MEGA MATRIX CORP.
10-Ks and 10-Qs
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark
One)
☒
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For
the quarterly period ended June 30, 2019
☐
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:
001-13387
AeroCentury Corp.
(Exact
Name of Registrant as Specified in Its Charter)
|
Delaware
|
|
94-3263974
|
|
(State
or Other Jurisdiction of Incorporation or
Organization)
|
|
(I.R.S.
Employer Identification No.)
|
1440 Chapin Avenue, Suite 310
Burlingame, California 94010
(Address
of Principal Executive Offices)
(650) 340-1888
(Registrant’s
Telephone Number Including Area Code)
None
(Former
Name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
Securities
registered pursuant to Section 12(b) of the Act:
|
Title
of each class
|
Trading
Symbol(s)
|
Name
of each exchange on which registered
|
|
Common
Stock
|
ACY
|
NYSE
American
|
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
☒
No
☐
Indicate
by check mark whether the registrant has submitted electronically
every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§ 232.405 of this chapter) during
the preceding 12 months (or for such shorter period that the
registrant was required to submit such files).
Yes
☒
No
☐
Indicate
by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, a smaller reporting
company, or an emerging growth company. See the definitions of
“large accelerated filer,” “accelerated
filer,” “smaller reporting company” and
“emerging growth company” in Rule 12b-2 of the Exchange
Act. (Check one):
|
Large
accelerated filer
☐
|
|
Accelerated filer
☐
|
|
Non-accelerated
filer
☒
|
|
Smaller
reporting company
☒
|
|
|
|
Emerging growth
company
☐
|
If an emerging growth company, indicate by check
mark if the registrant has elected not to use the extended
transition period for complying with any new or revised financial
accounting standards provided pursuant to Section 13(a) of the
Exchange Act.
☐
Indicate
by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act).
Yes
☐
No
☒
The number of shares of the registrant’s
common stock outstanding a
s of August 8, 2019 was 1,545,884.
As used
in this report, unless the context indicates otherwise,
“AeroCentury” refers to AeroCentury Corp. and the
“Company” refers to AeroCentury together with its
consolidated subsidiaries.
Forward-Looking Statements
This
Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). All
statements in this report other than statements of historical fact
are forward-looking statements for purposes of these provisions,
including any statements of the Company’s plans and
objectives for future operations, the Company’s future
financial or economic performance (including known or anticipated
trends), and the assumptions underlying or related to the
foregoing. Statements that include the use of terminology such as
"may," "will," "expects," "plans," "anticipates," "estimates,"
"potential," or "continue," or the negative thereof, or other
comparable terminology, are forward-looking
statements.
Forward-looking
statements in this report include statements about the following
matters, although this list is not exhaustive:
●
The Company’s
business plans and strategies, including its continued focus on
acquiring used regional aircraft, any potential for disposing of
certain assets or acquiring and managing new types and models of
regional aircraft, and its expectation that most of its future
growth will be outside of North America;
●
Matters related to
the Company’s merger with JetFleet Holding Corp. ("JHC"),
which was completed on October 1, 2018, and the anticipated
impact of the merger on the Company and its performance, including
any changes to the Company’s risk profile now that the
Company has internalized the management services previously
performed for the Company by JetFleet Management Corp. ("JMC"), a
subsidiary of JHC, and the expectation that the combination
effected by the merger could be accretive to the Company and create
value for the stockholders of the combined post-merger
company;
●
Certain industry
trends and their impact on the Company and its performance,
including: increasing competition that results in higher
acquisition prices for many of the aircraft types that the Company
has targeted to buy and, at the same time, downward pressure on
lease rates for these aircraft; increased production of new
regional aircraft in competition with used aircraft; relatively
lower market demand for older aircraft types that are no longer in
production, which could cause certain of the Company’s
aircraft to remain off lease for significant periods of time; and
expectations of shakeouts of weaker carriers in economically
troubled regions, which could impact the financial condition and
viability of certain of the Company’s customers, and as a
result, their demand for the Company’s aircraft and their
ability to fulfill their lease commitments and other obligations to
the Company under existing leases;
●
Expectations about
the Company’s future liquidity, cash flow and capital
requirements;
●
The Company’s
ability to comply with its credit facility (the “Credit
Facility”), recently established term loans (the “Term
Loans”) and other outstanding debt instruments, including
making payments of principal and interest thereunder as and when
required and complying with the financial and other covenants
included in these instruments and the Company’s ability to
effectively hedge interest rate fluctuation risk;
●
The Company’s
ability to access additional sources of capital in the future as
and when needed, in the amounts desired, on terms favorable to the
Company, or at all;
●
The expected impact
of existing or known threatened legal proceedings;
●
The effect on the
Company and its customers of complying with applicable government
and regulatory requirements in the numerous jurisdictions in which
the Company and its customers operate;
●
The Company’s
cyber vulnerabilities and the anticipated effects on the Company if
a cybersecurity threat or incident were to
materialize;
●
General economic,
market, political and regulatory conditions, including anticipated
changes in these conditions and the impact of such changes on
customer demand and other facets of the Company’s business;
and
●
The impact of the
foregoing on the prevailing market price and trading volume of the
Company’s common stock.
1
All of
the Company’s forward-looking statements involve risks and
uncertainties that could cause the Company's actual results to
differ materially from those projected or assumed by such
forward-looking statements. Among the factors that could cause such
differences are: the continued availability of financing under the
Credit Facility, the Term Loans or otherwise; the Company’s
ability to comply with the covenants under its Credit Facility,
Term Loans and other debt instruments; the potential impact on the
Company’s debt obligations of developments regarding LIBOR,
including the potential phasing out of this metric; the Company's
ability to locate and acquire appropriate and revenue-producing
assets; deterioration of the market for or appraised values of
aircraft owned by the Company; a surge in interest rates; any
noncompliance by the Company's lessees with obligations under their
respective leases, including payment obligations; any economic
downturn or other financial crisis; the timing, rate and amount of
maintenance expenses for the Company’s asset portfolio, as
well as the distribution of these expenses among the assets in the
portfolio; the Company's ability to internalize the
management services previously performed by JMC and the costs to
the Company to internally perform these services; the Company's
ability to raise capital on acceptable terms when needed and in
desired amounts, or at all; limited trading volume in the Company's
stock; and the other factors detailed under "
Factors That May Affect Future Results and
Liquidity
" in Item 2 of this report. In addition, the
Company operates in a competitive and evolving industry in which
new risks emerge from time to time, and it is not possible for the
Company to predict all of the risks it may face, nor can it assess
the impact of all factors on its business or the extent to which
any factor or combination of factors could cause actual results to
differ from expectations. As a result of these and other potential
risks and uncertainties, the Company’s forward-looking
statements should not be relied on or viewed as predictions of
future events.
This
cautionary statement should be read as qualifying all
forward-looking statements included in this report, wherever they
appear. All forward-looking statements and descriptions of risks
included in this report are made as of the date hereof based on
information available to the Company as of the date hereof, and
except as required by applicable law, the Company assumes no
obligation to update any such forward-looking statement or risk for
any reason. You should, however, consult the risks and other
disclosures described in the reports the Company files from time to
time with the United States Securities and Exchange Commission
(“SEC”) after the date of this report for updated
information.
2
Item 1. Financial Statements.
AeroCentury
Corp.
Condensed Consolidated Balance Sheets
(Unaudited)
|
ASSETS
|
||
|
|
June 30,
|
December 31,
|
|
|
2019
|
2018
|
|
Assets:
|
|
|
|
Cash
and cash equivalents
|
$
3,356,700
|
$
1,542,500
|
|
Securities
|
-
|
121,000
|
|
Accounts
receivable, including deferred rent of $926,100 and $869,600 at
June 30, 2019 and December 31, 2018, respectively
|
5,633,400
|
3,967,200
|
|
Finance
leases receivable
|
16,589,200
|
15,250,900
|
|
Aircraft and aircraft engines held for lease, net
of accumulated depreciation of $38,084,900 and $36,675,500 at June
30
,
2019 and December 31, 2018,
respectively
|
168,381,900
|
184,019,900
|
|
Assets
held for sale
|
9,682,700
|
10,223,300
|
|
Property,
equipment and furnishings, net of accumulated depreciation of
$5,900 and $2,200 at June 30, 2019 and December 31, 2018,
respectively
|
66,600
|
69,100
|
|
Lease
right of use, net of accumulated amortization of $201,300 at June
30, 2019
|
1,271,500
|
-
|
|
Favorable
lease acquired, net of accumulated amortization of $61,700 at
December 31, 2018
|
-
|
863,300
|
|
Deferred
tax asset
|
393,700
|
254,900
|
|
Prepaid
expenses and other assets
|
286,400
|
840,100
|
|
Total
assets
|
$
205,662,100
|
$
217,152,200
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||
|
Liabilities:
|
|
|
|
Accounts
payable and accrued expenses
|
$
333,200
|
$
1,025,600
|
|
Accrued
payroll
|
99,700
|
78,600
|
|
Notes
payable and accrued interest, net of unamortized debt issuance
costs of $5,036,500 and $674,300 at June 30, 2019 and December 31,
2018, respectively
|
123,416,800
|
131,092,200
|
|
Derivative
liability
|
2,229,100
|
-
|
|
Lease
liability
|
536,100
|
-
|
|
Maintenance
reserves
|
26,301,900
|
28,527,500
|
|
Accrued
maintenance costs
|
252,000
|
463,300
|
|
Security
deposits
|
3,052,800
|
3,367,800
|
|
Unearned
revenues
|
4,107,200
|
3,274,800
|
|
Deferred
income taxes
|
6,686,000
|
7,537,100
|
|
Income
taxes payable
|
184,300
|
497,400
|
|
Total
liabilities
|
167,199,100
|
175,864,300
|
|
Commitments
and contingencies (Note 9)
|
|
|
|
Stockholders’
equity:
|
|
|
|
Preferred
stock, $0.001 par value, 2,000,000 shares authorized, no shares
issued and outstanding
|
-
|
-
|
|
Common
stock, $0.001 par value, 10,000,000 shares authorized, 1,759,216
shares issued and 1,545,884 shares outstanding at June 30, 2019 and
December 31, 2018
|
1,800
|
1,800
|
|
Paid-in
capital
|
16,782,800
|
16,782,800
|
|
Retained
earnings
|
26,154,800
|
27,540,600
|
|
Accumulated
other comprehensive income
|
(1,439,100
)
|
-
|
|
|
41,500,300
|
44,325,200
|
|
Treasury
stock at cost, 213,332 shares at June 30, 2019 and December 31,
2018, respectively
|
(3,037,300
)
|
(3,037,300
)
|
|
Total
stockholders’ equity
|
38,463,000
|
41,287,900
|
|
Total
liabilities and stockholders’ equity
|
$
205,662,100
|
$
217,152,200
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
AeroCentury Corp.
Condensed Consolidated Statements of Operations
(Unaudited)
|
|
For the Six Months Ended
June 30,
|
For the Three Months Ended June 30,
|
||
|
|
2019
|
2018
|
2019
|
2018
|
|
Revenues
and other income:
|
|
|
|
|
|
Operating
lease revenue
|
$
14,114,200
|
$
13,286,800
|
$
6,966,000
|
$
6,823,900
|
|
Maintenance
reserves revenue, net
|
-
|
1,629,000
|
-
|
579,000
|
|
Finance
lease revenue
|
496,200
|
740,400
|
260,100
|
361,300
|
|
Net
loss on sales-type finance leases
|
(170,600
)
|
-
|
(170,600
)
|
-
|
|
Net
gain on disposal of assets
|
277,900
|
9,900
|
99,600
|
18,100
|
|
Other
income
|
10,800
|
2,600
|
6,600
|
1,200
|
|
|
14,728,500
|
15,668,700
|
7,161,700
|
7,783,500
|
|
Expenses:
|
|
|
|
|
|
Depreciation
|
6,170,700
|
6,092,300
|
2,970,000
|
3,150,400
|
|
Interest
|
5,397,500
|
4,619,400
|
2,485,000
|
2,365,100
|
|
Provision for
impairment in value of aircraft
|
1,568,400
|
298,200
|
160,000
|
298,200
|
|
Professional fees,
general and administrative and other
|
1,681,900
|
954,000
|
856,700
|
376,900
|
|
Salaries and
employee benefits
|
1,219,800
|
-
|
620,900
|
-
|
|
Management
fees
|
-
|
2,948,800
|
-
|
1,502,100
|
|
Maintenance
|
117,400
|
160,200
|
10,000
|
68,900
|
|
Insurance
|
279,500
|
157,700
|
139,000
|
78,000
|
|
Other
taxes
|
63,200
|
45,100
|
25,600
|
22,500
|
|
|
16,498,400
|
15,275,700
|
7,267,200
|
7,862,100
|
|
(Loss)/income
before income tax benefit
|
(1,769,900
)
|
393,000
|
(105,500
)
|
(78,600
)
|
|
Income
tax (benefit)/provision
|
(384,100
)
|
156,800
|
(27,900
)
|
2,500
|
|
Net
(loss)/income
|
$
(1,385,800
)
|
$
236,200
|
$
(77,600
)
|
$
(81,100
)
|
|
(Loss)/earnings per
share:
|
|
|
|
|
|
Basic
|
$
(0.90
)
|
$
0.17
|
$
(0.05
)
|
$
(0.06
)
|
|
Diluted
|
$
(0.90
)
|
$
0.17
|
$
(0.05
)
|
$
(0.06
)
|
|
Weighted
average shares used in
(loss)/earnings
per share computations:
|
|
|
|
|
|
Basic
|
1,545,884
|
1,416,699
|
1,545,884
|
1,416,699
|
|
Diluted
|
1,545,884
|
1,416,699
|
1,545,884
|
1,416,699
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
AeroCentury Corp.
Condensed Consolidated Statements of Comprehensive
Income
(Unaudited)
|
|
For the Six Months Ended
June 30,
|
For the Three Months Ended
June 30,
|
||
|
|
2019
|
2018
|
2019
|
2018
|
|
Net
(loss)/income
|
$
(1,385,800
)
|
$
236,200
|
$
(77,600
)
|
$
(81,100
)
|
|
Other
comprehensive loss:
|
|
|
|
|
|
Unrealized
losses on derivative instruments
|
(1,832,700
)
|
-
|
(1,287,900
)
|
-
|
|
Tax
benefit related to items of other comprehensive loss
|
393,600
|
-
|
276,600
|
-
|
|
Other
comprehensive loss
|
(1,439,100
)
|
-
|
(1,011,300
)
|
-
|
|
Total
comprehensive (loss)/income
|
$
(2,824,900
)
|
$
236,200
|
$
(1,088,900
)
|
$
(81,100
)
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
AeroCentury Corp.
