UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to
Commission File Number 1-13025

 

AirNet Systems, Inc.

(Exact name of registrant as specified in its charter)

 

Ohio		31-1458309
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
3939 International Gateway Columbus, Ohio 43219
(Address of principal executive offices) (Zip Code)
(614) 237-9777
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

 

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 ý No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

 

As of November 4, 2004, 10,109,883 of the registrant’s common shares, par value $0.01, were outstanding.

 

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets: September 30, 2004 (Unaudited) and December 31, 2003
	Condensed Consolidated Statements of Operations (Unaudited): Three and Nine Months Ended September 30, 2004 and 2003
	Condensed Consolidated Statements of Cash Flows (Unaudited): Nine Months Ended September 30, 2004 and 2003
	Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits
SIGNATURES
INDEX TO EXHIBITS

 

2

 

AIRNET SYSTEMS, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

In thousands, except par value		September 30, 2004			December 31, 2003
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	926		$	125
Accounts receivable, less allowances		22,248			18,647
Inventory		292			286
Taxes receivable		1,012			1,401
Deposits and prepaids		4,384			3,246
Total current assets		28,862			23,705
Net property and equipment		106,863			125,102
Other assets:
Goodwill, net of accumulated amortization		—			4,018
Other		313			448
Total assets		$	136,038		$	153,273
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	13,265		$	7,442
Salaries and related liabilities		4,307			4,955
Deferred revenues		1,286			184
Accrued expenses		1,102			887
Taxes payable		—			76
Deferred income taxes		4			4
Current portion of notes payable		21,933			5,256
Total current liabilities		41,897			18,804
Other liabilities		862			1,280
Notes payable, less current portion		38,301			32,520
Deferred tax liability		408			16,389
Shareholders’ equity:
Preferred shares, $.01 par value; 10,000 shares authorized; no shares issued and outstanding		—			—
Common shares, $.01 par value; 40,000 shares authorized; 12,763 shares issued at September 30, 2004 and at December 31, 2003		128			128
Additional paid-in-capital		76,963			77,759
Retained earnings		1,959			31,938
Accumulated other comprehensive loss		(35		)	(35		)
Treasury shares, 2,654 and 2,720 shares held at cost at September 30, 2004 and December 31, 2003, respectively		(24,445		)	(25,510		)
Total shareholders’ equity		54,570			84,280
Total liabilities and shareholders’ equity		$	136,038		$	153,273

 

See notes to condensed consolidated financial statements

 

3

 

AIRNET SYSTEMS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - Unaudited

 

		Three Months Ended September 30,						Nine Months Ended September 30,
In thousands, except per share data		2004			2003			2004			2003
NET REVENUES
Delivery services, net of excise tax:
Bank services		$	26,616		$	25,996		$	78,678		$	78,000
Express services		12,844			9,265			35,725			26,906
Total delivery services revenues		39,460			35,261			114,403			104,906
Passenger charter services		4,266			2,334			11,532			5,550
Aviation services and other operations		211			425			613			1,223
Total net revenues		43,937			38,020			126,548			111,679
COSTS AND EXPENSES
Wages and benefits		6,519			6,464			19,521			18,823
Aircraft fuel		7,140			4,655			18,862			14,548
Aircraft maintenance		3,567			2,750			10,448			9,085
Contracted air costs		3,540			2,411			9,738			7,596
Ground courier		7,465			6,443			22,494			18,884
Depreciation		5,638			4,549			15,577			13,060
Insurance, rent and landing fees		2,230			2,565			7,432			7,193
Travel, training and other		2,276			2,115			7,488			6,457
Selling, general and administrative		3,559			3,846			11,566			11,400
Net (gain) loss on disposition of assets		—			(24		)	289			(6		)
Impairment of assets		42,991			—			42,991			—
Impairment of goodwill		4,018			—			4,018			—
Total costs and expenses		88,943			35,774			170,424			107,040
Income (loss) from continuing operations		(45,006		)	2,246			(43,876		)	4,639
Interest expense		777			312			1,552			1,060
Income (loss) from continuing operations before income taxes		(45,783		)	1,934			(45,428		)	3,579
Provision (benefit) for income taxes		(15,599		)	862			(15,446		)	1,503
Income(loss) from continuing operations		$	(30,184	)	$	1,072		$	(29,982	)	$	2,076
Income(loss) from discontinued operations, net of taxes		—			$	(25	)	—			$	(8	)
Net income (loss)		$	(30,184	)	$	1,047		$	(29,982	)	$	2,068
Income (loss) per share - basic and diluted
Continuing operations		$	(2.99	)	$	0.11		$	(2.98	)	$	0.21
Discontinued operations		—			$	(0.01	)	—			$	(0.01	)
Net income (loss) per share - basic and diluted		$	(2.99	)	$	0.10		$	(2.98	)	$	0.20

