10-Q 1 doc1.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended August 31, 2002 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 0-18352 ------- INTERNATIONAL AIRLINE SUPPORT GROUP, INC. ----------------------------------------- (Exact name of Registrant as specified in its charter) Delaware 59-2223025 -------- ---------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 1954 Airport Road, Suite 200, Atlanta, GA 30341 ----------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (770) 455-7575 -------------- 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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO __ APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. The number of shares of the Company's common stock outstanding as of October 6, 2002 was 2,156,497. FORM 10-Q INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARYINDEX Page No. --------- Part I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets as of 3 May 31, 2002 and August 31, 2002 Condensed Consolidated Statements of Operations for the Three Months Ended August 31, 2001 and August 31, 2002 4 Condensed Consolidated Statements of Cash Flows for the Three Months Ended August 31, 2001 and August 31, 2002 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16 Item 4. Controls and Procedures 17 Part II OTHER INFORMATION Item 1. Legal Proceedings 18 Item 3. Defaults with respect to Senior Securities 18 Item 6. Exhibits and Reports on Form 8-K 18 FORM 10-Q INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS

*Condensed from audited Financial Statements The accompanying notes are an integral part of these condensed financial statements - 3 - FORM 10-Q INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

The accompanying notes are an integral part of these condensed financial statements - 4 - FORM 10-Q INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

The accompanying notes are an integral part of these condensed financial statements. - 5 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain adjustments (consisting only of normal and recurring adjustments) necessary to present fairly International Airline Support Group, Inc. and Subsidiaries' condensed consolidated balance sheets as of May 31, 2002 and August 31, 2002, the condensed consolidated statements of operations for the three months ended August 31, 2001 and August 31, 2002, and the condensed consolidated statements of cash flows for the three months ended August 31, 2001 and August 31, 2002. The accounting policies followed by the Company are described in the May 31, 2002 financial statements. The results of operations for the three months ended August 31, 2002 are not necessarily indicative of the results to be expected for the full year. 2. Inventories consisted of the following: May 31,2002 August 31,2002 ------------ --------------- Aircraft parts $ 6,110,083 $ 5,714,109 Aircraft and Engines available for sale 1,726,481 1,699,370 ----------- ----------- $ 7,836,564 $ 7,413,479 =========== =========== 3. Earnings Per Share: The Company's basic earnings (loss) per share are calculated by dividing net earnings (loss) by the weighted average shares outstanding during the period. The computation of diluted earnings per share includes all dilutive common stock equivalents in the weighted average shares outstanding. Financial Accounting Standards Board (FASB) Statement 128 "Earnings Per Share" was adopted by the Company on January 1, 1998 and requires the dual presentation of basic and diluted earnings per share on the face of the statement of earnings. The reconciliation between the computations is as follows: Three Months Ended Net Basic Basic Diluted Diluted August 31, Earnings (loss) Shares EPS Shares EPS ----------- ---------------- ------ --- ------ --- 2001 $ 820 2,021,497 $ - 2,023,654 $ - 2002 $ (1,878,136) 2,147,562 $(0.87) 2,147,562 $(0.87) INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 3. Earnings (loss) Per Share (cont.): Included in diluted shares are 2,157 common stock equivalents relating to stock options for the three months ended August 31, 2001. Common stock equivalents have been excluded from the diluted per share calculation for the three months ended August 31, 2002, as the Company incurred a net loss and their inclusion would have been anti-dilutive. Potential common stock equivalents at August 31, 2002 were outstanding stock options to purchase 668,796 shares of the Company's common stock with exercise prices ranging from $0.55 to $3.31 per share. 4. Reclassifications: Certain prior year amounts have been reclassified to conform with the current year presentation. 5. Credit Facility: The Company obtains working capital and long-term financing for inventory and aircraft acquisitions pursuant to the Credit Facility. The Credit Facility includes a revolving credit facility that permits the Company to borrow up to $14 million. It also includes two term loans that totaled approximately $7.8 million as of August 31, 2002. The Credit Facility matures in December 2005. The Company is required to make monthly repayments of the principal of the term loans. The interest rate that the Company pays on borrowings pursuant to the Credit Facility is subject to fluctuation and may change based upon certain financial covenants. As of September 1, 2002, the effective interest rate under the Credit Facility was the lender's base rate plus 1.75% (6.5%), which is based on the default rate specified in the Credit Facility. The Credit Facility is secured by substantially