Condensed Consolidated Statements of Stockholders’
Equity
For the Three Months and Six Months Ended June 30, 2018 and June
30, 2019
(Unaudited)
|
|
Number of Common
Stock Shares Outstanding
|
Common
Stock
|
Paid-in
Capital
|
Retained
Earnings
|
Treasury
Stock
|
Accumulated
Other Comprehensive Income
|
Total
|
|
Balance, December
31, 2017
|
1,416,699
|
$
1,600
|
$
14,780,100
|
$
35,621,800
|
$
(3,036,800
)
|
$
-
|
$
47,366,700
|
|
Net
income
|
-
|
-
|
-
|
317,300
|
-
|
-
|
317,300
|
|
Balance, March 31,
2018
|
1,416,699
|
1,600
|
14,780,100
|
35,939,100
|
(3,036,800
)
|
-
|
47,684,000
|
|
Net
loss
|
-
|
-
|
-
|
(81,100
)
|
-
|
-
|
(81,100
)
|
|
Balance, June 30,
2018
|
1,416,699
|
$
1,600
|
$
14,780,100
|
$
35,858,000
|
$
(3,036,800
)
|
$
-
|
$
47,602,900
|
|
|
|
|
|
|
|
|
|
|
Balance, December
31, 2018
|
1,545,884
|
$
1,800
|
$
16,782,800
|
$
27,540,600
|
$
(3,037,300
)
|
$
-
|
$
41,287,900
|
|
Net
loss
|
-
|
-
|
-
|
(1,308,200
)
|
-
|
-
|
(1,308,200
)
|
|
Accumulated other
comprehensive income
|
-
|
-
|
-
|
-
|
-
|
(427,800
)
|
(427,800
)
|
|
Balance, March 31,
2019
|
1,545,884
|
1,800
|
16,782,800
|
26,232,400
|
(3,037,300
)
|
(427,800
)
|
39,551,900
|
|
Net
loss
|
-
|
-
|
-
|
(77,600
)
|
-
|
-
|
(77,600
)
|
|
Accumulated other
comprehensive income
|
-
|
-
|
-
|
-
|
-
|
(1,011,300
)
|
(1,011,300
)
|
|
Balance, June 30,
2019
|
1,545,884
|
$
1,800
|
$
16,782,800
|
$
26,154,800
|
$
(3,037,300
)
|
$
(1,439,100
)
|
$
38,463,000
|
The accompanying notes are an integral part of these
condensed
consolidated financial
statements.
6
AeroCentury Corp.
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
For the Six
Months Ended
June
30,
|
|
|
|
2019
|
2018
|
|
Net cash provided
by operating activities
|
$
6,419,900
|
$
11,191,500
|
|
Investing
activities:
|
|
|
|
Proceeds from sale
of aircraft and aircraft engines held for lease, net of re-sale
fees
|
1,710,500
|
3,186,800
|
|
Proceeds from sale
of assets held for sale, net of re-sale fees
|
2,181,600
|
2,644,900
|
|
Investment in
aircraft parts and acquisition costs
|
-
|
(22,606,000
)
|
|
Net cash provided
by/(used in) investing activities
|
3,892,100
|
(16,774,300
)
|
|
Financing
activities:
|
|
|
|
Issuance of notes
payable – Credit Facility
|
5,100,000
|
21,000,000
|
|
Repayment of notes
payable – Credit Facility
|
(40,100,000
)
|
(17,500,000
)
|
|
Issuance of notes
payable – Term Loans
|
44,310,000
|
-
|
|
Repayment of notes
payable – UK LLC SPE Financing
|
(9,211,100
)
|
(2,127,000
)
|
|
Repayment of notes
payable – Term Loans
|
(3,533,600
)
|
-
|
|
Debt issuance
costs
|
(5,063,100
)
|
(70,000
)
|
|
Net cash (used
in)/provided by financing activities
|
(8,497,800
)
|
1,303,000
|
|
Net
increase/(decrease) in cash and cash equivalents
|
1,814,200
|
(4,279,800
)
|
|
Cash and cash
equivalents, beginning of period
|
1,542,500
|
8,657,800
|
|
Cash and cash
equivalents, end of period
|
$
3,356,700
|
$
4,378,000
|
During
the six months ended June 30, 2019 and 2018, the Company paid
interest totaling $4,119,300 and $3,942,500, respectively. The
Company paid income taxes of $427,000 and $1,600 during the six
months ended June 30, 2019 and 2018, respectively.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
7
AeroCentury
Corp.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
June 30, 2019
1.
Organization and Summary of Significant Accounting
Policies
(a)
The Company and Basis of
Presentation
AeroCentury Corp. (“AeroCentury”) is a Delaware
corporation incorporated in 1997. AeroCentury together with its
consolidated subsidiaries is referred to as
the “Company.”
In August 2016, AeroCentury formed two wholly-owned subsidiaries,
ACY 19002 Limited (“ACY 19002”) and ACY 19003 Limited
(“ACY 19003”) for the purpose of acquiring aircraft
using a combination of cash and third-party financing (“UK
LLC SPE Financing” or “special purpose
financing”) separate from AeroCentury’s credit facility
(the “Credit Facility”). The UK LLC SPE Financing was
repaid in full in February 2019 as part of a refinancing
involving new non-recourse term loans totaling approximately $44.3
million (“Term Loans”) made to ACY 19002, ACY 19003,
and two other newly formed special purpose subsidiaries of
AeroCentury. See Note 4(b) for more information about the Term
Loans.
On October 1, 2018, AeroCentury acquired JetFleet Holding Corp.
(“JHC”) in a reverse triangular merger
(“Merger”) for consideration of approximately $2.9
million in cash and 129,217 shares of common stock of AeroCentury,
as determined pursuant to an Agreement and Plan of Merger (the
“Merger Agreement”) entered into by AeroCentury, JHC
and certain other parties in October 2017. JHC is the parent
company of JetFleet Management Corp. (“JMC”), which is
an integrated aircraft management, marketing and financing business
and the manager of the Company’s assets. Upon completion of
the Merger, JHC became a wholly-owned subsidiary of the Company,
and as a result, JHC's results are included in the Company's
consolidated financial statements beginning on October 1,
2018.
In November 2018, AeroCentury formed two wholly-owned subsidiaries,
ACY SN 15129 LLC (“ACY 15129”) and ACY E-175 LLC
(“ACY E-175”), for the purpose of refinancing four of
the Company’s aircraft using the Term Loans. Because the Term
Loans did not close until February 2019, the subject aircraft
remained as collateral under the Credit Facility as of
December 31, 2018, and ACY 15129 and ACY E-175 had no activity
in 2018.
Financial information for AeroCentury and its consolidated
subsidiaries is presented on a consolidated basis in accordance
with accounting principles generally accepted in the United States
of America (“GAAP”) for interim financial information,
the instructions to Form 10-Q and Article 8 of Regulation S-X.
Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In
the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the three- month and
six-month periods ended June 30, 2019 are not necessarily
indicative of the results that may be expected for the year ending
December 31, 2019 or for any other period. All intercompany
balances and transactions have been eliminated in
consolidation.
(b)
Use of Estimates
The Company’s condensed consolidated financial statements
have been prepared in accordance with GAAP. The preparation of
consolidated financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the condensed
consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates. The Company bases its estimates
on historical experience and on various other assumptions that are
believed to be reasonable for making judgments that are not readily
apparent from other sources.
The most significant estimates with regard to these condensed
consolidated financial statements are the residual values and
useful lives of the Company’s long-lived assets, the amount
and timing of future cash flows associated with each asset that are
used to evaluate whether assets are impaired, accrued maintenance
costs, accounting for income taxes, the assumptions used to value
the Company’s derivative instruments, the valuation of the
right of use asset and related lease liability associated with the
Company’s office, and the amounts recorded as allowances for
doubtful accounts.
(c) Comprehensive Income
The
Company reflects changes in the fair value of its interest rate
swap derivatives that are designated as hedges in other
comprehensive income. Such amounts are reclassified into earnings
in the periods in which the hedged transaction occurs, and are
included in interest expense.
8
(d) Finance Leases
As of
June 30
, 2019, the Company had
four aircraft subject to sales-type finance leases and three
aircraft subject to direct financing leases. All seven leases
contain lessee bargain purchase options at prices substantially
below the subject asset’s estimated residual value at the
exercise date for the option. Consequently, the Company has
classified each of these seven leases as finance leases for
financial accounting purposes. For such finance leases, the Company
reports the discounted present value of (i) future minimum lease
payments (including the bargain purchase option) and (ii) any
residual value not subject to a bargain purchase option, as a
finance lease receivable on its balance sheet, and accrues interest
on the balance of the finance lease receivable based on the
interest rate inherent in the applicable lease over the term of the
lease. For each of the four sales-type finance leases, the Company
recognized as a gain or loss the amount equal to (i) the net
investment in the sales-type finance lease plus any initial direct
costs and lease incentives less (ii) the net book value of the
subject aircraft at inception of the applicable lease.
The Company recognized interest earned on finance leases in the
amount of $260,100 and $361,300 in the quarters ended June 30, 2019
and 2018, respectively and $496,200 and $740,400 in the six-month
periods ended
June
30, 2019 and
2018, respectively.
(e) Interest Rate Hedging
During
the first quarter of 2019, the Company entered into certain
derivative instruments to mitigate its exposure to variable
interest rates under the Term Loans debt and a portion of the
Credit Facility debt. Hedge accounting is applied to such a
transaction only if specific criteria have been met, the
transaction is deemed to be “highly effective” and the
transaction has been designated as a hedge at its inception. Under
hedge accounting treatment, generally, the effects of derivative
transactions are recorded in earnings for the period in which the
hedge transaction affects earnings. A change in value of a hedging
instrument is reported as a component of other comprehensive income
and is reclassified into earnings in the period in which the
transaction being hedged affects earnings.
(f)
Recent Accounting
Pronouncements
Topic 842
In
February 2016, the Financial Accounting Standards Board
(“FASB”) issued Accounting Standards Update
(“ASU”) 2016-02,
Leases (“
Topic 842
”)
in the Accounting Standards
Codification (“ASC”). Topic 842 substantially modifies
lessee accounting for leases, requiring that lessees recognize
lease assets and liabilities for leases extending beyond one year.
Leases will be classified as either finance or operating, with
classification affecting the pattern of expense recognition in the
income statement. The Company adopted Topic 842 on January 1, 2019,
electing to apply its provisions on the date of adoption and to
record the cumulative effect as an adjustment to retained earnings.
Lessor accounting under Topic 842 is similar to the prior
accounting standard and the Company has elected to apply practical
expedients under which the Company will not have to reevaluate
whether a contract is a lease, the classification of its existing
leases or its capitalized initial direct costs. In addition, the
Company, as lessor, has elected the practical expedient to combine
lease and non-lease components as one combined component for its
leased aircraft for purposes of determining whether that combined
component should be accounted for under Topic 606 or Topic
842.
The new
standard requires a lessor to classify leases as sales-type,
finance, or operating. A lease is treated as sales-type if it
transfers all of the risks and rewards, as well as control of the
underlying asset, to the lessee. If risks and rewards are conveyed
without the transfer of control, the lease is treated as a finance
lease. If the lessor does not convey risks and rewards or control,
an operating lease results. As a result of application of the
practical expedients, the Company was not required to alter the
classification or carrying value of its leased or finance lease
assets.
Lessee
reporting was changed by the new standard, requiring that the
balance sheet reflect a liability for most operating lease
obligations as well as a “right of use” asset. As such,
the Company was required to record a lease obligation of
approximately $600,000 in connection with the lease of its
headquarters office, and to increase the capitalized leasehold
interest / right of use asset by a similar amount upon adoption, as
discussed in Note 6. There was no effect on retained earnings
recorded as a result of adoption of the standard. The Company did
not elect the lessee practical expedient to combine the lease and
non-lease components.
ASU 2016-13
The
FASB issued ASU 2016-13,
Financial
Instruments – Credit Losses (Topic 326)
, in June of
2016 (“ASU 2016-13”)
.
ASU 2016-13 provides that financial
assets measured at amortized cost are to be presented as a net
amount, reflecting a reduction for a valuation allowance to present
the amount expected to be collected (the “current expected
credit loss” model of reporting). As such, expected credit
losses will be reflected in the carrying value of assets and losses
will be recognized before they become probable, as is required
under the Company’s present accounting practice. In the case
of assets held as available for sale, the amount of the valuation
allowance will be limited to an amount that reflects the marketable
value of the debt instrument. This amendment to GAAP is effective
for fiscal years beginning after December 15, 2019 (for the
Company, its fiscal year ending December 31, 2020) unless elected
earlier, and adoption is to be reflected as a cumulative effect on
the first date of adoption. The Company does not expect to early
adopt ASU 2016-13 and is evaluating the impact of the adoption of
ASU 2016-13 on its condensed consolidated financial statements and
related disclosures.
ASU 2017-12
In
August 2017, the FASB issued ASU 2017-12,
Derivatives and Hedging (Topic 815): Targeted
Improvements to Accounting for Hedging Activities
(“ASU 2017-12”). ASU 2017-12 was effective for public
companies for years beginning after December 15, 2018, and the
Company therefore adopted it on January 1, 2019. The revised
guidance includes reduced limitations on items that can be hedged
in order to more closely align hedge accounting with
entities’ risk management activities through changes to
designation and measurement guidance as well as new disclosure
requirements of balance sheet and income statement information
designed to increase the transparency of the impact of hedging.
Because the Company was not a party to any derivative transactions
during 2018, there was no effect on its financial statements upon
adoption. Derivatives entered into after adoption are accounted for
under the new standards.
9
ASU 2018-13
In
August 2018, the FASB issued ASU 2018-13,
Fair Value Measurement (Topic 820)
(“ASU 2018-13”). ASU 2018-13 was promulgated for the
purpose of simplifying disclosures related to fair values by
eliminating certain disclosures previously required (including,
with respect to public companies, the amount of and reasons for
transfers between Level 1 and Level 2 of the hierarchy, the policy
for timing of the transfers between levels, and the valuation
process for Level 3 fair value measurements and by modifying
others), as well as modifying other disclosure requirements.
Additional disclosures are also required by ASU 2018-13, including
(i) changes in unrealized gains and losses for the period included
in other comprehensive income for recurring Level 3 fair value
measurements held at the end of the reporting period, and (ii) the
range and weighted average of significant unobservable inputs used
to develop Level 3 fair value measurements (although disclosure of
other quantitative information in lieu of weighted average is
permitted if it is determined that such would be a more reasonable
and rational method to reflect distribution of unobservable
inputs). Adoption is required for years beginning after December
31, 2019, although early adoption is permitted. The Company has
chosen to early adopt ASU 2018-13 and there was no effect on the
Company’s financial statements.
2.
Aircraft Lease Assets
As
discussed in Note 1, the Company adopted Topic 842 on January 1,
2019, and elected to use certain practical expedients that resulted
in continuing the classification of capitalized indirect cost
associated with its operating and finance leases. As such, there
was no adjustment to its accounts related to the carrying value of
its sales-type and finance leases, assets held for lease or
capitalized initial direct costs, and its leases continue to be
accounted for the same as they had been before adoption of the new
accounting standard.
