fiscal 1998.
-25-
(c) Exhibits
2.1 Agreement relating to the Sale and Purchase of part of the Business of
British Airways plc dated December 20, 1997 by and among the Company,
Hawker Pacific Aerospace Limited and British Airways plc, and related
Landing Gear Overhaul Services Agreement (1)+
3.1 Amended and Restated Articles of Incorporation of the Company (1)
3.2 Amended and Restated Bylaws of the Company (1)
3.3 Certificate of Amendment to the Amended and Restated Articles of
Incorporation of the Company (1)
4.1 Specimen Common Stock Certificate (1)
4.2 Form 8-A12G, Registration of Certain Classes of Securities (6)
10.1 1997 Stock Option Plan and forms of Stock Option Agreements (1)
10.1A Amendment No. 1 to 1997 Stock Option Plan (1)
10.2 Employment Agreement dated November 1, 1996 between the Company and David
L. Lokken (1)
10.2A First Amendment to Employment Agreement for David L. Lokken (1)
10.3 Employment Agreement dated November 1, 1996 between the Company and Brian
S. Aune (1)
10.3A First Amendment to Employment Agreement for Brian S. Aune (1)
10.4 Employment Agreement dated November 1, 1996 between the Company and Brian
S. Carr (1)
10.4A First Amendment to Employment Agreement for Brian S. Carr (1)
10.5 Employment Agreement dated November 1, 1996 between the Company and
Michael A. Riley (1)
10.5A First Amendment to Employment Agreement for Michael A. Riley (1)
10.6 Form of Indemnity Agreement for directors and executive officers of the
Company (1)
10.7 Business Loan Agreement dated November 27, 1996 between the Company and
Bank of America National Trust and Savings Association (1)
10.7A Amendment No. 1 to Business Loan Agreement between the Company and Bank
of America National Trust and Savings Association (1)
10.8 Agreement of Purchase and Sale of Stock effective as of November 1, 1996
by and among BTR Dunlop, Inc., BTR, Inc., the Company and AqHawk, Inc (1)
10.9 Repair, Overhaul, Exchange, Warranty and Distribution Agreement dated
November 1, 1996 between the Company and Dunlop Limited, Aviation
Division (1)+
10.10 Distribution Agreement dated November 1, 1996 between the Company and
Dunlop Limited, Precision Rubber (1)
10.11 Repair, Overhaul, Exchange, Warranty and Distribution Agreement dated
November 1, 1996 between the Company and Dunlop Equipment Division (1)+
10.12 Repair Services Agreement dated September 9, 1997 between the Company
and American Airlines, Inc (1)+
10.13 Award/Contract dated September 20, 1995 issued by USCG Aircraft Repair
and Supply Center to the Company (1)+
10.14 Maintenance Services Agreement dated August 19, 1994 between the
Company and Federal Express Corporation (1)+
10.15 Lease Agreement dated March 31, 1997 by and between the Company and
Industrial Centers Corp (1)
10.15A First Amendment to Lease Agreement dated March 31, 1997 by and between
the Company and Industrial Centers Corp. (2)
10.16 Management Services Agreement dated November 14, 1997 between the
Company and Unique Investment Corp. (1)
10.17 Mergers and Acquisitions Agreement dated September 2, 1997 between the
Company and Unique Investment Corp. (1)
10.17A Form of First Amendment to Mergers and Acquisitions Agreement between
the Company and Unique Investment Corp. (1)
10.17B First Amendment to Mergers and Acquisitions Agreement, dated as of
January 23, 1998, by and between the Company and Unique Investment Corp.
(3)
10.18 Subordinated Note for $6,500,000 in favor of Unique Investment Corp. (1)
10.19 Amended and Restated Subordinated Promissory Note dated February 3, 1998
in favor of Unique Investment Corp. (2)
10.20 Certified Translation of Rental Agreement between Mr. C. G. Kortenoever
and Flight Accessory Services (1)
10.21 Lease Agreement dated July 28, 1994 by and between the Company and
Industrial Bowling Corp. (1)
10.21A First Amendment to Lease Agreement dated July 28, 1994 by and between
the Company and Industrial Bowling Corp. (2)
10.22 Lease Agreement dated July 28, 1994 by and between the Company and
Industrial Bowling Corp. (1)
10.23 Lease Agreement dated July 28, 1994 by and between the Company and
Industrial Bowling Corp. (1)
10.24 Lease Agreement dated July 28, 1994 by and between the Company and
Industrial Bowling Corp. (1)
10.25 Lease Agreement dated June 24, 1997 by and between the Company and
AllState Insurance Company (1)
10.25A First Amendment to Lease Agreement between the Company and AllState
Insurance Company (2)
-26-
10.26 Lease Agreement dated November 21, 1994 by and between the Company and
Gordon N. Wagner and Peggy M. Wagner, and Joseph W. Basinger and Viola
Marie Basinger (1)
10.27 Amended and Restated Business Loan Agreement dated January 23, 1998
between the Company and Bank of America National Trust and Savings
Association (2)
10.28 Security Agreement dated January 23, 1998 by the Company in favor of
Bank of America National Trust and Savings Association (2)
10.29 Pledge Agreement dated January 23, 1998 by the Company in favor of Bank
of America National Trust and Savings Association (2)
10.30 Subordination Agreement dated January 23, 1998 by and among the Company,
Hawker Pacific Aerospace Limited, Bank of America National Trust and
Savings Association, Melanie L. Bastian and Unique Investment Corp. (2)
10.31 Underlease, dated February 4, 1998, by and among British Airways plc,
Hawker Pacific Limited and the Company (3) +
10.32 Bailment and Services Agreement, dated as of September 1, 1997, by and
between Federal Express Corporation and the Company (3) +
10.33 Tenancy Agreement relating to Bennebroekerweg, Rijsinboat (Netherlands),
dated March 15, 1998, between Hawker Pacific Holland, a division of the
Company, and Mateor II C.V. (4)
10.34 Statement of Terms and Conditions of Employment, dated May 12, 1998, by
and between Hawker Pacific Aerospace, Ltd., and Richard Adey (4)
10.35 Statement of Terms and Conditions of Employment, dated October 1, 1998,
by and between Hawker Pacific Aerospace and Philip Panzera (5)
10.36 Statement of Terms and Conditions of Employment, dated October 12, 1998,
by and between Hawker Pacific Aerospace and Dennis Biety (5)
10.37 Loan and Security Agreement, dated December 22, 1998, between Hawker
Pacific Aerospace and Hawker Pacific Aerospace Limited, as borrowers, and
Heller Financial, Inc., and NMB-Heller Limited
10.38 Lease relating to Unit 3 Dawley Park, Hayes, Middlesex, dated April
7,1998, between Sun Life Assurance plc and Hawker Pacific Aerospace
Limited and Hawker Pacific Aerospace
10.39 Sublease related to Building 9, Sun Valley, dated January 14, 1998,
between Hawker Pacific Aerospace and Abex Display Systems, Inc.
10.40 Forbearance Agreement between Hawker Pacific Aerospace and Hawker Pacific
Aerospace Limited, as borrowers, and Heller Financial, Inc., and NMB-
Heller Limited, dated March 10, 1999
10.41 Second Forbearance Agreement between Hawker Pacific Aerospace and Hawker
Pacific Aerospace Limited, as borrowers, and Heller Financial, Inc., and
NMB-Heller Limited, dated April 13, 1999
21.1 Subsidiaries of Registrant (filed herewith on page 53)
27.1 Financial Data Schedule
_______________________________
+ Portions of exhibits deleted and filed separately with the Securities and
Exchange Commission pursuant to a request for confidentiality
(1) Previously filed as an exhibit to the Company's Registration Statement on
Form S-1, as amended (Registration No. 333-40295), and incorporated herein
by reference
(2) Previously filed as an exhibit to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997, and incorporated herein by reference
(3) Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997, and incorporated herein by
reference
(4) Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, and incorporated herein by
reference
(5) Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, and incorporated herein by
reference
(6) Previously filed with the Securities and Exchange Commission on March 23,
1999, and incorporated herein by reference
(d) Financial Statement Schedules
Schedule II -- Valuation And Qualifying Accounts, has been included
herein under Item 14(a) above.