all of the assets of the Company and availability of amounts for borrowing is subject to certain limitations and restrictions. As of the date hereof, the Company is not in compliance with certain covenants included in the Credit Facility and has defaulted on the payment of certain installments of principal of the term loans. The Company ceased to be in compliance with the covenants during the second quarter of fiscal 2002 when it recorded a non-cash impairment charge to eliminate the Company's investment in Air 41 LLC. A payment default occurred on August 31, 2002, upon the Company's failure to make a principal payment in the amount of approximately $216,000 with respect to the term loans. As a result of these defaults, the entire principal amount of the indebtedness outstanding under the Credit Facility has been classified as current in the accompanying balance sheet at August 31, 2002. - 6 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 5. Credit Facility (cont.): The Company and its lender have entered into a forbearance letter, pursuant to which the lender has agreed that it will not exercise the remedies available to it under the Credit Facility and that it will continue to advance funds to the Company in accordance with the terms of the Credit Facility. The lender's agreements terminate if the Company defaults on the performance of the terms of the Credit Facility other than the default that occurred when the Company failed to make a principal payment on August 31, 2002. The Company is required, pursuant to the forbearance letter, to provide weekly cash flow budgets to the lender, to cooperate with a consultant hired by the lender to evaluate the Company's prospects and to pay the lender's fees and expenses in connection with its evaluation of the Company. The forbearance letter expires if the Company and the lender have not entered into a formal forbearance agreement by October 31, 2002. Upon the expiration or earlier termination of the forbearance letter, the Company's lender could accelerate the Company's obligation to repay the amount of all borrowings outstanding under the Credit Facility, could refuse to extend additional credit to the Company and could foreclose on its lien on the Company's assets. The Company would be unable to continue operations if the lender took such actions. The report of the independent certified public accountants on the financial statements that accompany the Company's Annual Report on Form 10-K, for the year ended May 31, 2002, includes a paragraph that indicates the uncertainty about the Company's ability to continue as a going concern. The Company and its lender are negotiating the terms of a revised credit facility. In the negotiations, the Company is, among other things, seeking to delay the repayment of principal amounts due with respect to the term loans. The Company's lender had agreed that the Company would not be required to pay the monthly repayment of principal amounts for the month of September 2002. The Company has not made the payment for October 2002. The Company's lender is continuing to extend credit under the Credit Facility, although the Company has had no availability under the Credit Facility since September 15, 2002. As of October 6, 2002, the Company's lender had over advanced the Company approximately $115,000 pursuant to the revolving Credit Facility. The Company has no assurances, however, that the lender will continue to do so. The Company is continuing its negotiations with its lender but has no assurances that it will be able to consummate a revised credit facility with the lender. Accordingly, the Company is pursuing other alternatives. Such alternatives include discussions with other potential sources of financing and with companies that might pursue a business combination transaction with the Company. The Company has no assurance that any of such alternatives will materialize. - 7 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 6. Supplemental Cash Flow Disclosures: Cash payments for interest were $416,000 and $263,000 for the three months ended August 31, 2001 and August 31, 2002, respectively. Cash and cash equivalents include $29,000 and $69,000 of restricted cash at May 31, 2002 and August 31, 2002, respectively. Restricted cash includes customer receipts deposited into the Company's lockbox account, which are applied the next business day against the outstanding amount of the Credit Facility, and customer deposits on aircraft and engines leases. 7. Related Party Transactions: The Company had notes receivables from affiliate in the principal amount of $300,000, net of reserves, as of August 31, 2002 and May 31, 2002 relating to loans provided to North-South Airways (North-South) (see Note 8), which are secured by aircraft operated by the airline. The loans bear interest at 9.50% per annum, with monthly principal payments extending through August 2004. The Company believes that the interest rate on the loans is consistent with the market for similar loans. For more information, see Note 8 - Unconsolidated Subsidiaries. As of August 31, 2002, the Company leased three EMB-120 aircraft to North-South. The leases originated from September 2000 to February 2001 and have three-year terms. The leases contain similar terms and conditions to other EMB-120 aircraft leases entered into by the Company. Total lease revenue from these aircraft leases was approximately $119,000 and $225,000 for the three months ended August 31, 2002 and 2001, respectively. The Company