The
Company’s leases are normally “triple net leases”
under which the lessee is obligated to bear all costs, including
tax, maintenance and insurance, on the leased assets during the
term of the lease. In most cases, the lessee is obligated to
provide a security deposit or letter of credit to secure its
performance obligations under the lease, and in some cases is
required to pay maintenance reserves based on utilization of the
aircraft, which reserves are available for qualified maintenance
costs during the lease term and may or may not be refundable at the
end of the lease. Typically, the leases also contain minimum return
conditions, as well as an economic adjustment payable by the lessee
(and in some instances by the lessor) for amounts by which the
various aircraft or engine components are worse or better than a
targeted condition set forth in the lease. Some leases contain
renewal or purchase options, although the Company’s
sales-type and finance leases all contain a bargain purchase option
at lease end which the Company expects the lessees to
exercise.
Because
all of the Company’s leases transfer use and possession of
the asset to the lessee and contain no other substantial
undertakings by the Company, the Company has concluded that all of
its lease contracts qualify for lease accounting under Topic 842.
Certain lessee payments of what would otherwise be lessor costs
(such as insurance and property taxes) are excluded from both
revenue and expense.
The
Company evaluates the expected return on its leased assets by
considering both the rents receivable over the lease term, any
expected additional consideration at lease end, and the residual
value of the asset at the end of the lease. In some cases, the
Company depreciates the asset to the expected residual value
because it expects to sell the asset at lease end; in other cases,
it may expect to re-lease the asset to the same or another lessee
and the depreciation term and related residual value will differ
from the initial lease term and residual value. Residual value is
estimated by considering future estimates provided by independent
appraisers, although it may be adjusted by the Company based on
expected return conditions or location, specific lessee
considerations, or other market information.
Two of
the Company’s operating lease assets are subject to
manufacturer residual value guarantees at the end of their lease
terms in the fourth quarter of 2020 and totaling approximately $20
million.
Three additional aircraft are
subject to residual value guarantees, but the Company expects to
retain the aircraft after the date of such guarantees and re-lease
them to the current or other lessees.
The Company considers
the best market for managing and/or selling its assets at the end
of its leases, although it does not expect to retain ownership of
the assets under finance leases given the lessees’ bargain
purchase options.
10
(a)
Assets Held for Lease
At
June 30, 2019
and December 31,
2018, the Company’s aircraft and aircraft engines held for
lease consisted of the following:
|
|
June 30
,
2019
|
December 31
,
2018
|
||
|
Type
|
Number
Owned
|
% of net book
value
|
Number
owned
|
% of net book
value
|
|
Regional jet
aircraft
|
13
|
86
%
|
13
|
81
%
|
|
Turboprop
aircraft
|
2
|
14
%
|
4
|
18
%
|
|
Engines
|
-
|
-
%
|
1
|
1
%
|
The
Company did not purchase or sell any aircraft held for lease during
the second quarter of 2019.
None of
the Company’s aircraft and engines held for lease were off
lease at
June 30
, 2019. As
discussed below, the Company has three off-lease aircraft that were
reclassified in 2018 as held for sale and an engine that was
reclassified in the first quarter of 2019 as held for
sale.
As of
June 30
, 2019, minimum future
lease revenue payments receivable under non-cancelable operating
leases were as follows:
|
Years ending
December 31
|
|
|
|
|
|
Remainder of
2019
|
$
13,717,000
|
|
2020
|
25,749,600
|
|
2021
|
18,648,200
|
|
2022
|
16,690,600
|
|
2023
|
13,007,800
|
|
Thereafter
|
21,589,500
|
|
|
$
109,402,700
|
The remaining, weighted average lease term of the Company’s
assets under operating leases was 55 months and 58 months at June
30, 2019 and December 31, 2018, respectively.
(b)
Sales-Type and Finance Leases
As a result of a lease amendment containing a purchase option at
lease end,
during the second quarter of 2019, the Company
reclassified an asset that was
previously held for lease to a sales-type finance lease receivable
and recorded a loss of $170,600.
During the second quarter of 2019, the Company also amended the
sales-type leases for two aircraft to accommodate the
lessee’s request to transfer a portion of future lease
payment obligations from one of the leases to the other, as well as
to assign one of the leases and related aircraft to a different
lessee. Payments for both leases were also amended to reflect
a higher implicit interest rate, such that the fair value of the
leases after amendment equaled the carrying value of the leases
before the amendment. No gain or loss was recognized as a result of
these lease modifications.
At
June 30, 2019
and December 31,
2018, the net investment included in sales-type finance leases and
direct financing leases receivable were as follows:
|
|
June
30
,
2019
|
December
31,
2018
|
|
Gross minimum lease
payments receivable
|
$
18,153,300
|
$
17,107,100
|
|
Less unearned
interest
|
(1,564,100
)
|
(1,856,200
)
|
|
Finance leases
receivable
|
$
16,589,200
|
$
15,250,900
|
11
As of
June 30, 2019
, minimum future
payments receivable under finance leases were as
follows:
|
Years ending
December 31
|
|
|
|
|
|
Remainder of
2019
|
$
6,146,600
|
|
2020
|
4,708,200
|
|
2021
|
5,085,400
|
|
2022
|
2,213,100
|
|
|
$
18,153,300
|
The remaining, weighted average lease term of the Company’s
assets under sales-type and finance leases was 23 months and 32
months at June 30, 2019 and December 31, 2018,
respectively.
3.
Assets Held for Sale
During
the second quarter of 2019, based on its appraised value, the
Company recorded an impairment provision of $160,000 for one
turboprop aircraft.
Assets
held for sale at
June
30, 2019
included two turboprop aircraft and a spare engine, as well as a
turboprop aircraft for which a short-term operating lease was
entered into during the first quarter and airframe parts from two
turboprop aircraft.
During
the second quarter of 2019, the Company received $252,700 in cash
and accrued $142,200 in receivables for parts sales. These amounts
were accounted for as follows: $94,400 reduced accounts receivable
for parts sales accrued in the first quarter of 2019; $292,200
reduced the carrying value of the parts; and $8,300 was recorded as
gains in excess of the carrying value of the parts. During the
second quarter of 2018, the Company received $73,400 in cash and
accrued $41,000 in receivables for parts sales. These amounts were
accounted for as follows: $10,600 reduced accounts receivable for
parts sales accrued in the first quarter of 2018, $85,700 reduced
the carrying value of the parts, and $18,100 was recorded as gains
in excess of the carrying value of the parts.
4.
Notes Payable and Accrued
Interest
At June 30, 2019 and December 31, 2018, the Company’s notes
payable and accrued interest consisted of the
following:
|
|
June
30
,
2019
|
December
31
,
2018
|
|
Credit
Facility:
|
|
|
|
Principal
|
$
87,400,000
|
$
122,400,000
|
|
Unamortized
debt issuance costs
|
(3,849,900
)
|
(674,300
)
|
|
Accrued
interest
|
164,500
|
139,300
|
|
Special purpose
financing:
|
|
|
|
Principal:
|
|
|
|
UK
SPE Financing
|
-
|
9,211,200
|
|
Term
Loans
|
40,776,400
|
-
|
|
Unamortized
debt issuance costs
|
(1,186,600
)
|
-
|
|
Accrued
interest
|
112,400
|
16,000
|
|
|
$
123,416,800
|
$
131,092,200
|
12
(a)
Credit Facility
Before
modification, the Company’s Credit Facility was provided by a
syndicate of banks and was secured by all of the assets of the
Company except for the two aircraft in the UK LLC SPE Financing.
In February 2019, the Company entered
into a Third Amended and Restated Loan and Security Agreement
to the Credit Facility (the “Restated Loan Agreement”)
which, among other things, extended the maturity date of the
Credit Facility with the lenders thereunder from May 31,
2019 to February 19, 2023; decreased the maximum availability
thereunder from $170 million (with the ability for the Company to
request an increase up to $180 million) to $145 million (with the
ability for the Company to request an increase to up to $160
million); and modified certain of the Company’s financial
ratio covenants. Borrowings under the Credit Facility will
continue to bear interest at floating rates that reset periodically
to a market benchmark rate plus a credit margin, and the Company
will also continue to be obligated to pay a quarterly fee on any
unused portion of the Credit Facility at a rate of 0.50%. The
Credit Facility required that within 30 days after closing of the
financing, the Company enter into an interest rate protection
derivative instrument with respect to a minimum of $50 million of
the outstanding loan balance at closing. Accordingly, in March
2019, the Company entered into interest rate protection instruments
with respect to $50 million of its Credit Facility
debt.
The borrowings under the Restated Loan Agreement are secured by a
first priority lien on all of the Company's assets, including
the Company’s aircraft portfolio, except those aircraft that
are subject to the Term Loans. The Restated Loan
Agreement requires the Company to comply with certain covenants
relating to payment of taxes, preservation of existence,
maintenance of property and insurance, and periodic financial
reporting, as well as compliance with several financial ratio
covenants. The Restated Loan Agreement restricts the Company
with respect to certain corporate level transactions and
transactions with affiliates or subsidiaries without consent of the
lenders. Events of default under the Restated Loan Agreement
include failure to make a required payment within three business
days of a due date or to comply with other obligations (subject to
specified cure periods for certain events of default), a default
under other indebtedness of the Company, and a change in control of
the Company. Remedies for default include acceleration of the
outstanding debt and exercise of any remedies available under
applicable law, including foreclosure on the collateral securing
the borrowings under the Credit Facility.
As of
December 31, 2018, the Company was not in compliance with the
interest coverage, debt service coverage, no-net-loss and revenue
concentration covenants under the Credit Facility. The
noncompliance resulted primarily from the Company recording
aircraft impairment charges and losses on sale of aircraft totaling
$3,408,700 during 2018. The amendments included in the Restated
Loan Agreement in February 2019 discussed above cured the December
31, 2018 noncompliance and revised the compliance requirements
through the extended maturity date of the Credit
Facility.
The
unused amount of the Credit Facility was $57,600,000 and
$47,600,000 as of
June 30, 2019
and December 31, 2018, respectively.
The weighted average
interest rate on the Credit Facility was 6.19% and 5.92% at June
30, 2019 and
December
31, 2018
respectively.
(b)
Term Loans
On
February 8, 2019, the Company, through four wholly-owned subsidiary
limited liability companies (“LLC Borrowers”), each
entered into a Term Loan Agreement with the U.S. branch of a German
bank (“Term Loan Lender”) that provides for six
separate term loans with an aggregate principal amount of $44.3
million. Each of the Term Loans is secured by a first priority
security interest in a specific aircraft (“Term Loan
Collateral Aircraft”) owned by an LLC Borrower, the lease for
such aircraft, and a pledge by the Company of its membership
interest in each of the LLC Borrowers, pursuant to a Security
Agreement (the “Security Agreement”) among the LLC
Borrowers and a security trustee, and certain pledge agreements.
Two of the Term Loan Collateral Aircraft that are owned by the
Company’s two UK special purpose entities were previously
financed using special purpose financing. The interest rates
payable under the Term Loans vary by aircraft, and are based on a
fixed margin above either 30-day or 3-month LIBOR. The proceeds of
the Term Loans were used to pay down the Credit Facility and pay
off the UK LLC SPE Financing. The maturity of each Term Loan varies
by aircraft, with the first Term Loan maturing in October 2020
and the last Term Loan maturing in May 2025. The debt under
the Term Loans is expected to be fully amortized by rental payments
received by the LLC Borrowers from the lessees of the Term Loan
Collateral Aircraft during the terms of their respective leases and
remarketing proceeds.
The
Term Loans include covenants that impose various restrictions and
obligations on the LLC Borrowers, including covenants that require
the LLC Borrowers to obtain the Term Loan Lender’s consent
before they can take certain specified actions and certain events
of default. If such an event of default occurs, subject to certain
cure periods for certain events of default, the Term Loan Lender
would have the right to terminate its obligations under the Term
Loans, declare all or any portion of the amounts then outstanding
under the Term Loans to be accelerated and due and payable, and/or
exercise any other rights or remedies it may have under applicable
law, including foreclosing on the assets that serve as security for
the Term Loans.
13
5. Derivative Instruments
The
Company was not party to any derivative instruments in
2018.
In the
first quarter of 2019, the Company entered into eight fixed
pay/receive variable interest rate swaps (the
“Swaps”).
Six of
the Swaps were entered into by the LLC Borrowers and have reduced
notional amounts that mirror the amortization under the six Term
Loans entered into by the LLC Borrowers, effectively converting
each of the six Term Loans from variable to fixed rate, ranging
from 5.38% to 6.30%. Each of these six Swaps extend for the
duration of the corresponding Term Loan, with maturities from 2020
through 2025.
The
other two Swaps were entered into by the Company and have notional
amounts that total $50 million and extend through the maturity of
the Credit Facility in February of 2023.
The
Company entered into the Swaps in order to reduce its exposure to
the risk of increased interest rates. With respect to the six Swaps
entered into by the LLC Borrowers, it was deemed necessary so that
the anticipated cash flows of such entities, which arise entirely
from the lease rents for the aircraft owned by such entities, would
be sufficient to make the required loan principal and interest
payments, thereby preventing default so long as the lessees met
their lease rent obligations. The two Swaps entered into by the
Company protect against the exposure to interest rate increases on
$50 million of the Company’s Credit Facility
debt.
The
Company estimates the fair value of derivative instruments using a
discounted cash flow technique and uses creditworthiness inputs
that corroborate observable market data evaluating the
Company’s and counterparties’ risk of non-performance.
Valuation of the derivative instruments requires certain
assumptions for underlying variables and the use of different
assumptions would result in a different valuation. Management
believes it has applied assumptions consistently during the
period.
The
Company has designated seven of the Swaps as cash flow hedges.
Changes in the fair value of the hedged swaps are included in other
comprehensive income, which amounts are reclassified into earnings
in the period in which the transaction being hedged affects
earnings, i.e. with future settlements of the Swaps. One of the
Swaps is not eligible under its terms for hedge treatment. Changes
in fair value of non-hedge derivatives are reflected in earnings in
the periods in which they occur. As such, the Company has reflected
the following amounts in its income and other comprehensive income
amounts:
|
|
For the Six
Months
Ended June
30,
|
For the
Three Months
Ended June
30,
|
||
|
|
2019
|
2018
|
2019
|
2018
|
|
Change in value of
Swaps
|
$
451,400
|
$
-
|
$
43,000
|
$
-
|
|
Other
items
|
(22,100
)
|
-
|
(20,800
)
|
-
|
|
Included in
interest expense
|
$
429,300
|
$
-
|
$
22,200
|
$
-
|
|
The following
amount was included in other comprehensive income, before
tax:
|
|
|
|
|
|
|
|
|
|
|
|
Change in value of
hedged Swaps
|
$
(1,832,700
)
|
-
|
$
(1,287,900
)
|
$
-
|
Approximately
$416,000 of the current balance of accumulated other comprehensive
income is expected to be reclassified in the next twelve
months.