-27-
Report of Independent Auditors
The Board of Directors
Hawker Pacific Aerospace
We have audited the accompanying consolidated statements of operations and cash
flows of Hawker Pacific Aerospace, a wholly-owned subsidiary of BTR Dunlop
Holdings, Inc. (the "Predecessor") for the ten months ended October 31, 1996. We
have also audited the accompanying consolidated balance sheets of Hawker Pacific
Aerospace (the "Successor") as of December 31, 1997 and 1998, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for the two months ended December 31, 1996 and the years ended December
31, 1997 and 1998. These financial statements are the responsibility of the
Predecessor's and Successor's management. Our responsibility is to express an
opinion on these financial statements and schedule 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.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hawker Pacific
Aerospace at December 31, 1997 and 1998, and the results of their operations and
their cash flows, as the Predecessor and Successor companies, for the ten months
ended October 31, 1996, the two months ended December 31, 1996, and the years
ended December 31, 1997 and 1998, in conformity with generally accepted
accounting principles.
Ernst & Young LLP
Woodland Hills, California
February 13, 1999, except for
paragraphs 5 through 9 of Note 5,
for which the date is April 12, 1999
-28-
CONSOLIDATED BALANCE SHEETS
Assets
December 31, 1998 1997
----------------------------------------------------------------------------------------
Current assets
Cash $ 560,000 $ 160,000
Accounts receivable, less allowance for
doubtful accounts of $301,000 and $147,000
at December 31, 1998 and
1997, respectively 12,303,000 7,351,000
Other receivables 114,000 80,000
Inventories 21,645,000 14,814,000
Prepaid expenses and other current assets 617,000 240,000
------------ ------------
Total current assets 35,239,000 22,645,000
Equipment and leasehold improvements, net 9,298,000 5,083,000
Landing gear exchange, less accumulated
amortization of $1,844,000 and $375,000
at December 31, 1998 and 1997, respectively 37,877,000 11,067,000
Goodwill, less accumulated amortization of
$25,000 at December 31, 1997 -- 145,000
Deferred taxes 1,916,000 --
Deferred financing costs 798,000 262,000
Deferred offering costs -- 766,000
Other assets 2,109,000 930,000
------------ ------------
Total assets $ 87,237,000 $ 40,898,000
=============================================================================================
See Accompanying Notes to Consolidated Financial Statements
-29-
CONSOLIDATED BALANCE SHEETS
(continued)
Liabilities and Shareholders' Equity
December 31, 1998 1997
-------------------------------------------------------------------------------------
Current liabilities
Line of credit $37,185,000 $ 8,529,000
Accounts payable 12,171,000 6,946,000
Deferred revenue 1,023,000 848,000
Accrued payroll and employee benefits 1,433,000 812,000
Accrued expenses and other liabilities 1,242,000 316,000
Current portion of notes payable 11,280,000 1,450,000
------------ ------------
Total current liabilities 64,334,000 18,901,000
Notes payable
Bank note -- 11,200,000
Related party 2,500,000 6,500,000
------------ ------------
2,500,000 17,700,000
Commitments and contingencies
Shareholders' equity
Preferred stock: 5,000,000 and 400 shares
authorized at December 31, 1998 and 1997,
respectively; issued and outstanding: none and
400 shares at December 31, 1998 and
1997, respectively -- 2,000,000
Common stock: 20,000,000 shares authorized;
issued and outstanding: 5,822,222 and 2,972,222
shares at December 31, 1998 and 1997, respectively 21,108,000 1,040,000
Retained earnings (deficit) (941,000) 1,257,000
Accumulated other comprehensive income 236,000 --
------------ ------------
Total shareholders' equity 20,403,000 4,297,000
------------ ------------
Total liabilities and shareholders' equity $ 87,237,000 $ 40,898,000
==========================================================================================
See Accompanying Notes to Consolidated Financial Statements
-30-
CONSOLIDATED STATEMENTS OF OPERATIONS
Successor Predecessor
---------------------------------------------- -------------
Year Year Two Months Ten Months
Ended Ended Ended Ended
December 31, December 31, December 31, October 31,
1998 1997 1996 1996
- -------------------------------------------------------------------------------------------------------
Revenue $ 65,151,000 $ 41,042,000 $ 6,705,000 $ 32,299,000
Cost of revenue 55,059,000 31,430,000 4,599,000 27,027,000
------------ ------------ ----------- ------------
Gross profit 10,092,000 9,612,000 2,106,000 5,272,000
------------ ------------ ----------- ------------
Operating expenses
Selling expenses 3,621,000 3,191,000 525,000 2,248,000
General and administrative expense 6,143,000 2,706,000 534,000 2,796,000
Restructuring charges -- -- -- 1,196,000
------------ ------------ ----------- ------------
Total operating expense 9,764,000 5,897,000 1,059,000 6,240,000
------------ ------------ ----------- ------------
Income (loss) from operations 328,000 3,715,000 1,047,000 (968,000)
Other (expense) income
Interest expense (3,402,000) (2,431,000) (203,000) (1,609,000)
Interest income 74,000 3,000 7,000 --
Other expense, net -- (32,000) -- --
------------ ------------ ----------- ------------
Total other (expense) income (3,328,000) (2,460,000) (196,000) (1,609,000)
------------ ------------ ----------- ------------
Income (loss) before income
tax provision (benefit) and
extraordinary item (3,000,000) 1,255,000 851,000 (2,577,000)
Income tax provision (benefit) (1,402,000) 467,000 382,000 (971,000)
------------ ------------ ----------- ------------
Income (loss) before extraordinary
item (1,598,000) 788,000 469,000 (1,606,000)
Extraordinary loss on early
extinguishment of debt (net of
tax benefit of $354,000) (600,000) -- -- --
------------ ------------ ----------- ------------
Net income (loss) $ (2,198,000) $ 788,000 $ 469,000 $ (1,606,000)
======================================================================================================
Earnings (loss) per common share:
basic and diluted $( 0.39) $0.25 $0.15
============ =========== ==========
Weighted average common
and common equivalent
shares outstanding 5,622,770 3,145,079 3,170,551
============ =========== ==========
See Accompanying Notes to Consolidated Financial Statements
-31-
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Preferred Stock Common Stock Retained Other
--------------- ------------ Earnings Comprehensive
Shares Amount Shares Amount (Deficit) Income Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at November 1, 1996 -- $ -- -- $ -- $ -- $ -- $ --
Issuance of preferred stock 400 2,000,000 -- -- -- -- 2,000,000
Issuance of common stock to
founders -- -- 2,640,955 -- -- -- --
Issuance of common stock to
management -- -- 229,648 40,000 -- -- 40,000
Net income and comprehensive
income for the period -- -- -- -- 469,000 -- 469,000
------ ----------- --------- ----------- ----------- --------- -----------
Balance at December 31, 1996 400 2,000,000 2,870,603 40,000 469,000 -- 2,509,000
Issuance of common stock -- -- 101,619 1,000,000 -- -- 1,000,000
Net income and comprehensive
income for the year -- -- -- -- 788,000 -- 788,000
------ ----------- --------- ----------- ----------- --------- ----------
Balance at December 31, 1997 400 2,000,000 2,972,222 1,040,000 1,257,000 -- 4,297,000
Net loss for the year -- -- -- -- (2,198,000) -- (2,198,000)
Foreign currency translation -- -- -- -- -- 236,000 236,000
-----------
Comprehensive loss -- -- -- -- -- -- (1,962,000)
Conversion of preferred stock (400) (2,000,000) 250,000 2,000,000 -- -- --
Issuance of common stock -- -- 2,600,000 18,068,000 -- -- 18,068,000
------ ----------- --------- ----------- ----------- --------- -----------
Balance at December 31, 1998 -- $ -- 5,822,222 $21,108,000 $ (941,000) $ 236,000 $20,403,000
================================ ====== =========== ========= =========== =========== ========= ===========
See Accompanying Notes to Consolidated Financial Statements
-32-
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Year Two Months Ten Months
Ended Ended Ended Ended
December 31, December 31, December 31, October 31,
1998 1997 1996 1996
- -------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) ($2,198,000) $ 788,000 $ 469,000 ($1,606,000)
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Extraordinary loss 954,000 -- -- --
Deferred income taxes (1,771,000) 466,000 382,000 (971,000)
Depreciation 1,464,000 741,000 183,000 525,000
Amortization 1,743,000 463,000 17,000 294,000
Non cash restructuring charge -- -- -- 561,000
Stock compensation -- -- 40,000 --
(Gain) on the sale of machinery,
equipment and landing gear -- (78,000) -- --
Changes in operating assets and liabilities:
Accounts and other receivables (4,986,000) (1,036,000) (103,000) 1,771,000
Inventory (4,870,000) (185,000) (901,000) 1,156,000
Prepaid expenses and other
current assets (377,000) 104,000 21,000 (72,000)
Accounts payable 5,225,000 622,000 2,195,000 (2,681,000)
Deferred revenue 175,000 (745,000) 115,000 532,000
Accrued liabilities 1,546,000 (818,000) (139,000) 261,000
----------- ----------- ------------ -----------
Cash (used in) provided by operating
Activities (3,095,000) 322,000 2,279,000 (230,000)
- -------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of equipment, leasehold