performs certain administrative services on behalf of North-South, for which the Company charges North-South $5,000 per month. As of August 31, 2002 and May 31, 2002, the Company has receivables due, net of reserves, from North-South of approximately $47,000 and $225,000, respectively. - 8 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 8. Unconsolidated Subsidiaries: In April 2000, the Company purchased all of the outstanding stock of North-South, a small regional airline that operates under an Air Carrier Certificate under Part 135 of the regulations of the Federal Aviation Administration. The Company purchased North-South for approximately $125,000 in cash and approximately $880,000 in assumed debt. The acquisition was accounted for as a purchase and accordingly, the assets and liabilities were recorded at their estimated fair values at the date of acquisition. No goodwill was recorded as a result of this acquisition. The results of operations of North-South are included in the accompanying consolidated statement of operations as of the date of the acquisition. In September 2000, North-South sold shares of its common stock raising approximately $1,000,000. This sale of stock reduced the Company's ownership interest in North-South from 100% to approximately 33%. Accordingly, commencing September 2000, the Company began accounting for its investment in North-South under the equity method. Equity in net loss of unconsolidated joint ventures related to North-South was approximately $283,000 and $173,000 for the three months ended August 31, 2002 and 2001, respectively. The Company is in negotiations with certain third parties who have expressed an interest in providing equity capital to North-South. There can be no assurances that such parties will provide any equity capital. The Company has fully reserved all advances, trade accounts receivable and notes receivable due from North-South other than $47,750 that has been collected in September 2002. 9. Recent Developments: In fiscal 1999, the Company entered into a joint venture called Air 41 LLC for the acquisition of 20 DC-9-41H aircraft from Scandinavian Airlines System ("SAS"). The aircraft were leased back to SAS. The Company's initial investment in the joint venture was approximately $1.5 million. The aircraft were financed through the joint venture, utilizing non-recourse debt to the partners. In connection with the financing, the Company was required to post a $1.15 million letter of credit. As a result of the September 11, 2001 terrorist attacks on the U.S. and its impact on the aviation industry, Air 41 LLC re-evaluated the market value of its aircraft and wrote down the carrying value of its aircraft. In the second quarter of fiscal 2002, the Company recorded a non-cash impairment charge in the amount of $6,024,320 related to its investment in the joint venture. The impairment charge eliminated the Company's investment in the joint venture. During the fourth quarter of fiscal 2002, the lender to the joint venture drew the full amount of the letter of credit, which increased the amount of indebtedness outstanding under the Company's credit agreement by $1.15 million. Accordingly, the Company increased its impairment charge by this amount. During the first quarter of fiscal 2003, the joint venture reached an agreement with its lender to transfer its aircraft to the lender in exchange for the cancellation of the joint venture's indebtedness. The lender and the Company executed mutual releases in connection with the agreement between the lender and the joint venture. During the first quarter of fiscal 2003, the Company received a payment of $185,000 from the lender upon the consummation of the agreement between the lender and the joint venture. In exchange for this payment, the Company released any and all claims it may have had against the lender and the joint venture. - 9 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 9. Recent Developments (cont.): As of September 30, 2002, the Company received a notice of default and demand for payment under the Term Loan Agreement dated December 20, 2000, between the Company and Bombardier Capital. The loan, the principal amount of which is approximately $1,560,000, is secured by one of the Company's EMB-120 aircraft. The Company has not been able to make the monthly installments of principal and interest with respect to this loan since August 2002. The total amount past due is approximately $44,000. The lender has demanded payment in full of the amounts in default within 30 days from the date of the notice. It has stated that it may pursue and enforce all rights and remedies to which it is entitled under the loan agreement, including the repossession and sale of the aircraft if the amounts due are not repaid within such period. The Company does not have sufficient funds to repay the amount due and cannot obtain them by means of an advance under the Credit Facility. Accordingly, the Company expects that Bombardier Capital will repossess the aircraft and sell it for the best price obtainable. The Company will be liable to Bombardier Capital for any amount of the loan remaining unpaid after the aircraft is sold. As a result of this default under the Term Loan Agreement, the Company recorded an impairment charge of $611,186 related to the aircraft collateralizing the indebtedness owed to Bombardier Capital during the three months ended August 31, 2002 in order to write down the value of the aircraft to its estimated selling price upon foreclosure. 