 

See notes to condensed consolidated financial statements

 

4

 

AIRNET SYSTEMS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - Unaudited

 

		Nine Months Ended September 30,
In thousands		2004			2003
Operating activities:
Net income (loss)		$	(29,982	)	$	2,068
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation		15,577			13,060
Impairment of assets and goodwill		47,009			—
Deferred taxes		(15,986		)	1,450
Provision for losses on accounts receivable		117			347
(Gain) loss on disposition of assets		289			(93		)
Cash provided by (used in) operating assets and liabilities:
Accounts receivable		(3,717		)	(86		)
Inventory		(6		)	(215		)
Prepaid expenses		(1,138		)	(759		)
Accounts payable		5,471			2,093
Deferred revenues and accrued expenses		1,251			1,817
Taxes payable		315			(232		)
Salaries and related liabilities		(647		)	(180		)
Other, net		137			(26		)
Net assets of discontinued operations		—			1,188
Net cash provided by operating activities		18,690			20,432
Investing activities:
Purchases of property and equipment		(43,721		)	(13,418		)
Proceeds from sales of property and equipment		3,104			17
Proceeds from sale of Mercury Business Services		—			122
Net cash used in investing activities		(40,617		)	(13,279		)
Financing activities:
Proceeds from incentive stock plan programs		119			141
Net repayments under the revolving credit facility		(2,800		)	(5,700		)
Net borrowings (repayments) of long-term debt		25,258			(894		)
Issuance (purchase) of treasury shares		151			(236		)
Net cash provided by (used in) financing activities		22,728			(6,689		)
Net increase in cash		801			464
Cash and cash equivalents at beginning of period		125			1,055
Cash and cash equivalents at end of period		$	926		$	1,519

 

See notes to condensed consolidated financial statements

 

5

 

AIRNET SYSTEMS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.             Basis of Presentation

 

AirNet Systems, Inc. and its subsidiaries (“AirNet” or the “Company”) operate a fully integrated national air transportation network which provides delivery service for time-critical shipments for customers in the U.S. banking industry and other industries requiring the express delivery of packages.  AirNet also offers passenger charter services and retail aviation fuel sales and related ground services.

 

The accompanying condensed consolidated financial statements include the accounts of AirNet Systems, Inc. and its subsidiaries.  These financial statements are unaudited and have been prepared in accordance with the instructions for Form 10-Q.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by the instructions for Form 10-Q.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in AirNet Systems, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. The results of operations for the quarterly and nine month periods ended September 30, 2004 are not necessarily indicative of the results for the full year.

 

The financial information included herein reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the results of interim periods.

 

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in those financial statements and accompanying notes thereto.  Actual results could differ from those estimates.

 

Certain reclassifications have been made in the prior year’s financial statements to conform to the presentation for the three and nine month periods ended September 30, 2004.

 

2.   Impairment of Assets and Goodwill

 

AirNet recognizes impairment losses on long-lived assets used in operations in accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144).  AirNet recognizes impairment losses on long-lived assets used in operations, when events or changes in circumstances indicate, in management’s judgment, that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying value of those assets.  The net carrying value of the assets not recoverable is reduced to fair market value if lower than carrying value.  In determining the fair market value of the assets, AirNet considers market trends, published market data, and recent transactions involving sales of similar assets.