improvements and landing gear (7,427,000) (2,890,000) (155,000) (1,173,000)
Proceeds from disposals of equipment,
leasehold improvements and landing gear -- 250,000 -- --
Purchase of equipment and landing gear
from British Airways (26,585,000) -- -- --
Purchase of inventory from British Airways (1,961,000) -- -- --
Other assets (1,162,000) (824,000) -- (26,000)
Acquisition of Predecessor -- -- (28,398,000) --
----------- ----------- ------------ -----------
Cash used in investing activities (37,135,000) (3,464,000) (28,553,000) (1,199,000)
- -------------------------------------------------------------------------------------------------------------------
-33-
CONSOLIDATED STATEMENT OF CASH FLOWS
(continued)
Year Year Two Months Ten Months
Ended Ended Ended Ended
December 31, December 31, December 31, October 31,
1998 1997 1996 1996
------------- ------------- ------------- -----------
FINANCING ACTIVITIES
Borrowing under bank note $ 38,766,000 $ -- $13,500,000 $ --
Principal payments on bank note (40,136,000) (850,000) -- --
Principal payments on related party note (4,000,000) -- -- --
Borrowing under related party note -- -- 6,500,000 --
Borrowings/payments on line of credit, net 28,656,000 3,200,000 (1,287,000) --
Proceeds from equity offering 20,800,000 -- -- --
Initial borrowing under line of credit -- -- 6,616,000 --
Borrowings/payments on Due to Parent and
affiliates (net) -- -- -- 2,193,000
Deferred offering costs (1,966,000) (766,000) -- --
Deferred financing cost (1,490,000) (337,000) -- --
Issuance of preferred stock -- -- 2,000,000 --
Contributions to capital -- 1,000,000 -- 242,000
------------ ---------- ----------- -----------
Cash provided by financing activities 40,630,000 2,247,000 27,329,000 2,435,000
- -----------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash 400,000 (895,000) 1,055,000 1,006,000
Cash, beginning of period 160,000 1,055,000 -- 399,000
------------ ---------- ----------- -----------
Cash, end of period $ 560,000 $ 160,000 $ 1,055,000 $1,405,000
=================================================================================================================
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest $ 3,291,000 $2,261,000 $ 193,000 $1,279,000
Income taxes $ 81,000 $ 3,000 $ -- $ 20,000
Non-cash investing and financing activities
Acquisition of Predecessor:
Fair market value of assets acquired $34,973,000
Fair market value of liabilities assumed (5,170,000)
Less cash received (1,405,000)
-----------
Net cash paid $28,398,000
===========
See Accompanying Notes to Consolidated Financial Statements
-34-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Hawker Pacific Aerospace, formerly known as Hawker Pacific, Inc. (the
"Company") is a California corporation with headquarters in Sun Valley,
California, and satellite facilities in the Netherlands and, through May 31,
1996, Miami, Florida. In addition, the Company has a wholly owned subsidiary
known as Hawker Pacific Aerospace, Ltd. which operates an overhaul facility in
the United Kingdom ("UK"). The Company repairs and overhauls aircraft and
helicopter landing gear, hydromechanical components, and wheels, brakes and
braking system components for a diverse international customer base, including
commercial airlines, air cargo operators, domestic government agencies, aircraft
leasing companies, aircraft parts distributors, and original equipment
manufacturers. In addition, the Company distributes, manufactures and sells new
and overhauled spare parts and components for both fixed wing and helicopters.
Organization and Basis of Presentation
The accompanying financial statements have been prepared on the basis that the
Company will continue as a going concern. As a result of the significant
amounts of cash and operating costs related to the start up of the Company's
operations in the United Kingdom associated with the acquisition of the BA
Assets (see discussion below) and certain other charges incurred in 1998, the
Company incurred losses and negative cash flows from operating activities in
1998, has a working capital and an accumulated deficit at December 31, 1998, and
is in violation of certain financial covenants with regard to its credit
facility. Management's plans with respect to these conditions include carefully
managing cash flow, increasing liquidity and availability on the credit line
where possible, considering the viability of additional external financing,
improving the operations in the United Kingdom, and obtaining an amendment to
the Company's credit facility as discussed in Note 5.
The Company operated as a subsidiary of BTR Dunlop Holdings, Inc., a Delaware
Corporation, from December 21, 1994 to October 31, 1996. BTR Dunlop Holdings,
Inc. was a subsidiary of BTR plc, a United Kingdom company (collectively, the
"Parent").
Effective January 1, 1994, the Company merged its operations with certain
operations of Dunlop Aviation, Inc., a subsidiary of the Parent. The merger was
a combination of companies under common control and was accounted for similar to
the pooling of interests method of accounting.
Pursuant to an Agreement of Purchase and Sale of Stock, AqHawk, Inc.
purchased all of the Company's outstanding stock from BTR plc effective as of
November 1, 1996 (the "Acquisition"). AqHawk, Inc. was formed as a holding
company for the sole purpose of acquiring the stock of the Company and was
subsequently merged into the Company. The acquisition has been accounted for
under the purchase accounting method. The aggregate purchase price was
approximately $29,800,000, which includes the cost of the acquisition. The
aggregate purchase price was allocated to the assets of the Company, based upon
estimates of their respective fair market values. The excess of purchase price
over the fair values of the net assets acquired was $1,019,000 and was recorded
as goodwill. Goodwill has been subsequently reduced for the reduction of certain
allowances on deferred taxes and amortization.
The financial statements for the ten months ended October 31, 1996, are
presented under the historical cost basis of the Company, as a wholly owned
subsidiary of BTR Dunlop Holdings, Inc., the predecessor Company (the
"Predecessor"). The financial statements as of December 31, 1997 and 1998, and
for the two months ended December 31, 1996, and the years ended December 31,
1997 and 1998, are presented under the new basis of the successor company (the
"Successor") established in the Acquisition.
The following unaudited pro forma information combines the results of
operations of the Successor and Predecessor as if the Acquisition had occurred
on January 1, 1996, and includes certain pro forma adjustments to the historical
operating results for amortization of goodwill, depreciation and amortization of
fixed assets and interest expense. The pro forma information is presented for
illustrative purposes only, and is not necessarily indicative of what the actual
results of operations would have been during such period, nor is it intended to
be representative of future operations.
-35-
Twelve Months Ended
December 31, 1996
(Unaudited)
-----------------------
Revenue $39,004,000
Net loss (1,523,000)
Net loss per share (0.48)
On February 3, 1998, the Company completed an initial public offering (the
"Offering") of 2,766,667 shares of the Company's common stock. Of the 2,766,667
shares of common stock sold in the Offering, 2,600,000 shares were sold by the
Company and 166,667 shares were sold by a principal shareholder of the Company.
The principal shareholder sold 415,000 additional shares of common stock
pursuant to the exercise of an over allotment option granted to the underwriters
by the principal shareholder. The Company received net proceeds of approximately
$18.1 million, net of expenses of approximately $2.7 million. The Company used
approximately $9.2 million of the net proceeds to fund a portion of the purchase
price for certain assets of British Airways as discussed below, and
approximately $7.6 million to repay a portion of the revolving and term debt
previously outstanding under the Company's credit facility.
On February 4, 1998 (the "Acquisition Date"), the Company completed its
acquisition of certain assets of British Airways ("BA Assets"). The BA Assets
represent the assets of British Airways Engineering used to service landing gear
primarily on British Airways' aircraft. The purchase price for the BA Assets was
approximately $19.5 million, including acquisition related expenses, and
excluding a 747-400 landing gear rotable asset that was acquired during the
second quarter of 1998 for approximately $2.9 million. Transaction expenses of
$1.1 million were capitalized as part of the rotable asset value.
As part of the BA Acquisition, the Company and British Airways entered into a
seven-year exclusive service agreement on February 4, 1998, for the Company to
provide landing gear and related repair and overhaul services to substantially
all of the aircraft currently operated by British Airways.
As required by the BA purchase agreement, BA employees covered by a collective
bargaining contract continue to be covered by the contract until three years
after the date the Company completed the purchase. As of December 31, 1998,
there were 83 employees in the Company's UK subsidiary that are covered by the
BA collective bargaining agreement.