10. New Accounting Pronouncements: In July 2002, the FASB issued Statement 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 nullifics EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The statement provides guidance on the accounting and disclosure requirements for companies that incur costs to exit an activity. SFAS 146 is effective for exit or disposal activities initiated after December 31, 2002. Early application is encouraged. Restatement of previously issued financial statements is prohibited. Management believes that this standard will not have a material impact on its current operations. - 10 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following is management's discussion and analysis of certain significant factors which have affected the Company's operating results and financial position during the periods included in the accompanying condensed consolidated financial statements. RESULTS OF OPERATIONS: ------------------------ Revenues -------- Total revenue decreased 54% from $4.6 million for the three months ended August 31, 2001 to $2.1 million for the three months ended August 31, 2002, primarily due to decreases in net sales and lease revenue. Net sales for the three months ended August 31, 2002 were $1.7 million compared to $3.9 million for the three months ended August 31, 2001, primarily relating to a decrease in part sales and engine sales. The decline in parts sales is attributable to the weaker economy, pricing pressure from our competition, a higher percentage of turboprop part sales compared to jet part sales and a higher percentage of expendable part sales compared to rotable part sales. Turboprop parts on average tend to have lower selling prices than equivalent jet parts, while expendable parts also tend to sell for less than rotable parts. Engine sales are unpredictable transactions and may fluctuate significantly from year to year, dependent, in part, upon the Company's ability to purchase an engine at an attractive price and resell it within a relatively brief period of time, as well as the overall market for used engines. Lease revenue for the three months ended August 31, 2002 was $255,000, compared to $504,000 for the three months ended August 31, 2001. Lease and service revenue to North-South decreased from $225,000 during the three months ended August 31, 2001 to $119,000 during the three months ended August 31, 2002. Cost of Sales --------------- Cost of sales decreased 51% from $2.9 million during the three months ended August 31, 2001 to $1.4 million during the three months ended August 31, 2002, resulting primarily from a decrease in sales. As a percentage of total revenue, cost of sales for the three months ended August 31, 2002 was 68%, compared to 62% for the three months ended August 31, 2001. This increase was due primarily to a write off of a prepayment under an inventory agreement during the first quarter of fiscal 2003. The write off was approximately $106,000. The gross profit margin percentage on part sales decreased from 26% for the three months ended August 31, 2001 to 17% for the three months ended August 31, 2002. This decrease was due to the write off mentioned above, the weaker economy and pricing pressure from our competition. Selling, General and Administrative Expenses ------------------------------------------------ Selling, general and administrative expenses decreased 8%, from $1.2 million for the three months ended August 31, 2001 to $1.1 million for the three months ended August 31, 2002, resulting from decreases in commissions, owned aircraft expense, and travel and entertainment expense, partially offset by higher insurance expense and legal and other professional fees. The decreases in commissions and travel and entertainment expense were primarily due to reduced sales. - 11 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY Depreciation and Amortization ------------------------------- Depreciation and amortization increased from $237,000 for the three months ended August 31, 2001 to $318,000 for the three months ended August 31, 2002, primarily due to more assets being on lease during the quarter. Equity in Net Earnings (Loss) of Unconsolidated Joint Ventures ---------------------------------------------------------------------- Equity in net loss of unconsolidated joint ventures for the three months ended August 31, 2002 was $283,000, compared to earnings of $156,000 for the three months ended August 31, 2001. The equity in net earnings of $156,000 for the three months ended August 31, 2001 consisted of earnings of $329,000 from Air 41 LLC and a loss of $173,000 from North-South. During the first quarter of fiscal 2003, Air 41 LLC reached an agreement, dated as of August 9, 2002, with its lender and ceased its operations on June 1, 2002 (see Note 9). Impairment of Aircraft ------------------------ As of September 30, 2002, the Company received a notice of default and demand for payment under the Term Loan Agreement dated December 20, 2000, between the Company and Bombardier Capital. The loan, the principal amount of which is approximately $1,560,000, is secured by one of the Company's EMB-120 aircraft. The Company has not been able to make the monthly installments of principal and interest with respect to this loan since August 2002. The total amount past due is approximately $44,000. The lender has demanded payment in full of the amounts in default within 30 days from the date of the notice. It has stated that it may purse and enforce all rights