& nbsp;

AirNet’s long-lived assets used in its cargo operations, consisting primarily of aircraft and spare parts, were determined to be impaired as of September 30, 2004.  This determination was made as a result of recent industry trends in the adoption of electronic payment alternatives and evolving electronic alternatives to the physical movement of cancelled checks at a more rapid pace than previously accepted by the industry.  AirNet believes that enactment of the Check 21 Act in October 2004 will contribute to this trend.  Furthermore, recent market data and other disclosures by the Federal Reserve confirm the accelerating decline in cancelled check volume.  AirNet’s cargo airline was originally designed, and continues to operate, primarily to meet the needs of Bank services customers. AirNet believes that its airline capacity will exceed future demand, creating an im pairment of the aircraft and related assets. The impairment also reflects the overall decline in the market values of the aircraft in its cargo fleet which have not recovered as in previous economic cycles.  AirNet determined that the expected future undiscounted cash flows from its assets used in its cargo operations were less than the carrying value of those assets and were impaired.  Accordingly, a non-cash impairment charge of $43.0 million was recorded as of September 30, 2004, using estimated aircraft fair values.  The aircraft fair values used for this purpose are based upon published market sources as of September 30, 2004, which are also used under AirNet’s Amended Credit Agreement (See Note 7).

 

Under SFAS No. 142, “Goodwill and Other Intangible Assets”, AirNet evaluates its goodwill for impairment annually, or more frequently if changes in circumstances indicate impairment may have occurred sooner.  AirNet determined that as a result of the impairment of its long-lived assets used in its cargo operations, the remaining goodwill assigned to the cargo operations should be evaluated for potential impairment.  AirNet evaluates the fair value of its goodwill related to its cargo operations based upon a discounted future cash flow analysis.  As a result of the impairment test AirNet determined that its goodwill was impaired and, accordingly, a non-cash impairment charge of $4.0 million was recorded.

 

6

 

3.             Stock Plans and Awards

 

SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

 

The Company accounts for its employee and director stock-based compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.  No stock-based employee compensation cost is reflected in net income, as all options granted have an exercise price equal to the market value of the underlying common shares on the date of grant.  Pro forma information regarding net income (loss) and net income (loss) per share, as required by SFAS No. 148, has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123, Accounting for Stock-Based Compensation. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model.

 

The following table illustrates the effect on net income (loss) and net income (loss) per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share data):

 

		Three Months Ended September 30,							Nine Months Ended September 30,
		2004				2003			2004			2003
Net income (loss), as reported		$		(30,184	)	$	1,047		$	(29,982	)	$	2,068
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects		(34			)	(23		)	(154		)	(108		)
Pro forma net income (loss)		$	(30,218		)	$	1,024		$	(30,136	)	$	1,960
Net income (loss) per share
As reported
Basic and diluted		$	(2.99		)	$	.10		$	(2.98	)	$	.20
Pro forma
Basic and diluted		$	(2.99		)	$	.10		$	(2.99	)	$	.19

 

4.             Income (Loss) Per Share From Continuing Operations

 

The following table sets forth the computation of basic and diluted income (loss) per common share from continuing operations (in thousands, except per share data):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
Numerator:
Income (loss) from continuing operations		$	(30,184	)	$	1,072		$	(29,982	)	$	2,076
Denominator:
Basic – weighted average shares outstanding		10,100			10,070			10,070			10,106
Diluted
Stock options–employees, officers, and directors		—			19			—			20
Adjusted weighted average shares outstanding		10,100			10,089			10,070			10,126
Income (loss) per share from continuing operations
Basic and diluted		$	(2.99	)	$	0.11		$	(2.98	)	$	0.21

 

7

 

Common shares subject to outstanding stock options excluded from the diluted adjusted weighted average shares outstanding calculation were 771,207 and 742,927 for the three and nine month periods ended September 30, 2004, respectively.  These options were antidilutive and excluded from the calculation because (1) the exercise price of these options was greater than the average fair market value of the underlying common shares in the respective periods or (2) the losses for the three and nine month periods ended September 30, 2004 caused the options to be antidilutive.

 

5.  Comprehensive Income

 

Comprehensive income is comprised of net income of the Company and the change in the fair value of interest rate swap agreements, net of income taxes.  Comprehensive income (loss) for the nine months ended September 30, 2004 and September 30, 2003 was ($29,642,000) and $2,081,000, respectively. Comprehensive income (loss) for the three months ended September 30, 2004 and 2003 was ($30,184,000) and $1,060,000, respectively.

 

6.   Discontinued Operations

 

On August 11, 2003, AirNet Systems, Inc. completed the sale of substantially all of the assets of its Mercury Business Services unit to Mercury Business Services, Inc., a Delaware corporation owned by a group that include the original owners of the Mercury business.