Principles of Consolidation
The consolidated financial statements include the accounts of Hawker Pacific
Aerospace and its wholly owned subsidiary, Hawker Pacific Aerospace, Ltd. All
significant intercompany transactions and balances have been eliminated.
Landing Gear Exchange
Landing gear and other rotable assets are accounted for as fixed assets at
cost and are depreciated over their estimated useful lives to their respective
salvage values. These assets include various airplane, wing, body and nose
landing gear shipsets. Landing gear and other rotable assets are held for the
purpose of exchanging the asset with a customer to allow the customer's aircraft
to get back in service in the shortest possible time. Certain of the Company's
contracts could not have been obtained without sufficient rotable inventory to
meet the customer's requirements.
As the landing gear is exchanged and the customer is billed for the cost of
the repair, the landing gear or other parts are typically repaired and
overhauled and maintained as property of the Company for future exchanges. The
estimated useful lives range from 10 to 15 years depending on the age of the
aircraft type, and the Company's estimate of how many years of overhaul demand
remain. Amortization expense is recorded as a cost of revenue using the
straight-line amortization method.
Recognition of Revenue
The Company generates revenue primarily from repair and overhaul services. In
some cases repair and overhaul services include exchange fees for the exchange
of the Company's landing gear or other parts needing repair or overhaul
services. The Company also generates revenue from the sale and distribution of
spare parts. Spare parts sales and exchange fee revenues are each individually
less than 10% of total revenues.
-36-
Revenue for repair and overhaul services not involving an exchange transaction
is recognized when the job is complete and shipped to the customer. Deferred
revenue is principally comprised of customer prepayments and progress billings
related to the overhaul and repair of landing gear and other services which are
in process. Revenue from spare parts sales is recognized at the time of
shipment. Landing gear exchange fees are recognized on shipment of the exchanged
gear to the customer. Revenue for repair and overhaul service involving an
exchange is recognized when the cost of repairing the part received from the
customer is known and billable.
Concentrations of Risk
Major Customers. The Company performs credit evaluations and analysis of
amounts due from its customers; however, the Company generally does not require
collateral. Credit losses have been within management's expectations and an
estimate of uncollectible accounts has been provided for in the financial
statements.
Three customers accounted for 22.3%, 17.5% and 9.9% of the Company's revenue
for the year ended
December 31, 1998, and represented 25.7%, 19.4% and 5.1%, respectively, of the
accounts receivable balance at December 31, 1998.
One customer accounted for 19.3% of the Company's revenue for the year ended
December 31, 1997, and represented 18.9% of the accounts receivable balance at
December 31, 1997.
One customer accounted for 13.1% of the Company's revenue for the two month
period ended December 31, 1996, and represented 7.4% of the accounts receivable
balance at December 31, 1996.
Revenues from two customers, who each accounted for more than 10% of total
revenue, were 19.6% and 11.7%, respectively, of the Company's total revenue for
the ten month period ended October 31, 1996.
Major Vendors. Two vendors accounted for $17,510,000 of the Company's total
purchases during the year ended December 31, 1998.
Three vendors accounted for $9,283,000 of the Company's total purchases during
the year ended December 31, 1997.
Three vendors accounted for $1,901,000 of the Company's total purchases for
the two month period ended December 31, 1996.
Two vendors accounted for $7,030,000 of the Company's total purchases during
the ten month period ended October 31, 1996.
Inventories
Inventories are stated at the lower of cost or market. Purchased parts and
assemblies are valued based on their weighted average cost. Work-in-process
inventory includes purchased parts, direct labor and factory overhead.
Provisions for potentially obsolete or slow-moving inventory are made based on
management's analysis of inventory levels, turnover and future revenue
forecasts.
-37-
Equipment and Leasehold Improvements
Equipment and leasehold improvements are recorded at cost. Depreciation
expense is being provided using the straight-line method based on the following
estimated useful lives.
Predecessor Successor
----------------- -----------------
Leasehold improvements Lesser of life of Lesser of life of
lease or asset lease or asset
Machinery and equipment 13.3 years 8 years
Tooling 13.3 years 5 years
Furniture and fixtures 7 years 5 years
Vehicles 5 years 3 years
Computer equipment 5 years 3 years
Expenditures for repairs are expensed as incurred, and additions and
betterments are capitalized.
Goodwill
In connection with the purchase of the Company by AqHawk, Inc. as previously
described, the Company recorded goodwill which represents the excess of the
purchase price over the estimated fair value of the net assets acquired. The
Company was amortizing goodwill using the straight-line method over a period of
fifteen years. The Company assesses the recoverability of its goodwill whenever
adverse events or changes in circumstances or business climate indicate that
expected future cash flows for the business may not be sufficient to support
recorded goodwill.
At December 31, 1997 and 1998, goodwill was reduced by $466,000 and $145,000,
respectively, due to the realization of certain deferred tax assets and the
corresponding reduction of the valuation allowance established in the allocation
of the purchase price of the Acquisition. As a result of the reduction there is
no remaining amount of goodwill at December 31, 1998.
Foreign Currency Translation
The Company considers the local currency of its foreign operations to be the
functional currency. Accordingly, the Company translates the assets and
liabilities of its foreign operations at the rate of exchange in effect at the
period end. Revenues and expenses are translated using an average of exchange
rates in effect during the period. Translation adjustments are recorded as a
separate component of other comprehensive income (loss) and are included in
shareholders' equity. Transaction gains and losses other than on inter-company
accounts deemed to be of a long-term nature are included in net income in the
period they occur.
Realized and unrealized foreign exchange gains (losses) recognized in earnings
amounted to $33,000, ($3,000), $298,000 and $425,000 for the ten months ended
October 31, 1996, the two months ended December 31, 1996, and the years ended
December 31, 1997 and 1998, respectively.
Earnings (Loss) per Share
Earnings (loss) per common share are computed based on the weighted average
number of shares outstanding during each period. The weighted average number of
shares outstanding give effect to the stock split and conversion of preferred
stock discussed in Note 11 as if they had occurred on November 1, 1996.
Basic earnings (loss) per common share is computed based upon the weighted
average number of common shares outstanding for the period. Diluted earnings per
common share reflects the potential dilution that could occur if certain
securities were exercised or converted into common stock. Basic earnings (loss)
per share is the same as diluted earnings (loss) per share for all periods
presented and includes 250,000 shares issued upon the conversion of the
preferred stock discussed in Note 11, as if converted at the beginning of the
period. The number of shares used in the calculation of basic and diluted
earnings per share was 3,170,551, 3,145,079 and 5,622,770 for the two months
ended December 31, 1996 and the years ended December 31, 1997 and 1998,
respectively.
Options to purchase 613,107 shares of common stock at exercise prices between
$3.50 and $9.88 were outstanding during 1998 but were not included in the
computation of diluted earnings per share because the exercise price was greater
-38-
than the average market price of the common shares and/or the Company incurred a
loss for the period, therefore, the effect would be antidilutive.
Fair Value of Financial Instruments
The Company's financial instruments principally consist of accounts
receivable, accounts payable, line of credit, note payable to a bank, and notes
payable to a related party as defined by Statement of Financial Accounting
Standards No. 107, "Disclosures About Fair Value of Financial Instruments." The
carrying value of accounts receivable and accounts payable approximate their
fair value because of the short-term nature of these instruments. The carrying
value of the line of credit and note payable to a bank approximate their fair
market value since these financial instruments carry a floating interest rate.
The fair market value of the note payable to a related party approximates its
carrying value based on current market rates for such debt.
Management's Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements.
Significant estimates and assumptions include the accounts receivable allowance
for doubtful accounts, a provision for potentially obsolete or slow-moving
inventory, the warranty accrual, and the cost accruals for repair and overhaul
services. Actual results may differ from those estimates.
Stock-Based Compensation
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
No. 123"). Pursuant to SFAS No. 123, a company may elect to continue expense
recognition under Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB No. 25") or to recognize compensation expense
for grants of stock options, and other equity instruments to employees based on
the fair value methodology outlined in SFAS No. 123. SFAS No. 123 further
specifies that companies electing to continue expense recognition under APB No.
25 are required to disclose pro forma net income and pro forma earning per share
as if fair value based accounting prescribed by SFAS No. 123 has been applied.
The Company has elected to continue expense recognition pursuant to APB No. 25.
Comprehensive Income (Loss)
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes new rules for the reporting and display of comprehensive income
(loss) and its components. The components of other comprehensive income (loss)
consist entirely of foreign currency translation adjustments related to the
Company's operations in the United Kingdom.