and remedies to which it is entitled under the Loan Agreement, including the repossession and sale of the aircraft if the amounts due are not repaid within such period. The Company does not have sufficient funds to repay the amount due and cannot obtain them by means of an advance under the Credit Facility. Accordingly, the Company expects that Bombardier Capital will repossess the aircraft and sell it for the best price obtainable. The Company will be liable to Bombardier Capital for any amount of the loan remaining unpaid after the aircraft is sold. As a result of this default under the Term Loan Agreement, the Company recorded an impairment charge of $611,186 related to the aircraft collateralizing the indebtedness owed to Bombardier Capital during the three months ended August 31, 2002 in order to write down the value of the aircraft to its estimated selling price upon foreclosure. Interest Expense ----------------- Interest expense for the three months ended August 31, 2001 was $416,000 compared to $263,000 for the three months ended August 31, 2002. This decrease in interest expense is due to a decrease in interest rates. Net Earnings (loss) --------------------- Loss for the first quarter of fiscal 2002 was ($0.87) per share - diluted, based on 2,147,562 weighted average shares outstanding, compared to earnings for the first quarter of fiscal 2001 of $0.00 per share - diluted, based on 2,023,654 weighted average shares outstanding. - 12 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY Liquidity and Capital Resources ---------------------------------- The Company obtains working capital and long-term financing for inventory and aircraft acquisitions pursuant to the Credit Facility. The Credit Facility includes a revolving credit facility that permits the Company to borrow up to $14 million. It also includes two term loans that totaled approximately $7.8 million as of August 31, 2002. The Credit Facility matures in December 2005. The Company is required to make monthly repayments of the principal of the term loans. The interest rate that the Company pays on borrowings pursuant to the Credit Facility is subject to fluctuation and may change based upon certain financial covenants. As of September 1, 2002, the effective interest rate under the Credit Facility was the lender's base rate plus 1.75% (6.5%), which is based on the default rate specified in the Credit Facility. The Credit Facility is secured by substantially all of the assets of the Company and availability of amounts for borrowing is subject to certain limitations and restrictions. As of the date hereof, the Company is not in compliance with certain covenants included in the Credit Facility and has defaulted in the payment of installments of principal of the term loans. The Company ceased to be in compliance with the covenants during the second quarter of fiscal 2002 when it recorded a non-cash impairment charge to eliminate the Company's investment in Air 41 LLC. A payment default occurred on August 31, 2002, upon the Company's failure to make a principal payment in the amount of approximately $216,000 with respect to the term loans. As a result of the defaults, the entire principal amount of the indebtedness outstanding under the Credit Facility has been classified as current in the accompanying balance sheet at August 31, 2002. The Company and its lender have entered into a forbearance letter, pursuant to which the lender has agreed that it will not exercise the remedies available to it under the Credit Facility and that it will continue to advance funds to the Company in accordance with the terms of the Credit Facility. The lender's agreements terminate if the Company defaults in the performance of the terms of the Credit Facility other than the default that occurred when the Company failed to make a principal payment on August 31, 2002. The Company is required, pursuant to the forbearance letter, to provide weekly cash flow budgets to the lender, to cooperate with a consultant hired by the lender to evaluate the Company's prospects and to pay the lender's fees and expenses in connection with its evaluation of the Company. The forbearance letter expires if the Company and the lender have not entered into a formal forbearance agreement by October 31, 2002. Upon the expiration or earlier termination of the forbearance letter, the Company's lender could accelerate the Company's obligation to repay the amount of all borrowings outstanding under the Credit Facility, could refuse to extend additional credit to the Company and could foreclose on its lien on the Company's assets. The Company would be unable to continue operations if the lender took such actions. The report of the independent certified public accountants on the financial statements that accompany the Company's Annual Report on Form 10-K, for the year ended May 31, 2002, includes a paragraph that indicates the uncertainty about the Company's ability to continue as a going concern. - 13 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY Liquidity and Capital Resources (cont.) ------------------------------------------- The Company and its lender are negotiating the terms of a revised credit facility. In the negotiations, the Company is, among other things, seeking to delay the repayment of principal amounts due with respect to the term loans. The Company's lender had agreed that the Company would not be required to pay the monthly repayment of principal amounts for the month of September 2002. The Company has