 

The sales price of the transaction was approximately $1.1 million.  Mercury Business Services, Inc. paid approximately $455,000 of the sales price through the issuance of a ninety day promissory note secured by the assets being sold and guaranteed by each of the shareholders of Mercury Business Services, Inc.  Under the terms of the Asset Purchase Agreement, approximately $536,000 of the purchase price was paid with AirNet Systems, Inc. common shares owned by the shareholders of Mercury Business Services, Inc., including 56,000 common shares tendered to AirNet Systems, Inc. prior to closing at $4.30 per share (the closing price of the AirNet Systems, Inc. common shares on the NYSE on July 25, 2003) and 68,494 common shares tendered to AirNet Systems, Inc. on the closing date at $4.31 per share (the average closing price of the AirNet Systems, Inc. common shares on the NYSE on August 4-6, 2003).  The balance of the sales price was paid in cash.

 

AirNet accounted for these operations as discontinued operations.

 

The Mercury Business Services unit had revenues of $1.0 million and $5.9 million for the three and nine month periods ended September 30, 2003, respectively.

 

Pre-tax loss for AirNet’s Mercury Business Services unit was $41,000 and $13,000 for the three and nine month periods ended September 30, 2003, respectively.

 

7.   Bank Financing Matters

 

In June 2004, AirNet entered into an amended and restated term loan and revolving loan credit facility (collectively, the “Amended Credit Agreement”) with its banks. The Amended Credit Agreement provides AirNet with a secured revolving credit facility with up to $35.0 million available and a secured term loan in the aggregate amount of $14.0 million.  The amount of revolving loans available under the Amended Credit Agreement is further limited to a borrowing base equal to the aggregate of 80% of eligible accounts receivable, plus 50% of eligible inventory, plus 70% of the market value of certain fixed assets, reduced by the aggregate amount of AirNet’s outstanding letters of credit. As of September 30, 2004, $16.0 million and $12.0 million were outstanding under the secured revolving credit facility and secured term loan, respectively.  As of September 30, 2004, AirNet had approximately $19.0 million available to borrow on its secured revolving loan facility.

 

The revolving credit facility under the Amended Credit Agreement expires on September 30, 2005 and the secured term loan matures on September 30, 2007.  As of September 30, 2004, approximately $16.0 million of the revolving credit facility was reclassified on AirNet's Condensed Consolidated Balance Sheet as current liabilities.  Quarterly principal payments of $1.0 million are required for the secured term loan beginning in June 2004 and continuing through September 30, 2007. The Amended Credit Agreement is secured by a first lien on all of the property of AirNet and its subsidiaries, other than any interest in real estate and certain excluded fixed assets.  The Amended Credit Agreement permits AirNet and its subsidiaries to incur other indebtedness for the purpose of purchasing or refinancing aircraft and related tangible fixed assets, subject to certain annual limitations.  AirNet has also pledged the interests in its subsidiaries, and each of AirNet’s

 

8

 

subsidiaries has guaranteed AirNet’s obligations under the Amended Credit Agreement.  The Amended Credit Agreement contains limitations on operating leases, indebtedness, significant corporate changes including mergers and sales of assets, investments in subsidiaries and acquisitions, liens, capital expenditures, transactions with affiliates, sales of accounts receivable, sale and leaseback transactions and other off-balance sheet liabilities, contingent obligations and hedging transactions.  The Amended Credit Agreement also contains financial covenants that require AirNet to maintain a minimum consolidated tangible net worth and to not exceed fixed charge coverage and leverage ratios specified in the Amended Credit Agreement. As a result of the impairment charge taken in September 2004 as described in Note 2, AirNet was not in compliance with the fixed charge coverage ratio and the leverage ratio calculated as of September 30, 2004, and AirNet would not be in compliance with the minimum consolidated tangible net worth requirement to be calculated as of December 31, 2004 (pursuant to the Amended Credit Agreement, this ratio is calculated annually as of December 31, AirNet’s fiscal year-end).  Effective as of November 12, 2004, AirNet and its lenders under the Amended Credit Agreement executed a waiver of any defaults or potential defaults under the Amended Credit Agreement which resulted or may have resulted from the non-compliance with the foregoing financial covenants caused by the impairment charge.  Additionally, effective as of November 12, 2004, AirNet and its lenders under the Amended Credit Agreement executed a Change in Terms Agreement which modified the foregoing financial covenants so that, on a going-forward basis, the impairment charge does not cause a default or potential default of these financial covenants in the future.