2. INVENTORIES
Inventories are comprised of the following:
December 31,
--------------------------
1998 1997
----------- ------------
Purchased parts and assemblies $19,251,000 $11,961,000
Work-in-process 2,394,000 2,853,000
----------- -----------
$21,645,000 $14,814,000
=========== ===========
-39-
3. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements, at cost, consist of the following:
December 31,
------------
1998 1997
----------- -----------
Leasehold improvements $ 1,770,000 $ 1,575,000
Machinery and equipment 7,631,000 3,394,000
Tooling 533,000 356,000
Furniture and fixtures 265,000 199,000
Vehicles 38,000 30,000
Computer equipment 1,518,000 384,000
----------- -----------
11,755,000 5,938,000
Less: accumulated depreciation 2,457,000 855,000
----------- -----------
$ 9,298,000 $ 5,083,000
=========== ===========
4. INCOME TAXES
The tax provision of the Predecessor has been computed as if the Predecessor
filed a separate income tax return. Under a tax sharing arrangement with its
Parent, the Predecessor's deferred tax assets were expected to be recoverable
against the current or future earnings of the Predecessor or its Parent.
For the two months ended December 31, 1996, and the years ended December 31,
1997 and 1998, the tax provision has been computed on a stand-alone basis. A
full valuation allowance for the Successor's net deferred tax assets was
provided at the Acquisition date as an adjustment to goodwill due to future
uncertainty concerning the ultimate realization of the net deferred tax asset.
-40-
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
December 31,
-------------------------
1998 1997
----------- -----------
Deferred tax assets
Net operating loss carryforwards $4,308,000 $3,013,000
Inventory valuation accruals 709,000 439,000
Accounts receivable valuation accruals 121,000 64,000
Employee benefits and compensation 305,000 169,000
Product and service warranties -- 70,000
State tax credits 178,000 127,000
Other items, net -- 76,000
---------- ----------
Total deferred tax assets 5,621,000 3,958,000
Less valuation allowance (225,000) (659,000)
---------- ----------
Net deferred tax asset 5,396,000 3,299,000
========== ==========
Deferred tax liabilities:
Depreciation and amortization
in fixed assets basis 3,302,000 3,234,000
Other items, net due to accelerated depreciation
and tax deferred exchanges 178,000 65,000
---------- ----------
Total deferred tax liabilities 3,480,000 3,299,000
---------- ----------
Net deferred tax asset after allowance 1,916,000 $ --
========== ==========
Significant components of the provision (benefit) for taxes based on income
(loss) are as follows:
Successor Predecessor
------------ ------------
Year Year Two Months Ten Months
Ended Ended Ended Ended
December 31, December 31, December 31, October 31,
1998 1997 1996 1996
------------- ------------ ------------ ------------
Current:
Federal $ -- $ -- $ -- $ --
State 1,000 1,000 -- --
---------- ---------- --------- ----------
1,000 1,000 -- --
Deferred:
Federal (1,114,000) 466,000 277,000 (746,000)
State (289,000) -- 105,000 (225,000)
---------- ---------- --------- ----------
(1,403,000) 466,000 382,000 (971,000)
---------- ---------- --------- ----------
(Benefit) provision for taxes ($1,402,000) $467,000 $ 382,000 $ (971,000)
=========== =========== ========== ===========
For the years ended December 31, 1997 and 1998, reductions were made in the
valuation reserve of approximately $466,000 and $434,000, respectively, of which
$466,000 for 1997 and $145,000 for 1998 were credited against goodwill. For the
year ended December 31, 1997, deferred tax assets of $302,000 were determined
not to be realizable and were charged directly against the valuation allowance.
At December 31, 1998, there is no valuation allowance on the net deferred tax
asset because management considers the use of the net deferred tax asset more
likely than not.
-41-
A reconciliation of the statutory federal income tax rate to the effective tax
rate, as a percentage of income before tax, is as follows:
Successor Predecessor
-------------- -------------
Year Year Two Months Ten Months
Ended Ended Ended Ended
December 31, December 31, December 31, October 31,
1998 1997 1996 1996
-------------- ------------- ------------- -------------
Statutory federal income tax rate (34%) 34% 34% (34)%
Nondeductible expenses 7 3 3 2
State income taxes, net of
federal benefit (10) -- 8 (6)
Decrease in valuation reserve (10) -- -- --
---- ---- ---- ----
Effective tax rate (47)% 37% 45% (38%)
The Company has net operating loss carryforwards for federal tax purposes of
$11,437,000 which expire in the years 2008 to 2018. The Company also has state
net operating loss carryforwards of $4,745,000 which expire in the years 1999 to
2003. Utilization of approximately $7,600,000 of federal and $3,200,000 of state
net operating loss carryforwards are subject to limitation as a result of
ownership changes. Such limitations are not anticipated to have a material
impact on the Company's ability to utilize such net operating loss
carryforwards.
5. SUCCESSOR LINES OF CREDIT AND NOTES PAYABLE
On December 22, 1998, the Company secured a $66.3 million senior credit
facility from Heller Financial, Inc., and NMB-Heller Limited (collectively,
"Heller"). The Loan and Security Agreement (the "Heller Agreement") provides a
$55 million revolving line of credit, a Term Loan A in the amount of $4.3
million, and a Term Loan B in the amount of $7.0 million. The revolver and both
term loans expire in five years.
As a result of obtaining the Heller facility the Company incurred $954,000 of
expenses related to early extinguishment of its loan agreement with Bank of
America. This expense is presented in the Consolidated Statements of Operations
for the year ended as of December 31, 1998, as an extraordinary item net of
related tax benefit of $354,000.
At December 31, 1998, all three instruments carried interest at a base rate of
7.75%. Shortly thereafter the Company elected a LIBOR rate option, which
changed applicable interest on the line of credit, Term Loan A and Term Loan B
to 7.0%, 7.25% and 7.5%, respectively. At March 26, 1999, the weighted average
interest rate for all three loans was 7.1%.
Availability for the $55 million revolving line of credit may be limited by
borrowing base criteria related to levels of accounts receivable, inventory and
exchange assets. At December 31, 1998, the Company's borrowing base was $50.3
million, of which $37.2 million had been advanced, leaving remaining
availability of $13.1 million.
On February 19, 1999, Heller established a $5 million reserve on the line of
credit as a result of the Company being in default on certain financial
covenants. On March 26, 1999, certain exchange gears were temporarily excluded
from the borrowing base as they were located in ineligible foreign countries. At
March 26, 1999, excluding the $4.0 million unavailable as a result of these
foreign gears, the Company's borrowing base was $51.2 million, of which $43.0
million had been advanced, leaving remaining availability (after the $5 million
reserve) of $3.2 million.
On March 10, 1999, the Company entered into a Forbearance Agreement with
Heller which waived certain violations of financial covenants in the Heller
Agreement. In consideration therefor, the Company agreed to: (i) accept certain
stricter financial controls; (ii) provide a consolidated business plan, and an
operational improvements plan for the UK subsidiary; (iii) pay a $75,000 fee,
and (iv) hire a third party consultant to evaluate improvement plans underway in
the UK subsidiary.
This agreement was subsequently extended in a Second Forbearance Agreement
with an effective date of April 13, 1999. In exchange for Heller's continued
agreement to forbear, the Company agreed to: (i) continue the tighter financial
controls and retain a consultant as required in the Forbearance Letter; (ii)
accept a 1.5% interest rate increase on the revolving line; (iii) forego the
ability to elect the LIBOR interest rate option; (iv) forego the benefit of
future interest rate
-42-
reductions if financial conditions improve; and (v) provide supplemental
financial statements for 1998 conforming to certain financial criteria.
Unique Investment Corporation ("Unique"), an entity controlled by shareholders
of the Company, has a $5 million subordinated debt agreement with the Company.
At the closing of the Heller Agreement, $2.5 million of principal related to
this debt was repaid to Unique.
As additional consideration for the Second Forbearance Agreement, Unique (or a
shareholder of Unique) has agreed to provide Heller by April 23, 1999, a $2.5
million guarantee and stand-by letter of credit securing the Company's
obligations to Heller related to Term Loan B. Upon delivery of this guarantee
and letter of credit, the $5.0 million reserve against the line of credit shall
be released, and the Company will pay, to the extent available on the line of
credit, up to $4.15 million to reduce the outstanding principal balance on Term
Loan B to $2.5 million. At such time as the balance on Term Loan B is reduced to
$2.5 million, all remaining principal payments shall be deferred until the
expiration of Term Loan B on December 31, 2003. The Second Forbearance Agreement
expires on April 30, 1999. The Company and Heller are continuing to negotiate a
longer term amendment to the credit facility.