not made the payment for October 2002. The Company's lender is continuing to extend credit under the Credit Facility, although the Company has had no availability under the Credit Facility since September 15, 2002. As of October 6, 2002, the Company's lender had over advanced the Company approximately $115,000 pursuant to the Credit Facility. The Company has no assurances, however, that the lender will continue to do so. The Company is continuing its negotiations with its lender but has no assurances that it will be able to consummate a revised credit facility with the lender. Accordingly, the Company is pursuing other alternatives. Such alternatives include discussions with other potential sources of financing and with companies that might pursue a business combination transaction with the Company. The Company has no assurance that any of such alternatives will materialize. Recent Developments -------------------- In fiscal 1999, the Company entered into a joint venture called Air 41 LLC for the acquisition of 20 DC-9-41H aircraft from Scandinavian Airlines System ("SAS"). The aircraft were leased back to SAS. The Company's initial investment in the joint venture was approximately $1.5 million. The aircraft were financed through the joint venture, utilizing non-recourse debt to the partners. In connection with the financing, the Company was required to post a $1.15 million letter of credit. As a result of the September 11, 2001 terrorist attacks on the U.S. and its impact on the aviation industry, Air 41 LLC re-evaluated the market value of its aircraft and wrote down the carrying value of its aircraft. In the second quarter of fiscal 2002, the Company recorded a non-cash impairment charge in the amount of $6,024,320 related to its investment in the joint venture. The impairment charge eliminated the Company's investment in the joint venture. During the fourth quarter of fiscal 2002, the lender to the joint venture drew the full amount of the letter of credit, which increased the amount of indebtedness outstanding under the Company's credit agreement by $1.15 million. Accordingly, the Company increased its impairment charge by this amount. During the first quarter of fiscal 2003, the joint venture reached an agreement with its lender to transfer its aircraft to the lender in exchange for the cancellation of the joint venture's indebtedness. The lender and the Company executed mutual releases in connection with the agreement between the lender and the joint venture. During the first quarter of fiscal 2003, the Company received a payment of $185,000 from the lender upon the consummation of the agreement between the lender and the joint venture. In exchange for this payment, the Company released any and all claims it may have had against the lender and the joint venture. - 14 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY Recent Developments (cont.) ----------------------------- During fiscal 2000, the Company acquired a regional cargo airline, which does business as North-South Airways (North-South). During the second quarter of fiscal 2001, North-South sold shares of its common stock, reducing the Company's ownership interest from 100% to approximately 33%. The Company sells parts to North-South and leases it three Embraer EMB-120 aircraft. The Company is in negotiations with certain third parties who have expressed an interest in providing equity capital to North-South. There can be no assurances that such parties will provide any equity capital. The Company has fully reserved all advances, trade accounts receivable and notes receivable due from North-South. As of September 30, 2002, the Company received a notice of default and demand for payment under the Term Loan Agreement dated December 20, 2000, between the Company and Bombardier Capital. The loan, the principal amount of which is approximately $1,560,000, is secured by one of the Company's EMB-120 aircraft. The Company has not been able to make the monthly installments of principal and interest with respect to this loan since August 2002. The total amount past due is approximately $44,000. The lender has demanded payment in full of the amounts in default within 30 days from the date of the notice. It has stated that it may purse and enforce all rights and remedies to which it is entitled under the Loan Agreement, including the repossession and sale of the aircraft if the amounts due are not repaid within such period. The Company does not have sufficient funds to repay the amount due and cannot obtain them by means of an advance under the Credit Facility. Accordingly, the Company expects that Bombardier Capital will repossess the aircraft and sell it for the best price obtainable. The Company will be liable to Bombardier Capital for any amount of the loan remaining unpaid after the aircraft is sold. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risks that may impact the Consolidated Balance Sheets, Consolidated Statements of Operations and Consolidated Statements of Cash Flows due to changing interest rates. The Company does not currently participate in any significant hedging activities, nor does it currently utilize any significant derivative financial instruments. However, interest rate fluctuations expose the Company's variable-rate debt to changes in interest expense and cash flows. The Company's variable-rate debt, primarily short-term secured borrowings, amounted to approximately $20.1 million at August 31, 2002. Based on outstanding borrowings at quarter-end, a 10% adverse change in market interest rates at August 31, 2002 would result in additional after-tax interest expense of approximately $23,000 for the three months ended August 31, 2002. - 15 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARY ITEM 4. CONTROLS AND PROCEDURES The Chief Executive Officer and the Vice President - Finance, who servers as the chief financial officer of the Company, have concluded, based on their evaluation of the Company's disclosure controls within the 90 days of the date of the filing of this Quarterly Report on Form 10-Q, that the Company's disclosure controls were effective to ensure that material information relating to the Company, including its consolidated subsidiary, was made known to them by others within the Company during the period in which this Quarterly Report on Form 10-Q was being prepared. Forward Looking Statements ---------------------------- This Form 10-Q contains statements that may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Those statements include statements regarding the negotiations between the Company and its lender regarding the terms of a new credit facility and statements regarding the possible consequences of the Company's defaults pursuant to its credit agreements. The statements reflect the intent, belief or current expectations of the Company and members of its management team. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. The Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. - 16 - INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The Company is from time to time subject to legal proceedings and claims that arise in the ordinary course of its business. On the date hereof, no such proceedings are pending and no such claims have been asserted. Item 3. DEFAULTS UPON SENIOR SECURITIES The Company is in default in the payment of principal and in the performance of certain covenants with respect to its senior secured credit facility. As of October 14, 2002, the Company was in default in the payment of $432,767 of principal. The Company is in default in the payment of principal and interest with respect to the Term Loan Agreement, dated December 20, 2000, between the Company and Bombardier Capital, Inc. As of October 14, 2002, the Company was in default in the payment of $44,594 of principal, interest and late fees. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits -------- 3.2 Restated and Amended Bylaws of the Registrant. Incorporated by --- ----------------------------------------------- --------------- reference to Exhibit 3.2 to the 1996 Form 10-K. ------------------------------------------------------- 4.1 Specimen Common Stock Certificate. Incorporated by reference to --- ---------------------------------- ---------------------------- Exhibit 4.1 to the 1996 Form 10-K. ---------------------------------------- 10.1.1 Second Amended and Restated Employment Agreement, dated July 25, ------ ---------------------------------------------------------------- 2001, between the Registrant and Alexius A. Dyer III. Incorporated by ------------------------------------------------------------ --------------- reference to Exhibit 10.1.1 to the Company's Annual Report on Form 10-K for the -------------------------------------------------------------------------------- fiscal year ended May 31, 2001. ------------------------------------ 10.2.1 1996 Long-Term Incentive and Share Award Plan. Incorporated ------ ----------------------------------------------- ------------ by reference to Appendix B to the Proxy Statement/Prospectus included in the -------------------------------------------------------------------------------- Company's Registration Statement on Form S-4 (File No. 333-08065), filed on July -------------------------------------------------------------------------------- 12, 1996. ---------- 10.2.2 401(k) Plan. Incorporated by reference to Exhibit 10-H to ------ ------------- ---------------------------------------------- the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1992 ------------------------------------------------------------------------------ (the "1992 Form 10-K"). -------------------------- 10.2.3 Bonus Plan. Incorporated by reference to Exhibit 10.2.4 to ------ ------------ ----------------------------------------------- the 1992 Form 10-K. --------------------- 10.2.4 Cafeteria Plan. Incorporated by reference to Exhibit 10.2.5 ------ ---------------- ------------------------------------------- of the Company's Annual Report on Form 10-K for the fiscal year ended May 31, -------------------------------------------------------------------------------- 1993. ----- 10.2.5 Form of Option Certificate (Employee Non-Qualified Stock ------ -------------------------------------------------------------- Option). Incorporated by reference to Exhibit 10.2.5 to the 1996 Form 10-K. --- ------------------------------------------------------------------- 10.2.6 Form of Option Certificate (Director Non-Qualified Stock ------ -------------------------------------------------------------- Option). Incorporated by reference to Exhibit 10.2.6 to the 1996 Form 10-K. --- ------------------------------------------------------------------- 10.2.7 Form of Option Certificate (Incentive Stock Option). ------ ---------------------------------------------------------- Incorporated by reference to Exhibit 10.2.7 to the 1996 Form 10-K. ----------------------------------------------------------------------- 10.14 Commission Agreement dated December 1, 1995 between