At June
30, 2019, the fair value of the Company’s Swaps was as
follows:
|
Designated interest
rate hedges fair value
|
$
(2,147,700
)
|
|
Other interest rate
swap
|
(81,400
)
|
|
Total derivative
(liability)
|
$
(2,229,100
)
|
The Company evaluates the creditworthiness of the counterparties
under its hedging agreements. The swap counterparties for the Swaps
are large financial institutions in the United States that
possessed an investment grade credit rating. Based on this rating,
the Company believes that the counterparties are creditworthy and
that their continuing performance under the hedging agreements is
probable.
14
6. Lease Right of Use Asset and Liability
The
Company is a lessee under a lease of the office space it occupies
in Burlingame, California, which expires in June of 2020, but also
provides for two, successive one-year lease extension options for
amounts that are substantially below the market rent for the
property. The lease provides for monthly rental payments according
to a fixed schedule of increasing rent payments. As a result of the
below-market extension options, the Company has determined that it
is reasonably certain that it will extend the lease and has,
therefore, included such extended term in its calculation of the
right of use asset (“ROU Asset”) and lease liability
recognized in connection with the lease.
In
addition to a fixed monthly payment schedule, the office lease also
includes an obligation for the Company to make future variable
payments for certain common areas and building operating and lessor
costs, which have been and will be recognized as expense in the
periods in which they are incurred. As a direct pass-through of
applicable expense, such costs have not been allocated as a
component of the lease.
The ROU
Asset includes the amortized value of both the amount of liability
recognized at January 1, 2019 upon adoption of Topic 842 and the
amount attributable to the below market lease component recognized
upon acquisition of JHC on October 1, 2018.
The
lease liability associated with the office lease was calculated by
discounting the fixed, minimum lease payments over the remaining
lease term, including the below-market extension periods, at a
discount rate of 7.25%, which represents the Company’s
estimate of the incremental borrowing rate for a collateralized
loan for the type of underlying asset that was the subject of the
office lease at the time the lease liability was evaluated. The
Company estimates that the future minimum lease commitments for
base rent of its office space were as follows as of June 30, 2019
and December 31, 2018:
|
|
June
30,
2019
|
December
31,
2018
|
|
2019
|
$
98,200
|
$
193,500
|
|
2020
|
196,400
|
196,400
|
|
2021
|
199,300
|
199,300
|
|
2022
|
101,100
|
101,100
|
|
|
595,000
|
$
690,300
|
|
Discount
|
(58,900
)
|
|
|
Lease liability at
June 30, 2019
|
$
536,100
|
|
During
the quarter ended June 30, 2019, the Company recognized
amortization, finance costs and other expense related to the office
lease as follows:
|
Fixed rental
expense during the quarter
|
$
110,900
|
|
Variable lease
expense
|
32,000
|
|
Total lease expense
during the quarter
|
$
142,900
|
The
Company expects that the variable lease expense will total
approximately $10,700 per month through the end of the lease,
including the two extension periods.
7. Fair Value Measurements
Fair value is defined as the exchange price that would be received
for an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in
an orderly transaction between market participants on the
measurement date. Valuation techniques used to measure fair value
must maximize the use of observable inputs and minimize the use of
unobservable inputs, to the extent possible. The fair value
hierarchy under GAAP is based on three levels of
inputs.
Level 1 - Quoted prices in active markets for identical assets or
liabilities.
Level 2 - Inputs other than Level 1 that are observable, either
directly or indirectly, such as quoted prices for similar assets or
liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable
market data for substantially the full term of the assets or
liabilities.
Level 3 - Unobservable inputs that are supported by little or no
market activity and that are significant to the fair value of the
assets or liabilities.
15
Assets and Liabilities Measured and Recorded at Fair Value on a
Recurring Basis
As of
June 30, 2019, the Company measured the fair value of its interest
rate swaps of $90,776,400 (notional amount) based on Level 2
inputs, due to the usage of inputs that can be corroborated by
observable market data. The Company estimates the fair value of
derivative instruments using a discounted cash flow technique and
has used creditworthiness inputs that corroborate observable market
data evaluating the Company’s and counterparties’ risk
of non-performance. The Swaps had a net fair value of negative
$2,229,100 as of June 30, 2019. In the quarter and six months ended
June 30, 2019, $43,000 and $451,400 respectively, was realized
through the income statement as an increase in interest
expense.
The
following table shows, by level within the fair value hierarchy,
the Company’s assets and liabilities at fair value on a
recurring basis as of June 30, 2019 and December 31,
2018:
|
|
June 30, 2019
|
December 31, 2018
|
||||||
|
|
Total
|
Level 1
|
Level 2
|
Level 3
|
Total
|
Level 1
|
Level 2
|
Level 3
|
|
Money
market funds
|
$
659,100
|
$
659,100
|
$
-
|
$
-
|
$
656,400
|
$
656,400
|
$
-
|
$
-
|
|
Derivatives
|
(2,229,100
)
|
-
|
(2,229,100
)
|
-
|
-
|
-
|
-
|
-
|
|
Total
|
$
(1,570,000
)
|
$
659,100
|
$
(2,229,100
)
|
$
-
|
$
656,400
|
$
656,400
|
$
-
|
$
-
|
There
were no transfers between Level 1 and Level 2 in either the second
quarters or six months ended June 30, 2019 or 2018, and there were
no transfers into or out of Level 3 during the same
periods.
Assets Measured and Recorded at Fair Value on a Nonrecurring
Basis
The Company determines fair value of long-lived assets held and
used, such as aircraft and aircraft engines held for lease and
these and other assets held for sale, by reference to independent
appraisals, quoted market prices (e.g., offers to purchase) and
other factors. These are considered Level 3 within the fair value
hierarchy. An impairment charge is recorded when the Company
believes that the carrying value of an asset will not be recovered
through future net cash flows and that the asset’s carrying
value exceeds its fair value. The Company recorded impairment
charges totaling $160,000 on one of its assets held for sale in the
second quarter of 2019, which had a fair value of $2,340,000. The
Company recorded an impairment charge of $298,200 on one of its
aircraft held for lease in the second quarter of 2018.
The
following table shows, by level within the fair value hierarchy,
the Company’s assets at fair value on a nonrecurring basis as
of June 30, 2019 and December 31, 2018:
|
|
Assets Written Down to Fair Value
|
Total Losses
|
||||||||
|
|
June 30, 2019
|
December 31, 2018
|
For the Six Months Ended June 30,
|
|||||||
|
|
Total
|
Level 1
|
Level
2
|
Level
3
|
Total
|
Level
1
|
Level
2
|
Level
3
|
2019
|
2018
|
|
Assets
held for sale
|
$
5,703,000
|
$
-
|
$
-
|
$
5,703,000
|
$
5,800,000
|
$
-
|
$
-
|
$
5,800,000
|
$
1,568,400
|
$
-
|
During
the six months ended June 30, 2019, the Company recorded
impairment provisions of (i) $1,408,400 based on estimated sales
amounts and (ii) $160,000 based on third-party
appraisals.
16
There
were no transfers between Level 1 and Level 2 in either the second
quarters or six months ended June 30, 2019, and there were no
transfers into or out of Level 3 during the same
periods.
Fair Value of Other Financial Instruments
The
Company’s financial instruments, other than cash and cash
equivalents, consist principally of finance leases receivable,
amounts borrowed under the Credit Facility, notes payable under
special purpose financing and its derivative instruments. The fair
value of accounts receivable, accounts payable and the
Company’s maintenance reserves and accrued maintenance costs
approximates the carrying value of these financial instruments
because of their short-term maturities. The fair value of finance
lease receivables approximates the carrying value as discussed in
Note 1(
d)
. The fair value
of the Company’s derivative instruments is discussed in Note
5 and in this note above in “Assets and Liabilities Measured
and Recorded at Fair Value on a Recurring
Basis.”
Borrowings
under the Company’s Credit Facility bear floating rates of
interest that reset periodically to a market benchmark rate plus a
credit margin. The Company believes the effective interest rate
under the Credit Facility approximates current market rates for
such indebtedness at the dates of the condensed consolidated
balance sheets, and therefore that the outstanding principal and
accrued interest of $87,564,500 and $122,539,300 at
June 30
, 2019 and December 31, 2018,
respectively, approximate their fair values on such dates. The fair
value of the Company’s outstanding balance of its Credit
Facility is categorized as a Level 3 input under the GAAP fair
value hierarchy.
Before
their repayment in February 2019 in connection with the Term
Loans refinancing, the amounts payable under the UK LLC SPE
Financing were payable through the fourth quarter of 2020 and bore
a fixed rate of interest, as described in Note 4(b). As discussed
above, during February 2019, the UK LLC SPE Financing and four
assets that previously served as collateral under the Credit
Facility were refinanced using the Term Loans. The Company believes
the effective interest rate under the special purpose financings
approximates current market rates for such indebtedness at the
dates of the condensed consolidated balance sheets, and therefore
that the outstanding principal and accrued interest of $40,888,800
and $9,227,200 approximate their fair values at
June 30
, 2019 and December 31, 2018,
respectively. Such fair value is categorized as a Level 3 input
under the GAAP fair value hierarchy.
There
were no transfers in or out of assets or liabilities measured at
fair value under Level 3 during the six months ended June 30, 2019
and 2018.
8. Acquisition of Management Company
In
October 2017, AeroCentury, JHC and certain other parties entered
into the Merger Agreement for the acquisition of JHC by AeroCentury
for consideration of approximately $2.9 million in cash and 129,217
shares of common stock of AeroCentury, as determined pursuant to
the Merger Agreement. JHC is the parent company of JMC, which is
the manager of the Company’s assets as described in Note 11
below.
The Merger was consummated on
October 1, 2018.
AeroCentury
’s common
stock issued as consideration in the Merger was offered and issued
pursuant to an exemption from registration under Section 3(a)(10)
of the Securities Act of 1933.
As a
result of the Merger, the Company indirectly assumed all of
JHC’s assets, comprised primarily of securities, prepaid
expenses and an office lease, as well as liabilities of
approximately $0.9 million. As a subsidiary of the Company,
JHC’s results are included in the Company’s condensed
consolidated financial statements beginning on October 1,
2018.
During
the quarter and six months ended June 30, 2019, the Company accrued
no expenses related to the Merger transaction. During the quarter
and six months ended June 30, 2018, the Company accrued $64,300 and
$264,200 of expenses related to the Merger transaction. Such
expenses are included in professional fees, general and
administrative and other in the Company’s condensed
consolidated statements of operations.
17
9. Commitments and Contingencies
In the
ordinary course of the Company’s business, the Company may be
subject to lawsuits, arbitrations and administrative proceedings
from time to time. The Company believes that the outcome of any
existing or known threatened proceedings, even if determined
adversely, should not have a material adverse effect on the
Company's business, financial condition, liquidity or results of
operations.
10.
Computation of (Loss)/Earnings Per
Share
Basic and diluted earnings per share are calculated as
follows:
|
|
For the
Six Months
Ended June
30,
|
For the
Three Months
Ended June
30,
|
||
|
|
2019
|
2018
|
2019
|
2018
|
|
Net
(loss)/income
|
$
(1,385,800
)
|
$
236,200
|
$
(77,600
)
|
$
(81,100
)
|
|
Weighted average
shares outstanding for the period
|
1,545,884
|
1,416,699
|
1,545,884
|
1,416,699
|
|
Basic
(loss)/earnings per share
|
$
(0.90
)
|
$
0.17
|
$
(0.05
)
|
$
(0.06
)
|
|
Diluted
(loss)/earnings per share
|
$
(0.90
)
|
$
0.17
|
$
(0.05
)
|
$
(0.06
)
|
Basic
(loss)/
earnings per
common share is computed using net
(loss)/
income and the weighted average number of common
shares outstanding during the period. Diluted
(loss)/
earnings per common share is
computed using net
(loss)/
income and the weighted average number of common
shares outstanding, assuming dilution. Weighted average common
shares
outstanding, assuming dilution, include potentially
dilutive common shares outstanding during the period.
11
. Related Party
Transactions
See the
description of the Merger Agreement between the Company and JHC in
Note 8 above, pursuant to which the Company acquired JHC in the
Merger and JHC became a wholly-owned subsidiary of the Company on
October 1, 2018.
Before
completion of the Merger, the Company’s portfolio of aircraft
assets was managed and administered under the terms of a management
agreement with JMC (the “Management Agreement”).
Certain officers of the Company were also officers of JHC and JMC
and held significant ownership positions in both JHC and the
Company, and JHC was also a significant stockholder of AeroCentury.
Under the Management Agreement, JMC received a monthly management
fee based on the net asset value of the Company’s assets
under management. JMC also received an acquisition fee for locating
assets for the Company. Acquisition fees were included in the cost
basis of the asset purchased. JMC also received a remarketing fee
in connection with the re-lease or sale of the Company’s
assets. Remarketing fees were amortized over the applicable lease
term or included in the gain or loss on sale.
In
April 2018, subsequent to the execution of the Merger Agreement for
the acquisition of JHC, JHC agreed to waive its right to receive
management and acquisition fees (“Contract Fees”)
otherwise owed by the Company to JHC pursuant to the Management
Agreement for all periods after March 31, 2018 and until the
earlier of the consummation of the Merger or August 15, 2018. In
return, the Company agreed to reimburse JMC for expenses
(“Management Expense”) incurred in providing management
services set forth under the Management Agreement. In July 2018,
JHC agreed to extend the expiration of this agreement (the
“Waiver and Reimbursement Agreement”) through October
15, 2018. Thus, if the Merger Agreement was terminated on or before
October 15, 2018 or the Merger did not close by October 15, 2018,
the Company would have become obligated to pay JMC
any excess (the “JMC
Margin”) of (i) the Contract Fees that would have been paid
to JMC since April 1, 2018
in the absence of the Waiver and
Reimbursement Agreement over (ii) the Management Expenses actually
paid by the Company to JMC since April 1, 2018.
For the
quarter and six months ended June 30, 2018, contractual fees
exceeded the reimbursed management fees by $497,200 of management
fees and $494,400 of acquisition fees. Notwithstanding the Waiver
and Reimbursement Agreement, until the closing or termination of
the Merger Agreement, the Company accrued as an expense the total
Contract Fees that would have been due under the Management
Agreement. Because the Merger closed on October 1, 2018, the Waiver
and Reimbursement Agreement for the period April 1, 2018 through
September 30, 2018 was considered in the acquisition accounting for
the calculation of the settlement loss recognized by the Company
when the Merger was consummated.
The
Company incurred management fees of $1,502,100 and $2,948,800
during the three months and six months ended June 30, 2018,
respectively. Acquisition fees incurred during the same periods
totaled $494,400.
12
. Subsequent
Events
18
Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations.
The following discussion and analysis should be read together with
the Company’s unaudited condensed consolidated financial
statements and the related notes included in this report. This
discussion and analysis contains forward-looking statements. Please
see the cautionary note regarding these statements at the beginning
of this report.