The Company's note payable balance consists of the following:
December 31,
--------------------------
1998 1997
------------ -----------
Note payable to a financial institution, payable in 19
quarterly installments of $153,000, and a final payment
of $1,375,000 plus interest at prime rate, secured by the
fixed assets of the Company, maturing December 31, 2003.
The interest rate in effect at December 31, 1998, was 7.75%. $ 4,280,000 $ --
Note payable to a financial institution, payable in
quarterly installments of $350,000, plus interest at
prime rate maturing December 31, 2003. The
interest rate in effect at December 31, 1998. was 7.75%. 7,000,000 --
Note payable to a bank, payable in quarterly
installments increasing from $212,500 in 1997 to $625,000
in 2002, plus interest at either the offshore rate plus
1.875% or the bank's reference rate, paid in
full in 1998. -- 12,650,000
Note payable to related party, interest accrues
monthly at the greater of prime plus 4% or 11.8% per
annum, interest payments due monthly, subordinated
to the line of credit and term loans, maturing on the earlier
of the date such balance can be repaid per the loan
agreement or June 30, 2005. 2,500,000 6,500,000
----------- -----------
13,780,000 19,150,000
Less current 11,280,000 1,450,000
----------- -----------
$ 2,500,000 $17,700,000
=========== ===========
-43-
Maturity of notes payable as of December 31, 1998, is summarized as follows:
1999 $11,280,000
2000 --
2001 --
2002 --
2003 2,500,000
-----------
$13,780,000
===========
In February, 1998, the Company entered into an interest rate swap agreement
(the "Swap Agreement") to reduce the impact of changes in interest rates in its
floating-rate long-term debt. The Swap Agreement has an initial notional amount
of $14,700,000 reducing to $8,550,000 through the expiration date of March 28,
2002. The Company is required to pay interest on the notional amount at the rate
of 6.39% and receives from the bank a percentage of the notional amount based on
a floating interest rate. The Swap Agreement effectively reduces its interest
rate exposure to a fixed rate of 6.39% of the notional amount. The floating
interest rate in effect under the Swap Agreement is 5.625%. The Swap Agreement
had a negative fair market value of $458,000 at December 31, 1998. The Swap
Agreement is collateralized by a $1 million Treasury Bill, which is included in
Other Assets at cost, which approximates the fair value.
6. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases its facilities, certain office equipment and a vehicle
under operating lease agreements, which expire through June 2023, and which
contain certain escalation clauses based on various inflation indexes. Future
minimum rental payments as of December 31, 1998, are summarized as follows:
1999 $ 3,835,000
2000 3,279,000
2001 3,271,000
2002 3,214,000
2003 3,212,000
2004 and thereafter 45,706,000
-----------
$61,517,000
===========
In July 1997 the Company entered into a 13-year operating lease for additional
office space and warehouse facilities. In addition, significant leasehold
improvement costs were incurred during the year ended December 31, 1997.
The Company incurred rent expense of approximately $586,000, $109,000,
$795,000 and $2,898,000 for the ten months ended October 31, 1996, the two
months ended December 31, 1996, the year ended December 31, 1997, and the year
ended December 31, 1998, respectively.
Employment Agreements
The Company is obligated under certain management employment contracts through
October 31, 2001. Future minimum salary expense related to these contracts are
summarized as follows:
1999 $ 749,000
2000 525,000
2001 451,000
2002 160,000
2003 120,000
----------
$2,005,000
==========
Environmental Remediation
During 1993, the Company and other parties became defendants in a United
States Environmental Protection Agency and State of California lawsuit (the
"Plaintiffs") alleging violations of certain environmental regulations related
to the contamination of ground water in the San Fernando Valley Basin that
resulted from the release of hazardous substances.
-44-
During 1996, the Company recorded additional reserves related to this matter
for total reserves of $657,000 at October 31, 1996 and December 31, 1996. The
Company has been indemnified by BTR plc for any claims related to this matter in
excess of the amount recorded. The amount recorded at December 31, 1996,
represented the Company's portion of a settlement that was reached with the
Plaintiffs during 1997.
Included in general and administrative expense for the ten months ended
October 31, 1996, is $947,000 of legal fees and settlement cost associated with
investigating, defending and settling the environmental remediation matter.
There were no corresponding costs incurred in the two months ended December 31,
1996 or the years ended December 31, 1997 and 1998.
Litigation
The Company is involved in various lawsuits, claims and inquiries, which the
Company believes are routine to the nature of the business. In the opinion of
management, the resolution of these matters will not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company.
7. RELATED PARTY TRANSACTIONS
The Predecessor Company generated revenue and purchased goods and services
from its Parent and various subsidiaries of its Parent (collectively the
"Affiliates"). Certain long-term purchase agreements with the Affiliates have
continued under the Successor company.
Total revenue for the ten months ended October 31, 1996, from the Affiliates
was approximately $331,000. Total purchases for the ten months ended October
31, 1996, from the Affiliates was approximately $5,437,000.
In the ordinary course of business, the Company pays sales commissions to a
company which is also a shareholder of the Company. For the year ended December
31, 1997 and 1998, the Company paid $556,000 and $408,000, respectively of
commissions and reimbursed expenses to this related party.
As more fully described in Note 5, the Company is subject to a $5,000,000 note
payable to Unique, an entity controlled by shareholders of the Company. In
December 1998 the Company made a $2,500,000 principal payment on this note to
Unique. This debt is included in long-term notes payable on the 1997 and 1998
balance sheets. Interest expense on this note payable for the years ended
December 31, 1997 and 1998, amounted to $74,000 and $601,000, respectively. See
also Note 14--Subsequent Events, Related Party Transactions.
Management Fee
The Company had an agreement (the "Old Management Agreement") with Unique to
pay a management fee of $25,000 per month. Certain shareholders of the Company
are related parties to Unique. The Company paid and included in general and
administrative expense $50,000 to Unique during the period from November 1,
1996, through December 31, 1996, and $300,000 during the period from January 1,
1997, through December 31, 1997.
In September 1997, the Company and Unique entered into a new management
services agreement (the "New Management Services Agreement") pursuant to which,
upon the consummation of the Offering, the Old Management Agreement was
terminated, and Unique became entitled to receive $150,000 per year payable
monthly commencing in January 1999 for certain management services rendered to
the Company. No management fees were paid to Unique during 1998.
The New Management Services Agreement will terminate upon the Company
completing an underwritten public offering in which selling shareholders offer
25% or more of the common stock sold in such offering.
In September 1997, the Company also entered into a mergers and acquisitions
agreement with Unique pursuant to which Unique received $300,000 upon the
closing of the BA Acquisition for services provided in connection with the
acquisition. Such amount was recorded as part of the cost of the BA assets.
-45-
Due to Parent and Affiliates
The Predecessor generally funded its operations through borrowings from the
Parent through October 31, 1996. The Predecessor made payments against such
borrowings based on cash availability although there were no contractual payment
terms. During the ten months ended October 31, 1996, the weighted average
interest rate was 4.9%. During the ten months ended October 31, 1996, the
average borrowings outstanding on the Due to Parent and Affiliates account was
approximately $32,978,000. The Company recognized interest expense on borrowings
from its Parent and affiliates of $1,609,000. All borrowing amounts due to
Parent and affiliates were settled in connection with the November 1, 1996,
acquisition of the Company.
Parent Company Allocation of Expenses
The Predecessor received a charge from its Parent for certain insurance (i.e.,
workers' compensation, product liability, group medical, etc.) and employee
benefit program expenses that were contracted and paid by the Parent and
allocated to the various subsidiaries. Management believes these allocations
approximate the amounts that would have been incurred had the Predecessor
operated on a stand-alone basis. Included in general and administrative expense
and cost of revenues is $1,504,000 for the ten months ended October 31, 1996, of
costs charged to the Predecessor by the Parent for these programs.
Warranty Reimbursement from Parent
The Predecessor had an arrangement with the Parent whereby certain warranty
costs incurred by the Predecessor for the failure of parts purchased from the
Parent or its affiliates were reimbursed to the Predecessor.
8. STOCK OPTION PLAN
In November 1997, the Board of Directors adopted the Company's 1997 Stock
Option Plan (the "1997 Plan"). The 1997 Plan, provides for the grant of options
to directors, officers, other employees and consultants of the Company to
purchase up to an aggregate of 634,514 shares of common stock. The purpose of
the 1997 Plan is to provide participants with incentives that will encourage
them to acquire a proprietary interest in, and continue to provide services to,
the Company.