 

The Amended Credit Agreement bears interest, at AirNet’s option, at (a) a fixed rate equal to LIBOR plus a margin determined by AirNet’s leverage ratio as defined in the Amended Credit Agreement, or (b) a floating rate based on the greater of the sum of (i) the prime rate established by The Huntington National Bank from time to time plus a margin determined by AirNet’s leverage ratio and (ii) the sum of 0.5% plus the federal funds rate in effect from time to time.  After the effective date of the Amended Credit Agreement, AirNet paid off its three five-year term loans totaling approximately $3.4 million incurred during first quarter 2002.

 

During the second quarter 2004, AirNet entered into four seven-year term loans totaling $22.5 million with fixed interest rates of approximately 6.7%. As of September 30, 2004, there was $22.3 million outstanding on these secured term loans, and the net book value of the aircraft securing the loans totaled approximately $28.5 million.  In July 2004, AirNet financed two additional passenger charter Learjet 60’s for the Passenger Charter fleet at $5.0 million each with fixed rates of approximately 6.5%, for a total of $32.5 million in financing related to AirNet’s Passenger Charter services.  AirNet has pledged the interests in its subsidiaries, and each of AirNet’s subsidiaries has guaranteed AirNet’s obligations under the term loans.  Each of the term loans is secured by aircraft used in the Passenger Charter fleet.

 

9

 

AIRNET SYSTEMS, INC.

 

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

 

Safe Harbor Statement

 

Except for the historical information contained in this Form 10-Q, the matters discussed, including, but not limited to, information regarding future economic performance and plans and objectives of AirNet’s management, are forward-looking statements that involve risks and uncertainties. When used in this document, the words “believe”, “anticipate”, “estimate”, “expect”, “intend”, “may”, “plan”, “project” and similar expressions are intended to be among statements that identify forward-looking statements.  Such statements involve risks and uncertainties including, but not limited to, the following which could cause actual results to differ materially from any forward-looking statement: potential regulatory changes by the Federal Aviation Administration (“FAA”), which could increase the regulation of AirNet’s business, or potential regulatory changes by the Federal Reserve which could change the competitive environment of transporting cancelled checks; changes in check processing and shipment patterns of bank customers; the continued acceleration of migration of AirNet’s Bank customers to electronic alternatives to the physical movement of cancelled checks; adverse weather conditions; declines in the values of aircraft in AirNet’s fleet and any related asset impairment charges; the ability to successfully market the passenger charter business in light of global changes in the commercial airline industry; potential changes in locally and federally mandated security requirements; increases in aviation fuel costs not fully offset by AirNet’s fuel surcharge program; potential cost overruns associated with the construction of a new facility at Rickenbacker International Airport; acts of war and terrorist activities; the acceptance of AirNet’s time-critical service offerings within targeted Express markets; technological advances and increases in the use of electronic funds transfers; the availability and cost of financing required for operations; the impact of unusual items resulting from ongoing evaluations of our business strategies; as well as other economic, competitive and domestic and foreign governmental factors affecting AirNet’s markets, prices and other facets of its operations.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.  Please refer to the sections captioned “Forward-looking statements” and “Risk Factors” in Item 7 of the Annual Report on Form 10-K for the fiscal year ended December 31, 2003 of AirNet Systems, Inc. (File No. 1-13025) for additional details relating to risk factors that could affect AirNet’s results and cause those results to differ materially from those expressed in forward-looking statements.

 

General

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. AirNet maintains a thorough process to review the application of its accounting policies and to evaluate the appropriateness of the estimates; however, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information.

 

Management has discussed the development and selection of AirNet’s critical accounting policies and estimates with the Audit Committee of AirNet Systems, Inc.’s Board of Directors and with its independent auditors.  AirNet’s critical accounting policies have not changed significantly from the policies disclosed in Item 7 of AirNet Systems, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

 

AirNet’s audited consolidated financial statements for the fiscal year ended December 31, 2003, included in Item 8 of AirNet Systems, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, contain

 

10

 

additional disclosures regarding AirNet’s significant accounting policies and Item 7 of that Annual Report on Form 10-K includes a summary of AirNet’s critical accounting policies. The information appearing therein may be useful when reading this discussion and analysis of financial condition and results of operations.