Overview
The
Company provides leasing and finance services to regional airlines
worldwide. The Company is principally engaged in leasing its
aircraft portfolio, primarily consisting of mid-life regional
aircraft, through operating leases and finance leases to its
globally diverse customer base of eleven airlines in nine
countries. In addition to leasing activities, the Company sells
aircraft from its operating lease portfolio to third parties,
including other leasing companies, financial services companies,
and airlines. Its operating performance is driven by the
composition of its aircraft portfolio, the terms of its leases, the
interest rate of its debt, as well as asset sales.
The
Company purchased no aircraft during the second quarter of 2019.
During the same period, the Company reclassified an aircraft held
for lease to a sales-type finance lease receivable as a result of a
lease amendment requiring the lessee to purchase the aircraft for a
fixed amount at lease end and recorded a loss of $0.2 million. The
Company ended the quarter with a total of fifteen aircraft held for
lease, with a net book value of approximately $168 million. This
represents an 8% decrease compared to the net book value of the
Company’s aircraft and engines held for lease at December 31,
2018. In addition to the aircraft held for lease at quarter-end,
the Company held seven aircraft subject to finance leases and held
three aircraft and an engine for sale.
Average
portfolio utilization was approximately 99% and 91% during the
second quarters of 2019 and 2018, respectively. The year-to-year
increase was due to sales during 2018 of assets that were off lease
in the 2018 period.
The unused available borrowing capacity under the Company’s
Credit Facility was $57.6 million as of
June
30
, 2019, and the
weighted average interest rate was 6.19%.
In February 2019,
the Credit Facility, which was to expire on May 31, 2019, was
extended to February 19, 2023, and was amended in certain other
respects as described under
Liquidity and Capital Resources,
below.
Also in February 2019, the Company refinanced, using new
non-recourse Term Loans with an aggregate principal of $44.3
million, four aircraft that previously served as collateral under
the Credit Facility and two aircraft that previously served as
collateral under special purpose subsidiary
financings.
Net
loss for the second quarters of 2019 and 2018 was $0.1 million in
both quarters, resulting in basic and diluted (loss)/earnings per
share of $(0.05) and $(0.06), respectively. Net loss for the six
months ended
June 30, 2019
was
$1.4 million, compared to net income of $0.2 million in the same
period of 2018, resulting in basic and diluted (loss)/earnings per
share of $(0.90) and $0.17, respectively. Pre-tax profit margin
(which the Company calculates as its income before income tax
provision as a percentage of its revenues and other income) for the
quarter ended
June
30, 2019 was
(1%) in the second quarters of 2019 and 2018, and pre-tax profit
margin for the six months ended
June
30, 2019 was (12%) compared to 3% for
the same period of 2018.
On
October 1, 2018, the Company acquired JHC by way of the Merger. JHC
is the owner of JMC, the integrated aircraft management, marketing
and financing business that manages and administers the Company's
portfolio of aircraft assets. Before the Merger, such management
and administration were performed pursuant to the terms of the
Management Agreement between the Company and JMC. After the Merger,
the management and administration services provided under the
Management Agreement became internalized and under the control and
management of the Company itself. Expenses incurred by JMC in
providing services under the Management Agreement are, as of
October 1, 2018, expenses of the Company reflected in the
Company’s financial statements. In addition, after October 1,
2018, the management, acquisition and remarketing fees previously
paid by the Company to JMC as an unconsolidated third party are no
longer reflected in the Company’s financial statements;
rather, the expenses incurred by JMC in managing and administering
the Company’s assets are borne by the Company directly and
reflected in its financial statements accordingly.
19
Fleet Summary
(a) Assets Held for Lease
Key
portfolio metrics of the Company’s aircraft held for lease as
of
June 30
, 2019 and December
31, 2018 were as follows:
|
|
June
30
,
2019
|
December
31,
2018
|
|
Number of aircraft
and engines held for lease
|
15
|
18
|
|
|
|
|
|
Weighted average
fleet age
|
11.0 years
|
11.1 years
|
|
Weighted average
remaining lease term
|
55 months
|
58 months
|
|
Aggregate fleet net
book value
|
$
168,381,900
|
$
184,019,900
|
|
|
For the Six
Months
Ended
June
30,
|
For the Three
Months
Ended
June
30,
|
||
|
|
2019
|
2018
|
2019
|
2018
|
|
Average portfolio
utilization
|
98
%
|
90
%
|
99
%
|
91
%
|
The
year-to-year increase was primarily due to sales during 2018 of
assets that were off lease in the 2018 period.
The
following table sets forth the net book value and percentage of the
net book value, by type, of the Company’s assets that were
held for lease at
June 30
, 2019
and December 31, 2018:
|
|
June 30
,
2019
|
December 31,
2018
|
||
|
Type
|
Number
owned
|
% of net book
value
|
Number
owned
|
% of net book
value
|
|
Turboprop
aircraft:
|
|
|
|
|
|
Bombardier
Dash-8-400
|
2
|
14
%
|
2
|
13
%
|
|
Bombardier
Dash-8-300
|
-
|
-
%
|
2
|
5
%
|
|
|
|
|
|
|
|
Regional jet
aircraft:
|
|
|
|
|
|
Canadair
900
|
5
|
41
%
|
5
|
39
%
|
|
Embraer
175
|
3
|
18
%
|
3
|
16
%
|
|
Canadair
1000
|
2
|
14
%
|
2
|
14
%
|
|
Canadair
700
|
3
|
13
%
|
3
|
12
%
|
|
|
|
|
|
|
|
Engines:
|
|
|
|
|
|
Pratt
& Whitney 150A
|
-
|
-
%
|
1
|
1
%
|
During
the second quarter of 2019, the Company purchased no aircraft, sold
certain aircraft parts and reclassified one aircraft from held for
lease to a finance lease receivable. During the first six months of
2019, the Company purchased no aircraft, sold one aircraft and
certain aircraft parts, reclassified one aircraft from held for
lease to a finance lease receivable and reclassified an engine from
held for lease to held for sale. During the second quarter of 2018,
the Company purchased two aircraft and sold certain aircraft parts.
During the first six months of 2018, the Company purchased two
aircraft subject to operating leases and sold two aircraft and
certain aircraft parts.
20
The
following table sets forth the net book value and percentage of the
net book value of the Company’s assets that were held for
lease at
June 30
, 2019 and
December 31, 2018 in the indicated regions (based on the domicile
of the lessee):
|
|
June 30
,
2019
|
December 31,
2018
|
||
|
Region
|
Net book
value
|
%
of
net book
value
|
Net book
value
|
%
of
net book
value
|
|
Europe
|
$
102,877,100
|
61
%
|
$
110,069,000
|
60
%
|
|
North
America
|
65,504,800
|
39
%
|
68,485,400
|
37
%
|
|
Asia
|
-
|
-
%
|
5,465,500
|
3
%
|
|
|
$
168,381,900
|
100
%
|
$
184,019,900
|
100
%
|
For the
three months ended
June
30,
2019, approximately 29%, 28% and 21% of the Company’s
operating lease revenue was derived from customers in Slovenia, the
United States and Spain, respectively. Operating lease revenue does
not include interest income from the Company’s finance
leases. The following table sets forth geographic information about
the Company’s operating lease revenue for leased aircraft and
aircraft equipment, grouped by domicile of the lessee:
|
|
For the Six
Months Ended June 30,
|
For the Three
Months Ended
June
30,
|
||||||
|
|
2019
|
2018
|
2019
|
2018
|
||||
|
Region
|
Number
of
lessees
|
%
of
operating
lease
revenue
|
Number
of
lessees
|
%
of
operating
lease
revenue
|
Number
of
lessees
|
%
of
operating
lease
revenue
|
Number
of
lessees
|
%
of
operating
lease
revenue
|
|
Europe
|
4
|
62
%
|
4
|
57
%
|
4
|
64
%
|
3
|
56
%
|
|
North
America
|
4
|
36
%
|
4
|
38
%
|
3
|
36
%
|
4
|
39
%
|
|
Asia
|
1
|
2
%
|
1
|
5
%
|
-
|
-
%
|
1
|
5
%
|
At
June 30
, 2019 and December 31,
2018, the Company also had seven aircraft subject to finance
leases. For the quarter ended
June
30
, 2019, approximately 62% and 38% of the Company’s
finance lease revenue was derived from customers in Africa and
Europe, respectively.
(b) Assets Held for Sale
Assets
held for sale at
June
30, 2019
consisted of two Saab 340B Plus turboprop aircraft, one Bombardier
Dash-8-300 aircraft, one Pratt & Whitney 150A engine and
airframe parts from two turboprop aircraft.
Results of Operations
(a)
Quarter ended June 30, 2019 compared to the
quarter ended June 30, 2018
(i)
Revenues and Other Income
Revenues
and other income decreased by 8% to $7.2 million in the second
quarter of 2019 from $7.8 million in the second quarter of 2018.
The decrease was primarily a result of decreased finance lease
revenues, maintenance reserves revenue and a loss on a sales-type
finance lease, the effects of which were partially offset by an
increase in operating lease revenues and gains on
sale.
Operating
lease revenue increased by 2% to $7.0 million in the second quarter
of 2019 from $6.8 million in the second quarter of 2018, primarily
due to revenue from assets purchased in the second quarter of 2018
and an asset that was on lease in the 2019 period, but off lease in
the 2018 period, the effects of which were offset by the reduced
revenue from an asset sold in the first quarter of
2019.
Finance
lease revenue decreased by 28% to $0.3 million in the second
quarter of 2019 from $0.4 million in the second quarter of 2018,
primarily due to a lower finance lease receivables balance in the
2019 period and the purchase by the lessee of three aircraft
subject to finance leases during the third quarter of
2018.
Maintenance
reserves that are retained by the Company at lease end are recorded
as revenue at that time. The Company recorded no such revenue
during the second quarter of 2019. During the second quarter of
2018, the Company recorded $0.6 million of such revenue, arising
from cash received from the former lessee of three aircraft after
such aircraft were returned to the Company by the lessee during
2017. Such amounts were not accrued at lease termination based on
management’s evaluation of the creditworthiness of the
lessee.
During
the second quarter of 2019, the Company recorded a net gain of
approximately $0.1 million on the sale of aircraft parts and a net
loss of $0.2 million on the reclassification of an aircraft from
held for lease to a finance lease receivable.
During the second quarter of 2018,
the Company sold certain aircraft parts and recorded a net gain of
approximately $18,000.
(ii)
Expenses
Total
expenses decreased by 8% to $7.3 million in the second quarter of
2019 from $7.9 million in the second quarter of 2018. The decrease
was primarily a result of decreases in management fees and asset
impairment provisions. These increases were partially offset by
increases in salaries and employee benefits and professional fees
and general and administrative and other expenses.
21
Until
the acquisition of JHC on October 1, 2018, management fees paid to
JMC were based on the net book value of the Company’s
aircraft and engines as well as finance lease receivable balances.
After the Merger, JMC’s operating expenses, including
salaries and employee benefits, became the responsibility of the
Company. The total of salaries and employee benefits and
professional fees, general and administrative and other expenses
was approximately $1.5 million in the second quarter of 2019. The
total of management fees and professional fees, general and
administrative and other expenses was approximately $1.9 million in
the second quarter of 2018. Professional fees, general and
administrative and other expenses in the 2018 period included
$64,300 incurred in connection with the acquisition of
JHC.
During
the second quarter of 2019, the Company recorded an impairment
charge totaling $0.2 million for an asset held for sale, based on
appraised value.
During
the quarter ended June 30, 2018, the Company recorded an impairment
provision of $0.3 million for an asset held for lease, based on
appraised value.
(b)
Six months ended June 30, 2019 compared to the six
months ended June 30, 2018
(i)
Revenues and Other Income
Revenues
and other income decreased by 6% to $14.7 million in the first six
months of 2019 from $15.7 million in the same period of 2018. The
decrease was primarily a result of decreased maintenance reserves
revenue and finance lease revenues, the effects of which were
partially offset by an increase in operating lease revenues and
gains on sale.
Operating
lease revenue increased by 6% to $14.1 million in the first six
months of 2019 from $13.3 million in the same period of 2018,
primarily due to revenue from assets purchased in the second
quarter of 2018 and an asset that was on lease in the 2019 period,
but off lease in the 2018 period.
Finance
lease revenue decreased by 33% to $0.5 million in the six months
ended June 30, 2019 from $0.7 million in the six months ended June
30, 2018, primarily due to a lower finance lease receivables
balance in the 2019 period and the purchase by the lessee of three
aircraft subject to finance leases during the third quarter of
2018.
Maintenance
reserves that are retained by the Company at lease end are recorded
as revenue at that time. The Company recorded no such revenue
during the first six months of 2019. During the first six months of
2018, the Company recorded $1.6 million of such revenue, arising
from cash received from the former lessee of three aircraft after
such aircraft were returned to the Company by the lessee during
2017. Such amounts were not accrued at lease termination based on
management’s evaluation of the creditworthiness of the
lessee.
During
the six months ended June 30, 2019, the Company recorded a net gain
of approximately $0.3 million on the sale of an aircraft and
aircraft parts and a net loss of $0.2 million on the
reclassification of an aircraft from held for lease to a finance
lease receivable.
During
the six months ended June 30, 2018, the Company recorded net gains
of $9,900 on the sale of two aircraft and aircraft
parts.
(ii)
Expenses
Total
expenses increased by 8% to $16.5 million in the second quarter of
2019 from $15.3 million in the six months ended June 30, 2019
versus the same period of 2018. The increase was primarily a result
of increases in interest expense, salaries and employee benefits
and professional fees, general and administrative and other
expenses and asset impairment provisions. These increases were
partially offset by a decrease in management fees.
The
Company’s interest expense increased by 17% to $5.4 million
in the first six months of 2019 from $4.6 million in the same
period of 2018, primarily as a result of a higher average debt
balance, a higher average interest rate and $0.4 million of
valuation charges related to the Company’s interest rate
swaps.
22
Until
the acquisition of JHC on October 1, 2018, management fees paid to
JMC were based on the net book value of the Company’s
aircraft and engines as well as finance lease receivable balances.
After the Merger, JMC’s operating expenses, including
salaries and employee benefits, became the responsibility of the
Company. The total of salaries and employee benefits and
professional fees, general and administrative and other expenses
was approximately $2.9 million in the six months ended June 30,
2019. The total of management fees and professional fees, general
and administrative and other expenses was approximately $3.9
million in the six months ended June 30, 2018. Professional fees,
general and administrative and other expenses in the 2018 period
included $264,200 incurred in connection with the acquisition of
JHC.
During
the six months ended June 30, 2019, the Company recorded impairment
charges totaling $1.6 million on three aircraft and an engine held
for sale, based on expected sales proceeds or appraised values.
During the six months
ended June 30, 2018, the Company recorded an impairment provision
of $0.3 million for an asset held for lease, based on appraised
value.
Liquidity and Capital Resources
The
Company is currently financing its assets and operations primarily
through debt financing and excess cash flow from
operations.
(a)
Credit Facility
The
Company has a Credit Facility, as described in Note 4(a) to the
Company’s condensed consolidated financial statements in this
report. In February 2019, the Credit Facility, which had
availability of $170 million (with the ability for the Company to
request an increase up to $180 million) and was to mature on May
31, 2019, was extended to February 19, 2023, reduced to $145
million (with the ability for the Company to request an increase up
to $160 million) and amended in certain other respects, including
with respect to certain of the Company’s financial covenants
thereunder.
