Dennis Chung, Contributor
CHUNG
OVER THE past two weeks, much has been said of Air Jamaica, following the reported loss of US$64 million for the first five months of the current financial year.
I have commented on the need for greater transparency in light of the projected US$120 million loss for the year, if the trend continues. Reports have highlighted that the five-month loss is US$28million greater than projected, which Vin Lawrence says is due to the temporary accelerated maintenance programme. No doubt, this would have impacted the service levels of the airline, as it operates a small fleet of aircraft.
It is in light of these revelations that Pearnel Charles stated, in the Observer of July 1, that "The current management ... (should be) replaced by seasoned and experienced aviation professionals with the expertise to rescue the airline." I am a bit confused by this statement, as I thought that these were the types of persons in charge of the airline prior to take-over by Government. It would seem then that the failure of the airline was not caused by the lack of professional managers.
UNDERSTANDING THE DEMISE
To understand what may have contributed to Air Jamaica's demise, we would have to analyse the 2004 audited financial statements and see if the numbers can speak to us. We cannot rely on those who may have political or other objectives as, in many of those instances, the truth is sometimes the last thing to come out.
Air Jamaica recently was successful in securing US$200 million to repay short-term debt (US$125 million), purchase capital items (US$20 million), and provide working capital support. The raising of this financing, however, cannot be seen as an expression of confidence in Air Jamaica by investors, as the debt is guaranteed by the Government, without which it may not have been successful.
AUDIT REPORT
In analysing the 2004 financial statements, the first reading must be the audit report. This report in the last paragraph expressed that "continuation as a going concern is dependent on continued shareholders' support ..." I tried to get a copy of the 2003 audited statements, as it would have been interesting to see if such an opinion had been expressed. A look at a few liquidity ratios revealed that it might have been appropriate to express such a concern in 2003 also, as all indications were that the situation would worsen in 2004 and this would have been enough evidence of a serious liquidity problem.
The International Standard on Auditing 570 (ISA 570) adopted by Jamaica for financial statements ending on or after July 1, 2003, addresses the issues of management and the auditor's responsibility for considering going concern status. The standard states that management has responsibility for assessing the entity's ability to continue as a going concern (paragraph five) and the auditor has the responsibility to consider management's use of the going concern assumption and to report on it (paragraph nine), as was done in 2004. Table 1 gives extracts of indicators of significant concerns re going concern as outlined by ISA 570.
BALANCE SHEET
The current ratio (current assets/current liabilities) was 20.19 per cent and the acid test ratio (current assets, net of inventory/current liabilities) was 17.05 per cent. Both ratios indicate the ability of the company to meet its short-term liabilities, and are indications of short-term liquidity and working capital support. It is clear from these ratios that Air Jamaica would have found it very difficult to operate on a day-to-day basis. In fact, it seems that Air Jamaica needed the US$200 million from 2003 for day-to-day operations. On the face of it, I do not believe that management could have offered any reasonable explanation for omitting an expression of going concern doubt.
In 2003 the total assets covered only 22.49 per cent of total liabilities, while at the same time shareholder's equity was negative ($422M). These numbers further show that there is no way the airline could have survived without external assistance and at the rate of losses only the government could have saved the airline.
The balance sheet only looked better in 2004 because the government decided to convert to equity (1) loans of $129M; (2) trade liabilities of $68M; (3) statutory liabilities of $59M; (4) advances on equity of $156M; and (5) contribute a further $20M. In addition AJAG converted an amount of $2M advanced by it to a part of the preference shares held by government. Of note is the fact that from 2003 the government supplied an amount of $139M as "advances on equity", which could be construed as meaning that government had intentions from 2003 to acquire a much greater stake in Air Jamaica. A question therefore would be why the government did not seek to take over the airline from then.
One other ratio that is used in assessing a company is the debt to equity ratio. In this case, however, equity was negative and so it would make no sense to look at this, as there was no equity to compare debt against. Additionally, almost all of the liabilities could be considered debt and almost two thirds of the liabilities were current. This is further proof of serious liquidity concerns from 2003.
Income statement
An analysis of the Income Statement shows that losses not only continued from 2003 to 2004 but increased. The net loss for the year increased from $55M in 2003 to $99M in 2004, representing an increase of $44M, or 80%.
Further analysis shows that while revenues increased by $34M (7.75%), total operating expenses increased by $48M (9.79%). This was further compounded by the deterioration from $4M non-operating income, in 2003, to non-operating expenses of $26M in 2004, caused primarily by a significant reduction in the gain on foreign exchange holdings. This obviously was a recipe for disaster. It is necessary for the current Air Jamaica management to look at this as a priority as it is essential that revenues grow at a faster rate than expenses if a break even position is to be reached in three years.
A more detailed look at operating expenses shows that the major expenditures were (1) staff costs [20%]; (2) aircraft fuel and oil [18%]; (3) aircraft operating lease costs [15%]; (4) maintenance [12%]; and (5) other services [10%]. From these numbers it is obvious why the current management took the approach it did to rationalise costs. These costs together account for some 75% of total operating costs and if any significant savings are to be forthcoming it would have to come from a combination of these costs. The current management would therefore have been correct in assessing the profitability of each route and getting rid of the unprofitable ones in an effort to reduce operating losses. One possible explanation for the reduced revenue and increased losses over the year could have been the introduction of routes that were not profit makers.
The analyses of whether routes are profitable are not, however, cannot be on the basis of all allocated expenses. A variable costing approach is necessary. In other words a route that covers all its variable costs, even if it does not cover its allocated portion of the fixed costs must not necessarily be disbanded. The logic behind this is that whether or not that route exists, the fixed costs will not vary and so it is better to have a route that contributes to fixed costs, as long as the variable costs of the route are covered.
Cash flow statement
An analysis of the cash flow statements supports the expression of the going concern status. The cash flow statement shows that the major transactions had more to do with financing and debt payment rather than operating activities. The implication is that the company was concentrating more on debt management issues than with running the airline, as the liquidity problems were overwhelming.
In 2004, decreases in trade and other liabilities ($45M) and owing to related companies ($44M) imply a scaling down of the company's operational activities. The other two significant items on the 2004 cash flow was interest paid of $25M and proceeds from bank loan of $40M. The non-cash adjustments of $67M and $59M transfers to preference shares, further implies that much of the decrease in liabilities had to do with government liabilities rather than supplier balances. This further cements the point that reduced trading activity was taking place.
Notes
Two of the notes to the financials that require some mention are 30 and 31. Note 30 addresses claims and counterclaims with vendors and other creditors. It would be interesting to know the outcome of these contingencies and how they continue to affect the company. Note 31 speaks to the fact that Air Jamaica itself has no employees and that all employment contracts are through Air Jamaica Holdings, which it would be also interesting to see the financial obligations to employees, including employee benefits under International Accounting Standard 19 and pension obligations.
It is clear that Vin Lawrence and his team have a mammoth task ahead of them. Still he seems pretty upbeat about the future prospects of Air Jamaica. I am told the business plan should be revealed in another couple of weeks and it would be interesting to see what is outlined in it, as the final outturn of the Air Jamaica saga will have a significant impact, one way or the other, on Jamaica.
The release of the 2004 audit information by the government was welcome, albeit later than expected, as this has put the information out for all to see. The government must continue to release all past and future records of Air Jamaica, and so dispense with the rumours.
E-mail: dra_chung@hotmail.com