 

Results of Operations

 

Net Revenues

 

In ‘000’s Revenues		3 months ending September 30, 2004			3 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004		9 months ending September 30, 2004			9 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004
Package Delivery Services:
Bank Services		$	26,616		$	25,996		$	620		2%		$	78,678		$	78,000		$	678		1%
Express Services		12,844			9,265			3,579			39%		35,725			26,906			8,819			33%
Total Package Delivery Services		39,460			35,261			4,199			12%		114,403			104,906			9,497			9%
Passenger Charter Services		4,266			2,334			1,932			83%		11,532			5,550			5,982			108%
Aviation Services		211			425			(214		)	(50)%		613			1,223			(610		)	(50)%
Total Net Revenues		$	43,937		$	38,020		$	5,917		16%		$	126,548		$	111,679		$	14,869		13%

 

AirNet has experienced overall net revenue growth for the three months and nine months ended September 30, 2004 over the same periods of the prior year.  This can be attributed to several factors including increased Express shipment volume and growth in Passenger Charter services as well as additional fuel surcharge revenues.

 

Bank Services Revenues

 

In ‘000’s Revenues		3 months ending September 30, 2004			3 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004		9 months ending September 30, 2004			9 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004
Bank Weekday		$	23,600		$	23,845		$	(245	)	(1)%		$	70,956		$	71,333		$	(377	)	(1)%
Bank Weekend		1,948			1,890			58			3%		5,826			5,533			293			5%
Fuel Surcharge		1,688			841			847			101%		3,792			2,972			820			28%
Federal Excise Tax		(620		)	(580		)	(40		)	7%		(1,896		)	(1,838		)	(58		)	3%
Net Revenues		$	26,616		$	25,996		$	620		2%		$	78,678		$	78,000		$	678		1%

 

Bank weekday revenues decreased in the quarter and year-to-date 2004 as compared to the same periods of the prior year.  The third quarter decrease was primarily due to a decrease in the total number of shipments as well as the number of pounds per shipment by the Company’s bank customers, while the year-to-date decrease was primarily due to a decrease in the number of pounds per shipment.  Increased fuel prices in the third quarter and year-to-date 2004 resulted in significantly higher fuel surcharge revenues compared to the same quarter and year-to-date 2003.  AirNet believes that lower check delivery volume as a result of historically low interest rates, the declining use of checks, and the Check 21 Act which became effective in October 2004, will contribute to a significant reduction in bank revenues in future periods, as will increased competitive factors from regional carriers and transportation cost reduction initiatives by AirNet’s Bank customers.

 

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Express Services Revenues

 

In ‘000’s Revenues		3 months ending September 30, 2004			3 months ending September 30, 2003			$Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004		9 months ending September 30, 2004			9 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004
Express services		$	12,723		$	9,339		$	3,384		36%		$	35,553		$	26,978		$	8,575		32%
Fuel Surcharge		508			209			299			143%		1,269			742			527			71%
Federal Excise Tax		(387		)	(283		)	(104		)	37%		(1,097		)	(814		)	(283		)	35%
Net Revenues		$	12,844		$	9,265		$	3,579		39%		$	35,725		$	26,906		$	8,819		33%

 

Express services revenues continue to increase as a percentage of total revenues, increasing from 24.4% to 29.2% of total revenue for the quarter and from 24.1% to 28.2% year-to-date compared to the same periods of the prior year.  Shipments using AirNet’s air transportation network were up 4% and 5% for the quarter and year-to-date, respectively. Shipments sent via commercial airlines increased 23% and 36% for the quarter and year-to-date, respectively, and point to point surface shipments increased 34% and 38% for the quarter and year-to-date, respectively.  Commercial air and point to point surface shipments generally incur higher courier costs compared to shipments using AirNet’s airline.  The increase in shipments sent via commercial airlines is principally due to an increase in shipments outside the AirNet airline’s scheduled delivery times and locations, which generally results in lower gross margins per shipment than shipments carried on AirNet’s airline.