In
addition to payment obligations (including principal and interest
payments on outstanding borrowings and commitment fees based on the
amount of any unused portion of the Credit Facility), the Credit
Facility contains financial covenants with which the Company must
comply, including, but not limited to, positive earnings
requirements, minimum net worth standards and certain ratios, such
as debt to equity ratios.
The
Company was in compliance with all covenants under the Credit
Facility at June 30, 2019. The Company was not in compliance with
the interest coverage, debt service coverage, no-net-loss and
revenue concentration covenants under the Credit Facility at
December 31
, 2018. The
December 31, 2018 noncompliance was cured by the February 2019
amendment and restatement of the agreement governing the Credit
Facility, which also revised certain of these financial covenants
requirements through the February 2023 maturity date of the
extended Credit Facility.
If the
Company is out of compliance with any of its Credit Facility
covenants at future calculation dates, it would need to request
waivers or amendments of applicable covenants from the lenders if
such compliance failure is not timely cured. Any such future
noncompliance
that is
not timely cured or waived would result in a default under the
Credit Facility, which could have material negative consequences,
as described further below.
The
Company’s ability to maintain compliance with its covenants
in the Credit Facility is subject to a variety of factors,
including, among others (i) unanticipated decreases in the market
value of the Company’s assets, or in the rental rates deemed
achievable for such assets, that cause the Company to record an
impairment charge against earnings, (ii) lessee noncompliance with
lease obligations, (iii) inability to locate new lessees for
returned aircraft or equipment within a reasonable remarketing
period, or at a rent level consistent with projected rates, (iv)
inability to locate and acquire a sufficient volume of additional
assets at prices that will produce acceptable net returns, (v)
increases in interest rates, and (vi) inability to timely dispose
of off-lease assets at prices commensurate with their market
value.
Any
default under the Credit Facility, if not cured in the time
permitted or waived by the lenders, could result in the
Company’s inability to borrow any further amounts under the
Credit Facility, the acceleration of the Company’s obligation
to repay amounts borrowed under the Credit Facility, or foreclosure
upon any or all of the assets of the Company.
In
order to reduce its exposure to the risk of increased interest
rates, the Company entered into two Swaps in March 2019, which have
an aggregate total notional amount equal to $50 million and extend
through the maturity of the Credit Facility in February of
2023.
(b)
Special Purpose Financing and Term
Loans
In August 2016, the Company acquired, using wholly-owned special
purpose entities, two regional jet aircraft, using cash and
third-party financing (referred to as “special purpose
financing” or “UK LLC SPE Financing”) separate
from the Credit Facility, as described in Note 4(b) to the
Company’s condensed consolidated financial statements in this
report.
23
In
February 2019, the UK LLC SPE Financing was repaid as part of a
refinancing involving the Term Loans, which were made to special
purpose subsidiaries of the Company. Under the Term Loans, four
aircraft that previously served as collateral under the Credit
Facility were moved into newly formed special purpose subsidiaries
and, along with the aircraft owned by the two existing special
purpose subsidiaries, were pledged as collateral under the Term
Loans.
All of
the Term Loans contain cross-default provisions, so that any
default by a lessee of any of the subject aircraft could result in
the Term Loan lender exercising its remedies under the Term Loan
agreement, including, but not limited to, possession of the
aircraft that is subject to a lessee default. In addition, a
default under the Term Loan agreement would be a default under the
Credit Facility agreement.
Collectively,
the LLC Borrowers entered into six interest rate derivatives, or
Swaps. Each such swap has a notional amount that mirrors the
amortization under the corresponding Term Loan entered into by the
LLC Borrowers, effectively converting each of the six Term Loans
from variable rate to fixed rate. Each of these six Swaps extend
for the length of the corresponding Term Loan, with maturities from
2020 through 2025.
(c) Cash Flow
The Company’s primary sources of cash from operations are
payments due under the Company’s operating and finance
leases, maintenance reserves, which are billed monthly to lessees
based on asset usage, and proceeds from the sale of aircraft and
engines.
The
Company’s primary uses of cash are for (i) purchases of
assets, (ii) Credit Facility and Term Loans principal and interest
payments, (iii), salaries, employee benefits and general and
administrative expenses, (iv) maintenance expense and (v)
reimbursement to lessees from collected maintenance
reserves.
The
Company’s payments for maintenance consist of reimbursements
to lessees for eligible maintenance costs under their leases and
maintenance incurred directly by the Company for preparation of
off-lease assets for re-lease to new customers. The timing and
amount of such payments may vary widely between quarterly and
annual periods, as the required maintenance events can vary greatly
in magnitude and cost, and the performance of the required
maintenance events by the lessee or the Company, as applicable, are
not regularly scheduled calendar events and do not occur at uniform
intervals. The Company’s maintenance payments typically
constitute a large portion of its cash needs, and the Company may
from time to time borrow additional funds under the Credit
Facility, if available, or seek alternative sources of financing to
provide funding for these payments.
Prior
to the Company’s acquisition of JHC on October 1, 2018, the
Company’s portfolio of aircraft assets was managed and
administered under the terms of the Management Agreement with JMC.
Under the Management Agreement, JMC received a monthly management
fee based on the net asset value of the Company’s assets
under management. JMC also received an acquisition fee for locating
assets for the Company to acquire. Acquisition fees were included
in the cost basis of the asset purchased. JMC also received a
remarketing fee in connection with the re-lease or sale of the
Company’s assets. Remarketing fees were amortized over the
applicable lease term or included in the gain or loss on
sale.
Following
the Merger, the risk of increased JMC expenses, including employee
salaries and benefits, worldwide travel related to the management
of the Company's aircraft portfolio, office rent, outside technical
experts and other overhead expenses, is now the responsibility of
the Company. In addition, because the management and administrative
services previously performed by JMC are now internalized, the
Company is no longer paying management or acquisition fees to JMC
in exchange for the performance of these services. As a result, the
Company expects the types, timing and amounts of, and patterns and
trends with respect to, its recorded expenses to change as a result
of the Merger, but the manner and extent of these changes remains
uncertain until the Company has performed and controlled these
functions for some period of time.
The
amount of interest paid by the Company depends primarily on the
outstanding balance of its Credit Facility. Although the amounts
owed under the Credit Facility accrue interest at a floating rate
plus an interest rate margin, and are thus dependent on
fluctuations in prevailing interest rates, in March 2019 the
Company entered into two interest rate swap transactions for the
variable interest rate payment amounts due for $50 million of the
outstanding Credit Facility debt. As a result, although the amount
of interest paid by the Company under the Credit Facility will
fluctuate depending on prevailing interest rates, the swap will
offset some of this variability such that the Company will be
affected by interest rate fluctuations under the Credit Facility
only to the extent of any excess of the outstanding balance under
the Credit Facility over the amount covered by the related interest
rate swap. Interest related to the Company’s Term Loans also
accrues at variable rates, but the Company has entered into
interest rate swaps that effectively convert the Term Loans
interest payments to fixed rate payments.
The
Credit Facility and the Term Loans, as well as their related
interest rate swap transactions, use LIBOR as a benchmark for
establishing the rates at which interest accrues. LIBOR is the
subject of recent national, international and other regulatory
guidance and proposals for reform. These reforms and other
pressures may cause LIBOR to disappear entirely or to perform
differently than in the past. Although the consequences of these
developments cannot be entirely predicted, they could include an
increase in the cost to the Company of its LIBOR debt or even an
acceleration of maturity of such debt if a suitable replacement
index cannot be agreed upon or is not available.
Management believes that the Company will have adequate cash flow
to meet its ongoing operational needs, including any required
repayments under the Credit Facility and Term Loans, for at least
the next 12 months from the issuance of this Quarterly Report,
based upon its current estimates of future revenues and
expenditures. These estimates reflect assumptions about, among
other things, (i) compliance by lessees with the terms and
provisions of their respective leases, (ii) revenues from assets to
be re-leased, (iii) the amount, timing and patterns of management
and administrative expenses being borne by the Company, (iv) cost
and anticipated timing of aircraft maintenance to be performed, (v)
required debt payments, (vi) timely use of proceeds of unused debt
capacity for additional acquisitions of income-producing assets and
(vii) interest rates. Although the Company believes that the
assumptions it has made in forecasting its cash flow are reasonable
in light of experience, actual results could deviate from such
assumptions. As discussed above, in
Liquidity and Capital
Resources – (a) Credit Facility
, and below in
Outlook
and
Factors that May Affect Future
Results and Liquidity
, there
are a number of factors that may cause actual results to deviate
from these forecasts. If these assumptions prove to be incorrect
and the Company’s cash requirements exceed its cash flow, the
Company would need to pursue additional sources of financing to
satisfy these requirements, which may not be available when needed,
on acceptable terms or at all. See
Factors that May Affect Future
Results and Liquidity
below for
more information about financing risks and
limitations.
24
(i)
Operating activities
The
Company’s cash flow from operations decreased by $6.4 million
in the first six months of 2019 compared to the same period of
2018. As discussed below, the decrease in cash flow was primarily a
result of decreases in payments received for rent and maintenance
reserves, the effects of which were partially offset by a decrease
in payments made for maintenance.
(A)
Payments for
rent
Receipts
from lessees for rent decreased by $2.8 million in the first six
months of 2019 compared to the same period of 2018, primarily due
to delinquencies related to one of the Company’s customers,
and the sale of an aircraft during the first quarter of 2019, the
effects of which were partially offset by rent for two aircraft
acquired during the second quarter of 2018 and rent for an asset
that was on lease in the 2019 period, but off lease in the 2018
period.
(B)
Payments for maintenance
reserves
Receipts
from lessees for maintenance reserves decreased by $3.5 million in
the first six months of 2019 compared to the same period of 2018,
primarily due to delinquencies related to one of the
Company’s customers, as well as cash received in the 2018
period from the former lessee of three aircraft that were returned
to the Company during 2017. Such payments were for unpaid
maintenance reserves, as well as amounts due pursuant to the return
conditions of the applicable leases. The Company did not accrue
unpaid reserves or return condition amounts at the time of lease
termination based on management’s evaluation of the
creditworthiness of the lessee. Therefore, the Company has
accounted for payments from the former lessee as they are received
and has recorded the amount in maintenance reserves revenue in the
period in which a payment is received.
(D)
Payments for
maintenance
Payments
made for maintenance decreased by $2.2 million in the first six
months of 2019 compared to the first six months of 2018 as a result
of decreased maintenance performed by the Company on off-lease
aircraft to prepare them for sale or re-lease and decreased
maintenance reserves claims in the 2019 period.
(ii)
Investing activities
During the first six months of 2019 and 2018, the Company received
net cash of $3.9 million and $5.8 million, respectively, from the
sale of assets. During the first six months of 2018, the Company
used cash of $22.6 million for acquisitions of
aircraft.
(iii)
Financing activities
During the first six months of 2019 and 2018, the Company borrowed
$5.1 million and $21 million, respectively, under the Credit
Facility. In the same periods of 2019 and 2018, the Company repaid
$40.1 million and $17.5 million, respectively, of its total
outstanding debt under the Credit Facility. Such repayments were
funded by excess cash flow, the sale of assets and, in 2019,
proceeds from the Term Loans. During the first six months of 2019
and 2018, the Company’s special purpose entities repaid $9.2
million and $2.1 million, respectively, of UK LLC SPE Financing.
During the 2019 period, the Company also repaid $3.5 million of
Term Loans principal. During the first six months of 2019 and 2018,
the Company paid $5.1 million and $0.1 million, respectively, for
debt issuance and amendment fees.
(iv)
Off balance sheet arrangements
The Company has no material off balance sheet
arrangements.
Outlook
The
Company has identified five principal factors that it believes may
materially affect the Company’s growth and operating results
in the near term. These and other factors that could impact the
Company’s business, performance and liquidity are described
in more detail under
Factors that
May Affect Future Results and Liquidity
below.
●
One
of the Company’s largest customers based on operating lease
revenue, a well-established European regional carrier, has
accumulated a significant arrearage in payments owed under its
leases with the Company for four regional jets. The Company
is monitoring the lessee's situation closely and is currently
working with the lessee to address the arrearages and ensure proper
maintenance of its assets, while at the same time evaluating its
remedies should the lessee fail to timely remedy its lease payment
arrearages. The lessee has announced that it is currently seeking
additional equity to improve its financial status, which could
allow the lessee to address, at least partially, its arrearage with
the Company and allow the lessee to stay in compliance with its
lease obligations following the new capital infusion, but there is
no assurance that such financing will be consummated by the lessee.
Even if consummated, an investor of new capital may require a
significant concession from the lessee’s creditors in terms
of forgiveness of arrearages as a condition of the investment by
such investor. If the lessee is unable to timely cure its
defaults and stay in compliance with its lessee obligations, the
Company has the right to terminate its leases with the lessee and
repossess the aircraft. Upon such termination, the Company
would be entitled to retain the collected reserve payments and
security deposits (which for each aircraft are currently in excess
of the lessee’s arrearage to the Company). Such
termination could, however, have an impact on the Company’s
financial results from the loss of operating lease revenue
generated from the four aircraft leases while the Company seeks a
replacement lessee or from maintenance expense incurred following
repossession in order to make the aircraft ready for re-lease or
sale.
25
●
The
Company must source additional capital, though equity financings,
additional debt financings or other alternatives, in order to grow.
One of the motivations for AeroCentury’s acquisition of JHC
was to remove the outside management structure of the Company,
which was believed to be an impediment to attracting capital
sources. There can be no assurance that the Company will be able to
obtain additional capital when needed, in the amounts desired or on
favorable terms, as a successful capital-raising transaction
depends on many factors, many of which are outside the
Company’s control.
●
On
October 1, 2018, the Company acquired JHC, the sole shareholder of
JMC, which has acted as the management company for the Company
since the Company’s inception. The Company believes that the
combination of the management function performed by JMC and the
portfolio held by the Company could be accretive to the Company and
could create value for the stockholders of the combined post-Merger
company, but such accretion may not be realized until after
transaction and integration costs in connection with the Merger
have been incurred, or at all.
●
Increased
production of aircraft types in the Company’s market niche of
worldwide regional aircraft has resulted in some manufacturers
offering more competitive pricing for new aircraft to regional
aircraft customers. In addition, notwithstanding recent interest
rate increases in the United States, competition for assets in this
market niche has continued to increase. Some of the Company’s
newer competitors are funded by investment banks and private equity
firms seeking higher yields on investment assets than are currently
available from traditional income investment types. The increased
competition has resulted in higher acquisition prices for many of
the aircraft types that the Company has targeted to buy and, at the
same time, downward pressure on lease rates for these aircraft,
resulting in lower revenues and margins and, therefore, fewer
acceptable acquisition opportunities for the Company. The Company
anticipates this trend will continue for the short- to medium-term,
but could change if and when yields on alternative investments
return to a more normal historical range.