the ----- -------------------------------------------------------------- Registrant and J.M. Associates, Inc. Incorporated by reference to Exhibit ---------------------------------- ------------------------------------ 10.14 to the 1996 Form 10-K. ------------------------------- 10.15 Office Lease Agreement dated January 31, 1997 between the ----- ----------------------------------------------------------------- Registrant and Globe Corporate Center, as amended. Incorporated by reference --------------------------------------------- ------------------------- to Exhibit 10.17 to the 1997 Form 10-K. ---------------------------------------------- Incorporated by reference to Exhibit 10.18 to the 1997 Form 10-K. 10.16 Lease Agreement dated March 31, 1997 between the Registrant and ----- ----------------------------------------------------------------- Port 95-4, Ltd. ---------------- Incorporated by reference to Exhibit 10.20 to the Company's Quarterly Report for the quarter ending November 30, 2000. 10.17 Securities Purchase Agreement, dated September 18, 2000, among ----- ----------------------------------------------------------------- Diamond Aviation, Inc., the Registrant and the purchasers named therein. ------------------------------------------------------------------------------ Stockholders Agreement, dated September 18, 2000, among Diamond Aviation, Inc., the Registrant and the purchasers named therein. Incorporated by reference to Exhibit 10.19 to the Company's Quarterly Report for the quarter ending November 30, 2000. 10.18 ----- 10.19 Lease Extension and Modification Agreement dated December 10, ----- ----------------------------------------------------------------- 2001 between the Registrant and Port 95-4, Ltd. Incorporated by reference to -------------------------------------------- ---------------------------- Exhibit 10.19 to the Company's Annual Report on Form 10-K for the fiscal year -------------------------------------------------------------------------------- ended May 31, 2002. ---------------------- 10.20 Term Loan Agreement dated December 20, 2000 between the ----- --------------------------------------------------------------- Registrant and Bombardier Capital Inc. Incorporated by reference to Exhibit ---------------------------------- ------------------------------------ 10.20 to the Company's Annual Report on Form 10-K for the fiscal year ended May -------------------------------------------------------------------------------- 31, 2002. ---------- Letter dated October 15, 2002 from GMAC Commercial Finance to the Company establishing the terms on which GMAC Commercial Finance will refrain from exercising remedies. 10.21 Filed herewith ----- --------------- 10.22 Letter dated September 20, 2002 from Bombardier Capital Inc. to ----- ----------------------------------------------------------------- the Company declaring an Event of Default under Term Loan Agreement Filed --------------------------------------------------------------------- ----- herewith ------- Settlement Agreement, dated as of August 9, 2002, by and between Finova Capital Corporation, Air 41, LLC, Aircorp, Inc. and the Company. 10.23 Filed herewith ----- --------------- Letter dated October 15, 2002 from GMAC Commercial Finance to the Company extending the expiration date of the September 20, 2002 forbearance ;etter 10.24 Filed herewith ---- --------------- Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the "Act") and pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Act. 99.1 Filed herewith. ---- ---------------- 99.2 Certification of the Principal Financial Officer pursuant to ---- ------------------------------------------------------------------ Section 302 of the Sarbanes-Oxley Act of 2002 (the "Act") and pursuant to 18 --------------------------------------------------------------------------- U.S.C. Section 1350, as adopted pursuant to Section 906 of the Act. Filed ------------------------------------------------------------------- ----- herewith. ------- (d) Reports on Form 8-K. ---------------------- None INTERNATIONAL AIRLINE SUPPORT GROUP, INC. AND SUBSIDIARIES SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INTERNATIONAL AIRLINE SUPPORT GROUP, INC. -------------------------------------------- (Registrant) /s/Alexius A. Dyer III October 15, 2002 ------------------------- ------------------ Alexius A. Dyer III Date Chairman, President and Chief Executive Officer /s/Qiang Wang October 15, 2002 -------------- ------------------ Qiang Wang Date Vice President - Finance and Principal Accounting Officer CERTIFICATIONS I, Alexius A. Dyer III, certify that 1. I have reviewed this Quarterly Report on Form 10-Q of International Airline Support Group, Inc. 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Quarterly Report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and (c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: October 15, 2002 /s/ Alexius A. Dyer III _____ --------------------------- Name: Alexius A. Dyer III Title: Chairman, President and Chief Executive Officer I, John Wang, certify that 1. I have reviewed this Quarterly Report on Form 10-Q of International Airline Support Group, Inc. 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Quarterly Report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and (c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: October 15, 2002 /s/ Qiang Wang ---------------- Name: Qiang Wang Title: Vice President - Finance

INTERNATIONAL AIRLINE SUPPORT GROUP INC 10-Q