 

Passenger Charter Services Revenues

 

In ‘000’s Revenues		3 months ending September 30, 2004			3 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004		9 months ending September 30, 2004			9 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004
Passenger Charter Services		$	4,266		$	2,334		$	1,932		83%		$	11,532		$	5,550		$	5,982		108%

 

Passenger Charter services revenues continue to grow as a percentage of total revenues, as AirNet has invested in additional aircraft to support additional passenger charter demand.  Revenues increased from 6.1% to 9.7% of total revenue for the quarter and from 5.0% to 9.1% year-to-date compared to the same periods of the prior year.  AirNet increased the number of passenger charter aircraft it operates from seven aircraft (two Learjet 60’s and five Learjet 35’s) at September 30, 2003 to fourteen (ten Learjet 60’s and four Learjet 35’s) at September 30, 2004.

 

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Costs and Expenses

 

In ‘000’s Costs and Expenses		3 months ending September 30, 2004			3 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			% Increase (Decrease) 2003 to 2004		9 months ending September 30, 2004			9 months ending September 30, 2003			$ Increase (Decrease) 2003 to 2004			$ Increase (Decrease) 2003 to 2004
Wages and benefits		$	6,519		$	6,464		$	55		1%		$	19,521		$	18,823		$	698		4%
Aircraft fuel		7,140			4,655			2,485			53%		18,862			14,548			4,314			30%
Aircraft maintenance		3,567			2,750			817			30%		10,448			9,085			1,363			15%
Contracted air costs		3,540			2,411			1,129			47%		9,738			7,596			2,142			28%
Ground courier		7,465			6,443			1,022			16%		22,494			18,884			3,610			19%
Depreciation		5,638			4,549			1,089			24%		15,577			13,060			2,517			19%
Insurance, rent and landing fees		2,230			2,565			(335		)	(13)%		7,432			7,193			239			3%
Travel, training and other		2,276			2,115			161			8%		7,488			6,457			1,031			16%
Selling, general and administrative		3,559			3,846			(287		)	(8)%		11,566			11,400			166			2%
Net (gain) loss on disposition of assets		0			(24		)	24					289			(6		)	295
		41,934			35,774			6,160			17%		123,415			107,040			16,375			15%
Impairment of assets		42,991			0			42,991					42,991			0			42,991
Impairment of goodwill		4,018			0			4,018					4,018			0			4,018
Total costs and expenses		$	88,943		$	35,774		$	53,169				$	170,424		$	107,040		$	63,384

 

As operating activities for AirNet’s Express and Passenger Charter services continue to increase, total operating costs and expenses increased for both the quarter and year-to-date compared to the same periods of the prior year.

 

Increases in fuel costs, wages, maintenance and depreciation are attributable, in part, to the expansion of AirNet’s Passenger Charter Services.  Five aircraft, two of which are managed aircraft, have been added to AirNet’s Passenger Charter fleet in the first nine months of 2004.  An additional 16 pilots were hired during this nine month period compared to the prior year to support Passenger Charter Services.

 

Fuel costs increased for both the quarter and year-to-date as a result of increasing fuel prices, additional fuel purchased at higher retail rates at FBO locations outside of the Port Columbus facility, and additional fuel purchases related to the increase in Passenger Charter Services.  Fuel costs related to Passenger Charter Services increased by $615,000 and $1,305,000, respectively, for the quarter and year-to-date.  The increase in fuel costs, net of fuel surcharge, related to AirNet’s cargo fleet was approximately $723,000 and $1,662,000 for the quarter and year-to-date.

 

Ground courier costs continue to increase as AirNet serves a broader group of customers outside of AirNet’s traditional bank customer.  AirNet’s growing number of Express customers are more costly to serve than the traditional bank customer due to more unscheduled pickup and delivery services and more geographically dispersed locations.  Ground courier costs have risen as Express shipments continue to increase as a proportion of total shipments.  The growth rate in shipments transported either exclusively via point to point surface or commercial airlines is increasing as AirNet expands the number of Express customers; a trend Management believes will continue.

 

Depreciation increased as a result of the addition of five Learjet 60’s (acquired in December 2003, January, May and June 2004) to the Passenger Charter fleet since the end of the 2003 fiscal year and continuing reductions to AirNet’s estimates of aircraft and engine salvage values.

 

AirNet recognizes impairment losses on long-lived assets used in operations in accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144).  AirNet recognizes impairment losses on long-lived assets used in operations, when events or changes in circumstances indicate, in management’s judgment, that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying value of those assets.  The net carrying value of the assets not recoverable is reduced to fair market value if lower than carrying value.  In determining the fair market value of the assets, AirNet considers market trends, published market data, and recent transactions involving sales of similar assets.

 

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