The exercise price of any incentive stock options granted may not be less than
100% of the fair market value of the Company's common stock as of the date of
grant (110% of the fair market value if the grant is to an employee who owns
more than 10% of the total combined voting power of all classes of capital stock
of the Company). Nonqualified options may be granted under the 1997 Plan at an
exercise price of not less than 85% of the fair market value of the Common Stock
on the date of grant. Options may not be exercised more than ten years after the
date of grant (five years after the date of grant if the grant is an incentive
stock option to an employee who owns more than 10% of the total combined voting
power of all classes of capital stock of the Company). The number of options
outstanding and the exercise price thereof are subject to adjustments in the
case of certain transactions such as mergers, recapitalizations, stock splits or
stock dividends.
In November 1997, the Board of Directors of the Company granted six-year
options to purchase 259,572 shares of common stock under the 1997 Plan. All of
these options are exercisable at the initial public offering price per share
(i.e., $8 per share). The options generally are subject to vesting and become
exercisable at a rate of 5% per quarter from the date of grant, subject to the
optionee's continuing employment with the Company. Certain options become fully
vested and exercisable upon a change in control.
In addition, in November 1997, the Board of Directors granted five-year
management stock options to purchase an aggregate of 115,365 shares of common
stock. All of these options are vested and are exercisable at the initial public
offering price per share.
The Company has adopted the disclosure-only requirements of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"). Therefore, the following information is presented in
accordance with the provisions of that Statement.
-46-
Had the Company elected to recognize compensation cost based on the fair value
of options granted as prescribed by FAS 123, net income and earnings per share
would have been reported as the pro forma amounts indicated below for the year
ended December 31, 1998:
Reported net loss ($2,198,000)
Pro forma net loss (2,695,000)
Reported diluted loss per share (0.39)
Pro forma diluted loss per share (0.48)
The fair value of each option grant was estimated as of the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
Risk free interest rate 5.2%
Dividend yield 0%
Expected stock price volatility 75.0%
Expected option lives
Incentive 5.0 years
Non-qualified 5.0 years
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options. The Company's employee stock options have
characteristics significantly different from those of traded options such as
vesting restrictions and extremely limited transferability. In addition, the
assumptions used in option valuation models (see above) are highly uncertain,
particularly the expected stock price volatility of the underlying stock.
Because changes in these uncertain input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not provide
a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosure, the estimated fair value of the options
is amortized over the option vesting periods. The pro forma effect on net
income for 1998 is not representative of the pro forma effect on net income in
future years because it does not take into consideration pro forma compensation
expense for a full year as certain options were granted at different times
during the year and it does not consider future grants. Pro forma information
in future years will reflect the amortization of a larger number of stock
options granted in several succeeding years.
A summary of the Company's stock option plans and changes in outstanding
options for the year ended December 31, 1998, is presented below:
Shares Weighted
Under Average
Option Exercise Price
--------- --------------
Options granted in connection with IPO 374,937 $8.00
Options granted 406,892 4.48
Options cancelled (168,722) 8.00
Options exercised -- --
-------
Options outstanding at end of year 613,107 5.66
-------
Options exercisable at end of year 165,836 4.76
-------
Weighted average fair value of options
granted during the year $2.61
=====
Included in the totals of options granted and options cancelled were 144,207
options that were repriced from $8.00 to $3.56. These options included all
115,365 options granted to senior management in November 1997, and 28,842
options granted to senior management under the 1997 Plan. These options were
repriced to be consistent with options granted to certain members of middle
management in October 1998. The strike price for these options was established
at the $3.56 closing price of the Company's common stock on the date issued.
-47-
The following table summarizes stock options outstanding information at December
31, 1998.
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------- ---------------------------------
Weighted-Average Weighted
Range of Remaining Weighted Average Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- --------------- ----------- ---------------- -------------- ----------- --------------
$6.91-$7.90 43,261 9.8 $7.00 -- $0.00
$7.90-$8.89 235,937 8.7 $8.00 44,703 $8.00
$8.89-$9.88 14,861 9.2 $9.88 -- $0.00
$2.96-$3.95 319,048 7.6 $3.56 121,133 $3.56
------- --- ----- ------- -----
613,107 9.2 $5.66 165,836 $4.75
======= =======
9. EMPLOYEE BENEFIT PLANS
During the ten months ended October 31, 1996, the Company recorded a net
periodic pension expense of $234,000 as part of the allocated charges from the
Parent.
Effective January 1, 1997, the Company adopted a defined benefit pension plan
(the "1997 Plan") to provide retirement benefits to its employees. This non-
contributory plan covers substantially all employees of the Company as of the
effective date of the plan. Pursuant to plan provisions, normal monthly
retirement benefits are equal to the participant's credited benefit service (up
to a maximum of 35 years), times the sum of 0.75% of the participant's final
average monthly compensation, plus 0.65% of such compensation in excess of the
participant's covered average monthly wage. The plan also provides for early
retirement and certain death and disability benefits. The Company's funding
policy for the plan is to contribute amounts sufficient to meet the minimum
funding requirements of the Employee Retirement Income Security Act of 1974,
plus any additional amounts which the Company may determine to be appropriate.
The net pension cost for the Company-sponsored defined benefit pension plan
for the years ended December 31, 1997 and 1998, includes the following
components:
Pension Benefits
-----------------
1998 1997
----------------- ------------
Change in benefit obligation
Benefit obligation at beginning of year $1,040,000 $ --
Service cost 137,000 94,000
Interest cost 73,000 54,000
Actuarial losses 87,000 147,000
Prior service costs -- 745,000
Benefits paid (8,000) --
---------- -----------
Benefit obligation at end of year 1,329,000 1,040,000
---------- -----------
Change in plan assets
Fair value of plan assets at beginning of year -- --
Actual return on plan assets 51,000 --
Company contributions 340,000 --
Benefits paid (8,000) --
---------- -----------
Fair value of plan assets at end of year 383,000 --
---------- -----------
Funded status of the plan (underfunded) (946,000) (1,040,000)
Unrecognized net actuarial losses 149,000 113,000
Unamortized prior service cost 711,000 745,000
---------- -----------
Prepaid (accrued) benefit cost $ (86,000) $ (182,000)
========== ===========
The Company made contributions of $340,000 to the Plan during 1998. No
contributions were made to the Plan during 1997.
-48-
The assumptions used in the determination of the net pension cost for the
defined benefit pension plan for the years ended December 31, 1997 and 1998,
were as follows:
Discount rate 7%
Rate of increase in compensation levels 3%
Expected long-term rate of return on assets 7%
Effective January 1, 1997, the Company also adopted a defined contribution
401(k) retirement savings plan which covers substantially all employees of the
Company. Plan participants are allowed to contribute up to 15% of their base
annual compensation and are entitled to receive a company match equal to 50% of
the participant's contribution up to a maximum of 6% of the participant's annual
base compensation. Participant contributions to the plan are immediately fully
vested while the Company matching contributions are subject to a five-year
vesting period. All contributions to the plan are held in a separate trust
account. During the years ended December 31, 1997, and December 31, 1998, the
Company's matching contribution amounted to $137,000 and $168,000, respectively.
This amount was expensed during the period and is included in the Statement of
Operations.
Employees associated with the BA Acquisition continued to participate in the
BA pension plan in 1998. The Company incurred $436,000 of expense related to
contributions to this plan. As of December 31, 1998, the Company had accrued
$100,000 which will be contributed to the BA plan in 1999. As of January 1,
1999, the Company instituted its own pension plan for UK employees which covers
the former BA employees. The Company has no further obligation to the BA Plan
as of January 31, 1999.
10. RESTRUCTURING CHARGES
The Predecessor closed its facility in Miami, Florida, in May 1996. This
closure and the transfer of certain fixed assets and inventory to the Sun
Valley, California, facility resulted in a nonrecurring restructuring charge of
$1,196,000 in the Statement of Operations for the ten months ended October 31,
1996. The nonrecurring charge primarily includes costs incurred related to fixed
and other asset write-offs of approximately $600,000, payroll and severance
costs of approximately $190,000, moving and integration costs of approximately
$243,000, with the remainder applied to facility and other charges.
Additionally, the Company recorded Miami related inventory write-offs of
approximately $489,000, which were charged to cost of sales during the ten
months ended October 31, 1996. Revenue and operating loss of Miami, Florida,
operations were approximately $2,049,000 and ($40,000), respectively for the ten
months ended October 31, 1996.
