Saturday, September 22, 2012

Indianapolis Airport Authority investors ask why AAR isn't being audited

The Indianapolis Airport Authority's massive maintenance facility has lost money for most of the past 10 years, yet it has only conducted one audit to ensure the building's biggest tenant is paying its fair share.

The lack of audits is a sore spot for bondholders who helped finance construction of the $600 million aircraft repair center in the mid-1990s. Bondholders haven't been paid since a bankrupt United Airlines abandoned the facility in 2003, and are still owed $170 million plus interest from the $220 million bond issue.

The airport's biggest tenant today is AAR Corp., an Illinois-based aircraft maintenance firm. The airport signed a 10-year lease with AAR for 10 of the maintenance center's 12 hangar bays in 2004.

The lease includes a profit-sharing arrangement that requires AAR to turn over to the airport a third of its operating profits that exceed 9.25 percent of gross sales at the facility. The lease also allows the airport to audit AAR annually to make sure it's following the profit-sharing arrangement.

Airport and AAR officials say the company's profits have never met the profit-sharing threshold.

Chris Mason, a spokesman for AAR, declined to provide The Star with financial information about the facility, but said the Indianapolis maintenance center is more costly to operate than any of the company's other facilities.

"As such, we have never met the annual threshold for operating profit or as a result owed payments under the provision," he said.

But some bondholders are suspicious of that claim. Scott Connelly, a California investor who owns about 500 bonds, points to AAR's corporate-wide financial statements. Since it began leasing the Indianapolis facility in 2004, the firm's overall revenues have shot up 217 percent, from $652 million to $2.1 billion. The company's financial statements also show that in 2008, its operating margin exceeded 9.25 percent.

None of that proves that AAR would have owed the airport money, but it should be enough to prompt the airport to conduct regular audits, especially since the maintenance center has lost $23.4 million, Connelly said.

"If a company is growing at this type of rate, how can (the airport authority) just decide to not audit AAR every single year?" he said. "It should be like clockwork."

The only profit-sharing audit the airport has conducted is five years old. The report from that audit is less than a page in length and contains only three paragraphs. It is not signed or dated, provides no financial or accounting information, and does not explain how the airport arrived at its conclusion that AAR did not meet the profit-sharing threshold.

Experts who reviewed the audit at The Star's request said it doesn't comply with governmental or public accounting standards.

"As near as we can tell, this was not an audit conducted with professional standards, and therefore we can't judge the value of this audit," said Steve Sossei of the Association of Government Accountants. "The reason you conduct audits in accordance with professional standards is so you can rely on the quality."

Troy Janes, an accounting professor at Purdue University, agreed.

"The report as presented here doesn't follow the standards an external auditor would follow," he said. "If there are concerns about the thoroughness of the audit, I can understand how that would be the case, since it was not done by an external auditor."

In an attempt to determine how airport auditors reached their conclusion, The Star requested on Sept. 13 any working documents associated with the audit. Airport officials have not provided those records.

Airport spokesman Carlo Bertolini said airport auditors examined AAR's general ledger, which provided access to information about gross margin, net sales, direct labor costs, professional fees, and other itemized expenses. He said auditors also contacted other airports for assurance that AAR's reported results were within market norms.

Still, bondholders question why the airport hasn't conducted additional audits since then.

"The airport is using a facility that we paid $220 million to help build, and in return they provide us with literally a one-page 'percentage rent audit' for AAR that was done one time in 2007, and they expect us to take that seriously," said Barry Swenson, a developer in California who owns nearly a third of the bonds. "Someone needs to be accountable to us."

Tensions between bondholders and the airport authority have been high since the airport tried twice to buy the bonds this summer for pennies on the dollar. Bondholders overwhelmingly rejected those offers.

Airport officials have argued that bondholders aren't likely to get repaid. Even though the facility is beginning to make money, the airport must be repaid for its past losses before bondholders can be paid, according to the terms of the settlement agreement that came out of the United Airlines bankruptcy.

Bondholders accuse the airport of putting politics ahead of fiscal responsibility. Taxpayers contributed more than $280 million to build the maintenance center, and 1,500 jobs were lost when United abandoned the facility. To save face and keep jobs, airport officials rented space at below-market rates that didn't cover expenses, bondholders say.

A 2011 financial review obtained by The Star confirmed that some leases at the maintenance center fell well below market value.

At the request of bondholders, financial advisory firm Deloitte analyzed airport accounting records to determine if any information contradicted the airport authority's reported operating and financial results. Deloitte also compared tenant lease rates to market estimates.

In a nine page report, Deloitte found no problems with the airport's financial reporting, but it found that the terms of five of the eight maintenance center leases it reviewed were 45 percent to 55 percent below market rate. AAR's lease was within 10 percent of market range, the report said.

The airport's losses would have been cut by $14.3 million if not for the below-market rate leases, the report said.

Eric Anderson, the airport authority's property director, questioned how Deloitte arrived at those figures.

"I don't know where they got their comps," he said. "We're confident of what we've been doing."

See full article:  http://www.indystar.com

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