●
The
Company has a signed purchase agreement for the sale of two
turboprop aircraft that are currently off lease and classified as
held for sale, and the Company expects the sales to occur in the
third quarter of 2019.
Critical Accounting Policies, Judgments and Estimates
The
Company’s discussion and analysis of its financial condition
and results of operations are based upon the condensed consolidated
financial statements included in this report, which have been
prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these
financial statements requires management to make estimates and
judgments that affect the reported amounts of assets and
liabilities, revenues and expenses, and the related disclosure of
contingent assets and liabilities at the date of the financial
statements or during the applicable reporting period. In the event
that actual results differ from these estimates or the Company
adjusts these estimates in future periods, the Company’s
operating results and financial position could be materially
affected. For a further discussion of Critical Accounting Policies,
Judgments and Estimates, refer to Note 1 to the Company’s
condensed consolidated financial statements in this
report.
Factors that May Affect Future Results and Liquidity
The
Company’s business, financial condition, results of
operations, liquidity, prospects and reputation could be affected
by a number of factors. In addition to matters discussed elsewhere
in this discussion, the Company believes the following are the most
significant factors that may impact the Company; however,
additional or other factors not presently known to the Company or
that management presently deems immaterial could also impact the
Company and its performance and liquidity.
Availability of Financing.
As described above, the Company
must source additional capital, through equity financings,
additional debt financings or other alternatives, in order to grow.
One of the current primary limitations on the Company’s
ability to borrow additional amounts under its Credit Facility or
incur any other additional debt financing is the covenant
limitation on the Company’s maximum debt to equity ratio. As
a result, unless this ratio changes due to equity financing or
otherwise, the Company’s ability to rely upon the Credit
Facility as a capital resource will remain limited. Additionally,
although one of the motivations for AeroCentury’s acquisition
of JHC was to remove the outside management structure of the
Company, which was believed to be an impediment to attracting
capital sources, there could be other material factors, many of
which are outside of the Company’s control, that prevent or
limit the Company’s ability to access additional capital. As
a result, there can be no assurance that the Company will be able
to obtain additional capital when needed, in the amounts desired or
on favorable terms in the future.
Noncompliance with Debt Financial Covenants.
The
Company’s use of debt as its primary form of acquisition
financing subjects the Company to increased risks associated with
leverage. In addition to payment obligations, the
Company’s debt agreements include financial covenants,
including some requiring the Company to have positive earnings,
meet minimum net worth standards and comply with certain other
financial ratios. The Company was not in compliance with certain of
these standards and ratios under the Credit Facility as of
December 31, 2018. Although this noncompliance was cured with
the February 2019 amendments to the Credit Facility agreement,
which revised certain of these financial covenants to better
accommodate the Company’s financial circumstances as a
post-Merger entity with unified asset and portfolio management and
to position the Company for future growth, the Company may be
subject to additional compliance failures of these or other debt
covenants at future calculation dates, and the lenders are under no
obligation to forbear or waive any such future noncompliance. Any
default under the Credit Facility or any other debt agreement, if
not cured in the time permitted or waived by the respective lender,
could result in the Company’s inability to borrow under the
debt instrument, the acceleration of the Company’s debt
obligations, or the foreclosure upon any or all of the assets of
the Company.
Credit Facility Debt Limitations.
The amount available to be
borrowed under the Credit Facility is limited by asset-specific
advance rates. Lease arrearages or off-lease periods for a
particular asset that serves as collateral under the Credit
Facility may reduce the loan advance rate permitted with respect to
that asset and, therefore, reduce the permitted borrowing under the
facility or require repayments. Amounts subject to payment deferral
agreements also reduce the amount of permitted borrowing. The
Company believes it will have sufficient borrowing availability
under the Credit Facility to meet its anticipated capital needs in
the near term in spite of these limitations and it will have
sufficient cash funds to make any required principal repayment that
arises due to any such borrowing limitations, but actual cash
levels could deviate from these assumptions.
26
Term Loan Debt Limitations
. The special purpose
subsidiaries, ACY 19002 Limited, ACY 19003 Limited,
ACY SN 15129 LLC, and ACY E-175
LLC,
that own the six aircraft serving as collateral for the
Term Loans are the named borrowers (“Borrower LLCs”)
under the Term Loans, and each Term Loan is secured by the
corresponding aircraft owned by the applicable Borrower LLC.
AeroCentury, as the parent corporation of each Borrower LLC, is not
a party to the Term Loan agreements, but has entered into
agreements with lessees of the Borrower LLCs to guarantee certain
obligations to such lessees under each lessee’s lease
agreement with a Borrower LLC and with the Term Loan Lender to
guarantee certain representations, warranties and covenants
delivered by the Borrower LLCs to the Term Loan Lender in
connection with the refinancing transaction. As a result, although
the Term Loans are non-recourse to AeroCentury, AeroCentury could
become directly responsible for the Borrower LLCs’
obligations under the Term Loans and the related lease agreements
pursuant to these guaranty arrangements. Moreover, any
noncompliance under the Term Loans by a Borrower LLC could
negatively affect the liquidity, aircraft portfolio and reputation
of the Company as a whole.
The
required payments under each Term Loan are expected to be funded by
the operating lease rental revenue received from the lessee of the
corresponding aircraft, and each Borrower LLC’s continued
compliance with its Term Loan will depend upon the lessee’s
compliance with its lease payment obligations. Failure by a lessee
to make timely payments could result in a default under the
applicable Term Loan and could result in an acceleration of all
Term Loan indebtedness of the applicable Borrower LLC or
foreclosure by the Term Loan lender on the applicable aircraft.
Furthermore, a default by any Borrower LLC under its Term Loan
would also constitute a default under the Credit Facility, and
therefore any failure by a Borrower LLC’s lessee to comply
with its lease payment obligations or any other compliance failure
by a Borrower LLC under its Term Loan could result in the
Company’s noncompliance under several of its debt agreements,
which could have a material negative adverse effect on the
Company’s liquidity and capital resources.
Concentration of Lessees.
For the quarter ended
June
30, 2019, the Company’s three
largest customers accounted for a total of approximately 78% of the
Company’s monthly operating lease revenue. A lease default by
or collection problem with one or a combination of any of these
significant customers could have a disproportionately negative
impact on the Company’s financial results and borrowing base
under the Credit Facility, and, therefore, the Company’s
operating results are especially sensitive to any negative
developments with respect to these customers in terms of lease
compliance or collection. In addition, if the Company’s
revenues become overly concentrated in a small number of lessees,
the Company could fail to comply with certain financial covenants
in its Credit Facility related to customer concentration, which
could result in the negative effects of such a default as described
under
Noncompliance with Debt
Financial Covenants
, above.
As
discussed in “
Outlook
” above, one of the
Company’s largest customers based on operating lease revenue,
which operates four aircraft leased by the Company, is experiencing
financial difficulties and has accrued a substantial arrearage for
rent and maintenance reserves. Because of the proportion of the
Company’s lease revenue generated by this particular lessee,
should the lessee be declared in default and the aircraft
repossessed by the Company, such repossession could generate a
significant unanticipated expense and the loss of rental for the
aircraft while they are being remarketed and may have a significant
negative impact on the Company’s financial results. The
Company is monitoring the financial status of the lessee closely
and its efforts to restructure and obtain additional equity to
enable it to meet its obligations to the Company and other
creditors, but there is no assurance that the lessee’s
efforts will be successful.
Consummation of Merger May Subject the Company to Additional
Risks.
On October 1, 2018 the Company acquired JHC, the sole
shareholder of the Company’s management company, JMC. The
acquisition of JHC subjects the Company to certain risks, including
the following:
●
Assumption of Expenses Covered under
Management Agreement.
Under the Management Agreement with
JMC, the Company paid management fees to JMC based upon the book
value of the Company’s aircraft assets, an acquisition fee
for each asset purchased by the Company, and a remarketing/re-lease
fee for each sale or re-lease transaction entered into with respect
to the Company’s aircraft. In return, JMC provided the
Company with comprehensive management services, under which JMC had
full responsibility for payment of all employee salaries and
benefits, outside technical services, worldwide travel needed to
promote the Company's business, office space, utilities, IT and
communications, furniture and fixtures, and other general
administrative and overhead costs. Under the Management Agreement,
if the fees collected were not adequate to cover JMC’s
expenses in managing the Company’s portfolio, such losses
were borne entirely by
JMC.
Upon completion of
the Merger on October 1, 2018, the Company became responsible for
all expenses that were previously incurred by JMC in managing the
Company. The risk of increased costs for these expenses is now the
responsibility of the Company, and such costs are no longer limited
to the amount of the management fee, as was the case under the
third -party management structure with JMC. Consequently, the risk
of any cost overruns or unanticipated expenses in asset management
are borne solely by the Company and are no longer shifted to an
unconsolidated third party. As a result, the Company’s
expense categories, amounts, timing and patterns could change
significantly in post-Merger periods and could be subject to
increased period-to-period fluctuations.
●
Internalization of Management.
JHC is
now a wholly-owned subsidiary of the Company, and sole
responsibility for management of the combined company now falls
upon the Company’s management. If the Company is dissatisfied
with management services, the Company will have to address the
shortcomings internally, and if they cannot be resolved with
existing management and personnel, the Company may be required to
reorganize its management structure and/or replace personnel or
seek new third-party management services, either of which could
result in the Company incurring significant expense and use of
resources.
●
Assumption of JHC Liabilities.
By
acquiring JHC in the Merger, JHC has become a wholly-owned
subsidiary of the Company. To the extent that JHC or any of its
subsidiaries have liabilities, these have become liabilities of the
Company on a consolidated basis. Although the Merger Agreement
provides for limited indemnification by JHC shareholders for
certain liabilities of JHC or its subsidiaries that arise from
pre-Merger occurrences and the Company performed due diligence
reviews of the liabilities of JHC and its subsidiaries before
completion of the Merger, the indemnification is limited to the
scope of representations and warranties in the Merger Agreement,
some of which have already expired, recovery under the
indemnification is limited to the consideration paid by the Company
to JHC’s shareholders and such due diligence reviews are
inherently non-exhaustive and may not have uncovered all known or
contingent liabilities or presently unknown liabilities that may
emerge after the Merger’s completion.
27
Ownership Risks.
The Company’s leases typically are
for a period shorter than the entire, anticipated, remaining useful
life of the leased assets. As a result, the Company’s
recovery of its investment and realization of its expected yield in
such a leased asset is dependent upon the Company’s ability
to profitably re-lease or sell the asset following the expiration
of the lease. This ability is affected by worldwide economic
conditions, general aircraft market conditions, regulatory changes,
changes in the supply or cost of aircraft equipment, and
technological developments that may cause the asset to become
obsolete. If the Company is unable to remarket its assets on
favorable terms when the leases for such assets expire, the
Company’s financial condition, cash flow, ability to service
debt, and results of operations could be adversely
affected.
The
Company typically acquires used aircraft equipment. The market for
used aircraft equipment has been cyclical, and generally reflects
economic conditions and the strength of the travel and
transportation industry. The demand for and value of many types of
used aircraft in the recent past has been depressed by such factors
as airline financial difficulties, airline consolidations, the
number of new aircraft on order, an excess supply of newly
manufactured aircraft or used aircraft coming off lease, as well as
introduction of new aircraft models and types that may be more
technologically advanced, more fuel efficient and/or less costly to
maintain and operate. Values may also increase or decrease for
certain aircraft types that become more or less desirable based on
market conditions and changing airline capacity. Declines in the
value of the Company’s aircraft and any resulting decline in
market demand for these aircraft could materially adversely affect
the Company’s revenues, performance and liquidity. Also,
because the Company’s ability to borrow under the current
terms of its Credit Facility is subject to a covenant setting forth
a maximum ratio of (i) the outstanding debt under the facility to
(ii) the appraised value of the collateral base of aircraft assets
securing the Credit Facility, a significant drop in the appraised
market value of the portfolio could require the Company to make a
substantial prepayment of outstanding principal under the Credit
Facility in order to avoid a default under the Credit Facility and
limit the utility of the Credit Facility as a source of future
funding.
In
addition, a successful investment in an asset subject to an
operating lease depends in part upon having the asset returned by
the lessee in the condition as required under the lease. Each
operating lease obligates a customer to return an asset to the
Company in a specified condition, generally in a condition that
will allow the aircraft to be readily re-leased to a new lessee,
and/or pay an economic settlement for redelivery that is not in
compliance with such specified conditions. The Company strives to
ensure this result through onsite management during the return
process. However, if a lessee becomes insolvent during the term of
its lease and the Company has to repossess the asset, it is
unlikely that the lessee would have the financial ability to meet
these return obligations. In addition, if a lessee files for
bankruptcy and rejects the aircraft lease, the lessee would be
required to return the aircraft but would be relieved from further
lease obligations, including return conditions specified in the
lease. In either case, it is likely that the Company would be
required to expend funds in excess of any maintenance reserves
collected to return the asset to a remarketable
condition.
Several
of the Company’s leases do not require payment of monthly
maintenance reserves, which serve as the lessee’s advance
payment for its future repair and maintenance obligations. If
repossession due to lessee default or bankruptcy occurred under
such a lease, the Company would need to pay the costs of
unperformed repair and maintenance under the applicable lease and
would likely incur an unanticipated expense in order to re-lease or
sell the asset.
Furthermore,
the occurrence of unexpected adverse changes that impact the
Company’s estimates of expected cash flow from an asset could
result in an asset impairment charge against the Company’s
earnings. The Company periodically reviews long-term assets for
impairment, particularly when events or changes in circumstances
indicate the carrying value of an asset may not be recoverable. An
impairment charge is recorded when the carrying amount of an asset
is estimated to be not recoverable and exceeds its fair value. The
Company recorded impairment charges for some of its aircraft in
2018 and 2019, and may be required to record asset impairment
charges in the future as a result of a prolonged weak economic
environment, challenging market conditions in the airline industry,
events related to particular lessees, assets or asset types or
other factors affecting the value of aircraft or
engines.
Interest Rate Risk.
Although the debt under the Term Loans
is fully covered by interest rate swaps that effectively convert
the variable interest rate Term Loan payments to fixed rate
payments, only approximately half of the Credit Facility debt
currently outstanding is subject to such an interest rate swap. As
a result, the amount of interest paid by the Company under the
Credit Facility will fluctuate depending on prevailing interest
rates to the extent of any excess of the outstanding balance under
the Credit Facility over the amount covered by the related interest
rate swap. Consequently, interest rate increases could materially
increase the Company’s interest payment obligations under the
Credit Facility and thus could have a material adverse effect on
the Company’s liquidity and financial condition. Further,
because the interest rates under the Credit Facility and the Term
Loans are based on LIBOR, which is
the subject of recent national,
international and other regulatory guidance and proposals for
reform, the amount of the Company’s interest payments under
these arrangements could increase if LIBOR is phased out or
performs differently than in the past.