11. SHAREHOLDERS' EQUITY
AqHawk, Inc., was formed on November 1, 1996, with the issuance of 400 shares
of Series A Preferred Stock to an individual for $2,000,000 and the issuance of
5,741,206 shares of common stock to the same individual, certain shareholders of
Unique, and certain members of management of the Company. Effective November 1,
1996, AqHawk, Inc., merged with the Company through the issuance of 2,870,603
shares of common stock of the Company in exchange for the 5,741,206 shares of
common stock of AqHawk, Inc., and the issuance of 400 shares of Series A
Preferred Stock of the Company for 400 shares of Preferred Stock of AqHawk, Inc.
A value of $40,000 was assigned to 229,648 shares of common stock issued to
management, and such amount was expensed as compensation expense in the two
months ended December 31, 1996.
In 1997 the Company received $1,000,000 for the issuance of 101,619 shares of
the Company's common stock. The capital infusion was made pursuant to an
agreement under which the majority shareholder had agreed to provide to the
Company up to $1,000,000 in return for common stock. The Series A Preferred
Stock was converted into 250,000 shares of common stock in connection with the
Company's initial public offering.
As part of the Company's initial public offering, warrants to purchase 222,716
shares were issued to the underwriters. These warrants allow them to purchase a
share of stock for each warrant at $8.00 per share. The Board of Directors has
reserved 972,595 shares for these warrants, for options issued in 1997, and for
options issued or available with respect to the 1997 Plan.
-49-
In connection with the initial public offering, the Company effected a
579.48618 for one stock split of the Company's common stock in November 1997 and
a one for .9907406 reverse stock split in January 1998. All references in the
accompanying financial statements to the number of shares of common stock, per
common share amounts have been retroactively adjusted to reflect the stock
splits. All of the Company's Series A Preferred Stock were converted into an
aggregate of 250,000 shares of common stock. In addition, the Company's capital
structure was changed to reflect 20,000,000 shares of common stock. The Board of
Directors has authority to fix the rights, preferences, privileges and
restrictions, including voting rights, of those shares without any future vote
or action by the shareholders.
12. NON-MONETARY EXCHANGE TRANSACTION
During the year ended December 31, 1997, the Company sold certain landing gear
with a book value of $1,240,000 for a different landing gear valued at
$1,800,000 and cash of $250,000. In connection with the exchange transaction the
Company recognized profit of $78,000 during the year ended December 31, 1997,
representing the pro rata portion of the gain associated with the cash received.
The landing gear received in the exchange was recorded in the amount of
$1,068,000.
13. SEGMENT INFORMATION
On December 31, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). The new rules establish revised standards for public
companies relating to the reporting of financial and descriptive information
about their business segments and their enterprise-wide operations. The Company
operates in one segment. The following table sets forth certain geographic
information related to the Company's operations.
United States United Kingdom Consolidated
------------- -------------- ------------
As of December 31, 1998
- -----------------------
Total assets $46,202,000 $41,035,000 $87,237,000
Total long-lived assets (net of
depreciation and amortization) 17,097,000 30,078,000 47,175,000
For the year ended December 31, 1998
- ------------------------------------
Revenue by location of operations 49,232,000 15,919,000 65,151,000
Loss before income tax benefit
and extraordinary item (382,000) (2,618,000) (3,000,000)
The Company generated revenue from customers located outside of the United
States of $4,493,000, $1,517,000, $11,856,000 and $26,660,000, of which
$2,887,000, $1,191,000, $9,901,000 and $10,802,000 were revenues generated
from the Company's United States location for the ten months ended October 31,
1996, the two months ended December 31, 1996, and the years ended December 31,
1997 and 1998, respectively.
14. SUBSEQUENT EVENTS (unaudited)
UK Facility Lease. In April 1999 the Company entered into a 25-year operating
lease for a new 140,000 square foot facility in Hayes, approximately four miles
from Heathrow Airport. This facility replaces the current UK facility belonging
to British Airways on Heathrow. The Company takes possession of the building in
April 1999, and commences rent payments in October 1999. Annual rental payments
under the operating lease are $1,992,000.
Related Party Transactions. In April 1999, Unique (or a shareholder of
Unique) has agreed to provide Heller a $2.5 million guarantee and stand-by
letter of credit securing the Company's obligations to Heller related to Term
Loan B. See also "Note 5--Successor Lines of Credit and Notes Payable".
-50-
Preferred Share Purchase Rights. On March 25, 1999, the Company declared a
dividend distribution of one Preferred Share Purchase Right on each outstanding
share of its common stock. The Rights will be attached to the Company's common
stock and will trade separately and be exercisable only in the event that a
person or group acquires or announces the intent to acquire 20% or more of the
Company's common stock. Each Right will entitle shareholders to buy one one-
hundredth of a share of a new series of junior participating preferred stock at
an exercise price of $15.
The Company is not aware of any current intent to acquire a sufficient number
of shares of the Company's stock to trigger distribution of the Rights.
If the Company is acquired in a merger or other business combination
transaction after a person has acquired 20% or more of the Company's outstanding
common stock, each Right will entitle its holder to purchase, at the Right's
then-current exercise price, a number of the acquiring company's common shares
having a market value of twice such price. In addition, if a person or group
acquires 20% or more of Hawker Pacific Aerospace's outstanding common stock,
each Right will entitle its holder (other than such person or members of such
group) to purchase, at the Right's then-current exercise price, a number of its
common shares having a market value of twice such price.
Following an acquisition by a person or group of beneficial ownership of 20%
or more of the Company's common stock and before an acquisition of 50% or more
of the common stock, the Company's Board of Directors may exchange the Rights
(other than Rights owned by such person or group), in whole or in part, at an
exchange ratio of one one-hundredth of a share of the new series of junior
participating preferred stock per Right. Before a person or group acquires
beneficial ownership of 20% or more of the Company's common stock, the Rights
are redeemable for $.0001 per Right at the option of the Board of Directors.
The Rights are intended to enable the Company's shareholders to realize the
long-term value of their investment in the Company. They will not prevent a
takeover, but should encourage anyone seeking to acquire the Company to
negotiate with the Board prior to attempting a takeover.
The dividend distribution was made on March 25, 1999, payable to the
shareholders of record on that date. The Rights will expire on March 25, 2009.
The Rights distribution is not taxable to shareholders.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
Accounts Receivable Allowance for Doubtful Accounts
Balance at Charged to Charged to Balance at
Beginning Costs and Other the End of
Description of Period Expenses Accounts Deductions (a) Period
- ----------- --------- -------- -------- -------------- ------
Predecessor
Ten Months Ended October 31, 1996 $ 39,000 $345,000 $ -- ($188,000) $196,000
Successor
Two Months Ended December 31, 1996 196,000 -- -- (129,000) 67,000
Year Ended December 31, 1997 67,000 167,000 -- (87,000) 147,000
Year Ended December 31, 1998 $147,000 $158,000 $28,000 ($32,000) $301,000
- ---------------------
(a) Represents amounts written-off against the allowance for doubtful accounts.
-51-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HAWKER PACIFIC AEROSPACE
By /s/ Daniel J. Lubeck
------------------------
Daniel J. Lubeck
Chairman Of The Board
Date: April 14, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Daniel J. Lubeck Chairman of the Board April 14, 1999
- ------------------------------- and Secretary
Daniel J. Lubeck
/s/ David L. Lokken President, Chief Executive April 14, 1999
- ------------------------------- Officer and Director
David L. Lokken (Principal Executive
Officer)
/s/ Philip M. Panzera Vice President and Chief April 14, 1999
- ------------------------------- Financial Officer (Principal
Philip M. Panzera Financial and Accounting
Officer)
/s/ John G. Makoff Director April 14, 1999
- -------------------------------
John G. Makoff
/s/ Scott W. Hartman Director April 14, 1999
- -------------------------------
Scott W. Hartman
/s/ Joel F. McIntyre Director April 14, 1999
- -------------------------------
Joel F. McIntyre
/s/ Daniel C. Toomey, Jr. Director April 14, 1999
- -------------------------------
Daniel C. Toomey, Jr.
/s/Mellon C. Baird Director April 14, 1999
- -------------------------------
Mellon C. Baird
-52-
Exhibit 21.1 Subsidiaries of Registrant
Registrant has one wholly-owned subsidiary, Hawker Pacific Aerospace Ltd.,
which is located and incorporated in the United Kingdom.
-53-