Lease
rates typically, but not always, move over time with interest
rates, but market demand and numerous other asset-specific factors
also affect lease rates. Because the Company’s typical lease
rates are fixed at lease origination, interest rate changes during
the lease term have no effect on existing lease rental payments.
Therefore, if interest rates rise significantly and there is
relatively little lease origination by the Company following such
rate increases, the Company could experience decreased net income
as additional interest expense outpaces revenue growth. Further,
even if significant lease origination occurs following such rate
increases, other contemporaneous aircraft market forces may result
in lower or flat rental rates, thereby decreasing net
income.
28
Lessee Credit Risk.
The Company carefully evaluates the
credit risk of each customer and attempts to obtain a third-party
guaranty, letters of credit or other credit enhancements, if it
deems them necessary, in addition to customary security deposits.
There can be no assurance, however, that such enhancements will be
available, or that, if obtained, they will fully protect the
Company from losses resulting from a lessee default or
bankruptcy.
If a
U.S. lessee defaults under a lease and seeks protection under
Chapter 11 of the United States Bankruptcy Code, Section 1110 of
the Bankruptcy Code would automatically prevent the Company from
exercising any remedies against such lessee for a period of 60
days. After the 60-day period had passed, the lessee would have to
agree to perform the lease obligations and cure any defaults, or
the Company would have the right to repossess the equipment.
However, this procedure under the Bankruptcy Code has been subject
to significant litigation, and it is possible that the
Company’s enforcement rights would be further adversely
affected in the event of a bankruptcy filing by a defaulting
lessee.
Lessees
located in low-growth or no-growth areas of the world carry
heightened risk of lessee default. The Company has had customers
that have experienced significant financial difficulties, become
insolvent, or have entered bankruptcy proceedings. A
customer’s insolvency or bankruptcy usually results in the
Company’s total loss of the receivables from that customer,
as well as additional costs in order to repossess and, in some
cases, repair the aircraft leased by the customer. The Company
closely monitors the performance of all of its lessees and its risk
exposure to any lessee that may be facing financial difficulties,
in order to guide decisions with respect to such lessee in an
attempt to mitigate losses in the event the lessee is unable to
meet or rejects its lease obligations. There can be no assurance,
however, that additional customers will not become insolvent, file
for bankruptcy or otherwise fail to perform their lease
obligations, or that the Company will be able to mitigate any of
the resultant losses.
It is
possible that the Company may enter into deferral agreements for
overdue lessee obligations. When a customer requests a deferral of
lease obligations, the Company evaluates the lessee’s
financial plan, the likelihood that the lessee can remain a viable
carrier, and whether the deferral is likely to be repaid according
to the agreed schedule. The Company may elect to record the
deferred rent and reserves payments from the lessee on a cash
basis, which could have a material effect on the Company’s
financial results in the applicable periods. Deferral agreements
with lessees also reduce the Company’s borrowing capacity
under its Credit Facility.
Concentration of Aircraft Type.
The Company’s aircraft
portfolio is currently focused on a small number of aircraft types
and models relative to the variety of aircraft used in the
commercial air carrier market. A change in the desirability and
availability of any of the particular types and models of aircraft
owned by the Company could affect valuations and future rental
revenues of such aircraft, and would have a disproportionately
significant impact on the Company’s portfolio value. In
addition, the Company is dependent on the third-party companies
that manufacture and provide service for the aircraft types in the
Company’s portfolio. The Company has no control over these
companies, and they could decide to curtail or discontinue
production of or service for these aircraft types at any time or
significantly increase their costs, which could negatively impact
the Company’s prospects and performance. These effects would
diminish if the Company acquires assets of other types. Conversely,
acquisition of additional aircraft of the types currently owned by
the Company will increase the Company’s risks related to its
concentration of those aircraft types.
Competition.
The aircraft leasing industry is highly
competitive. The Company competes with other leasing
companies, banks, financial institutions, private equity firms,
aircraft leasing syndicates, aircraft manufacturers, distributors,
airlines and aircraft operators, equipment managers, equipment
leasing programs and other parties engaged in leasing, managing or
remarketing aircraft. Many of these competitors have longer
operating histories, more experience, larger customer bases, more
expansive brand recognition, deeper market penetration and
significantly greater financial resources. Further,
competition in the Company's market niche of regional aircraft has
increased significantly recently as a result of increased focus on
regional air carriers by competitors who have traditionally
neglected this market, new entrants to the acquisition and leasing
market and consolidation of certain competitors. If and as
competition continues to increase, it has and will likely continue
to create upward pressure on acquisition prices for many of the
aircraft types that the Company has targeted to buy and, at the
same time, create downward pressure on lease rates, resulting in
lower revenues and margins for the Company and, therefore, fewer
acceptable acquisition opportunities for the Company.
Risks Related to Regional Air Carriers.
The Company’s
continued focus on its customer base of regional air carriers
subjects the Company to certain risks. Many regional airlines rely
heavily or even exclusively on a code-share or other contractual
relationship with a major carrier for revenue, and can face
financial difficulty or failure if the major carrier terminates or
fails to perform under the relationship or files for bankruptcy or
becomes insolvent. Some regional carriers may depend on contractual
arrangements with industrial customers such as mining or oil
companies, or franchises from governmental agencies that provide
subsidies for operating essential air routes, which may be subject
to termination or cancellation on short notice. Furthermore, many
lessees in the regional air carrier market are start-up,
low-capital, and/or low-margin operators. A current concern for
regional air carriers is the supply of qualified pilots. Due to
recently imposed regulations of the U.S. Federal Aviation
Administration requiring a higher minimum number of hours to
qualify as a commercial passenger pilot, many regional airlines
have had difficulty meeting their business plans for expansion.
This could in turn affect demand for the aircraft types in the
Company’s portfolio and the Company’s business,
performance and liquidity.
General Economic Conditions and Lowered Demand for Travel.
Because of the international nature of the Company’s
business, a downturn in the health of the global economy could have
a negative impact on the Company’s financial results.
Furthermore, because the Company’s portfolio is not entirely
globally diversified, a localized downturn in one of the key
regions in which the Company leases assets could have a significant
adverse impact on the Company. The Company’s significant
sources of operating lease revenue by region are summarized in
Fleet Summary – Assets Held
for Lease,
above.
29
Much of
the recent growth in demand for regional aircraft has come from
developing countries, and has been driven by mining or other
resource extraction operations by Chinese enterprises in these
countries. A downturn in the Chinese domestic economy that reduces
demand for imported raw materials could have a significant negative
impact on the demand for business and regional aircraft in these
developing countries, including in some of the markets in which the
Company does, or seeks to do, business.
Furthermore,
instability arising from new U.S. sanctions or trade wars against
U.S. trading partners, and the reaction by the sanctioned countries
to such sanctions, or due to other factors, could have a negative
impact on the Company’s customers located in regions affected
by such sanctions.
Also,
the withdrawal of the United Kingdom (UK) from the European Union,
known as “Brexit,” could threaten
“open-sky” policies under which UK-based carriers
operate throughout the European Union, and European Union-based
carriers operate between the UK and other European Union countries.
Losing open-sky flight rights could have a significant negative
impact on the health of the Company’s European lessees and,
as a result, the financial performance and condition of the
Company.
If
international conflicts erupt into military hostilities, heightened
visa requirements make international travel more difficult,
terrorist attacks involving aircraft or airports occur, or a major
flu outbreak occurs, passengers may avoid air travel altogether,
and global air travel worldwide could be significantly affected.
Any such occurrence would have an adverse impact on many of the
Company’s customers.
Airline
reductions in capacity in response to lower passenger loads can
result in reduced demand for aircraft and aircraft engines and a
corresponding decrease in market lease rental rates and aircraft
values. This reduced market value could affect the Company’s
results if the market value of an asset or assets in the
Company’s portfolio falls below carrying value, and the
Company determines that a write-down of the value is appropriate.
Furthermore, if older, expiring leases are replaced with leases at
decreased lease rates, the lease revenue from the Company’s
existing portfolio is likely to decline, with the magnitude of the
decline dependent on the length of the downturn and the depth of
the decline in market rents.
International Risks.
The Company leases assets in overseas
markets. Leases with foreign lessees, however, may present
different risks than those with domestic lessees. Most of the
Company’s expected growth is outside of North
America.
A lease
with a foreign lessee is subject to risks related to the economy of
the country or region in which such lessee is located, which may be
weaker or less stable than the U.S. economy. An economic downturn
in a particular country or region may impact a foreign
lessee’s ability to make lease payments, even if the U.S. and
other foreign economies remain strong and stable.
The
Company is subject to certain risks related to currency conversion
fluctuations. The Company currently has one customer with rent
obligations payable in Euros, and the Company may, from time to
time, agree to additional leases that permit payment in foreign
currency, which would subject such lease revenue to monetary risk
due to currency exchange rate fluctuations. During the periods
covered by this report, the Company considers the estimated effect
on its revenues of foreign currency exchange rate fluctuations to
be immaterial; however, the impact of these fluctuations may
increase in future periods if additional rent obligations become
payable in foreign currencies.
Even
with U.S. dollar-denominated lease payment provisions, the Company
could still be negatively affected by a devaluation of a foreign
lessee’s local currency relative to the U.S. dollar, which
would make it more difficult for the lessee to meet its U.S.
dollar-denominated payments and increase the risk of default of
that lessee, particularly if its revenue is primarily derived in
its local currency.
Foreign
lessees that operate internationally may also face restrictions on
repatriating foreign revenue to their home country. This could
create a cash flow crisis for an otherwise profitable carrier,
affecting its ability to meet its lease obligations. Foreign
lessees may also face restrictions on payment obligations to
foreign vendors, including the Company, which may affect their
ability to timely meet lease obligations to the
Company.
Foreign
lessees are not subject to U.S. bankruptcy laws, although there may
be debtor protection similar to U.S. bankruptcy laws available in
some jurisdictions. Certain countries do not have a central
registration or recording system which can be used to locally
record the Company’s interest in equipment and related
leases. This could make it more difficult for the Company to
recover an aircraft in the event of a default by a foreign lessee.
In any event, collection and enforcement may be more difficult and
complicated in foreign countries.
Ownership
of a leased asset operating in a foreign country and/or by a
foreign carrier may subject the Company to additional tax
liabilities that are not present with aircraft operated in the
United States. Depending on the jurisdiction, laws governing such
tax liabilities may be complex, not well formed or not uniformly
enforced. In such jurisdictions, the Company may decide to take an
uncertain tax position based on the best advice of the local tax
experts it engages, which position may be challenged by the taxing
authority. Any such challenge could result in increased tax
obligations in these jurisdictions going forward or assessments of
liability by the taxing authority, in which case the Company may be
required to pay penalties and interest on the assessed amount that
would not give rise to a corresponding foreign tax credit on the
Company’s U.S. tax returns.
The Trump administration and members of the U.S. Congress have made
public statements about significant changes in U.S. trade policy
and have taken certain actions that materially impact U.S. trade,
including terminating, renegotiating or otherwise modifying U.S.
trade agreements with countries in various regions and imposing
tariffs on certain goods imported into the United States. These
changes in U.S. trade policy have triggered and could continue to
trigger retaliatory actions by affected countries, including China,
resulting in “trade wars” with these countries. These
trade wars could generally increase the cost of aircraft, aircraft
and engine components and other goods regularly imported by the
Company’s customers, thereby increasing costs of operations
for its air carrier customers that are located in the affected
countries. The increased costs could materially and adversely
impact the financial health of affected air carriers, which in turn
could have a negative impact on the Company’s business
opportunities, and if the Company’s lessees are significantly
affected, could have a direct impact on the Company’s
financial results. Furthermore, the Company often incurs
maintenance or repair expenses not covered by lessees in foreign
countries, which expenses could increase if such countries are
affected by such a trade war.
30
Level of Portfolio Diversification.
The Company intends to
continue to focus solely on regional aircraft. Although the Company
invested in a limited number of turboprop aircraft types in the
past, including two in 2018, the Company has also acquired several
regional jet aircraft types, which now comprise a larger percentage
of the Company’s portfolio based on number of aircraft and
net book value. The Company may continue to seek acquisition
opportunities for new types and models of aircraft used by the
Company’s targeted customer base of regional air carriers.
Acquisition of aircraft types not previously owned by the Company
entails greater ownership risk due to the Company’s lack of
experience managing those assets and the potentially different
types of customers that may lease them. Conversely, the
Company’s focus on a more limited set of aircraft types and
solely on regional aircraft subjects the Company to risks that
disproportionately impact these aircraft markets, which are
described elsewhere in this discussion. As a result, the level of
asset and market diversification the Company chooses to pursue
could have a significant impact on its performance and
results.
Transition to LIBOR alternative reference rate.
The
London Inter-bank Offered Rate (“LIBOR”) represents the
interest rate at which banks offer to lend funds to one another in
the international interbank market for short-term loans, and is the
index rate of the Company’s Credit Facility debt and the Term
Loan Indebtedness of the LLC Borrower subsidiaries. Beginning in
2008, concerns were expressed that some of the member banks
surveyed by the British Bankers’ Association (the
“BBA”) in connection with the calculation of LIBOR
rates may have been under-reporting or otherwise manipulating the
interbank lending rates applicable to them. Regulators and law
enforcement agencies from a number of governments have conducted
investigations relating to the calculation of LIBOR across a range
of maturities and currencies. If manipulation of LIBOR or another
inter-bank lending rate occurred, it may have resulted in that rate
being artificially lower (or higher) than it otherwise would have
been. Responsibility for the calculation of LIBOR was transferred
to ICE Benchmark Administration Limited, as independent LIBOR
administrator, effective February 1, 2014.
On
July 27, 2017, the U.K. Financial Conduct Authority announced
that it will no longer persuade or compel banks to submit rates for
the calculation of LIBOR rates after 2021 (the “July 27th
Announcement”). The July 27th Announcement indicates that the
continuation of LIBOR on the current basis cannot and will not be
guaranteed after 2021. Consequently,
at
this time, it is not possible to
predict whether and to what extent banks will continue to provide
LIBOR submissions to the administrator of LIBOR or whether any
additional reforms to LIBOR may be enacted in the United Kingdom or
elsewhere. Similarly, it is not possible to predict whether LIBOR
will continue to be viewed as an acceptable benchmark, what rate or
rates may become accepted alternatives to LIBOR or the effect of
any such changes in views or alternatives on the value of
LIBOR-linked securities.
Although the Financial Stability Oversight Council has recommended
a transition to an alternative reference rate in the event LIBOR is
no longer available after 2021, which would affect the
Company’s Credit Facility and some of its Term Loans, such
plans are still in development and, if enacted, could present
challenges. Moreover, contracts linked to LIBOR are vast in number
and value, are intertwined with numerous financial products and
services, and have diverse parties. The downstream effect of
unwinding or transitioning such contracts could cause instability
and negatively impact the financial markets and individual
institutions. The uncertainty surrounding the sustainability of
LIBOR more generally could undermine market integrity and threaten
individual financial institutions and the U.S. financial system
more broadly.
With respect to the Company’s indebtedness, the inability of
the Company and its lenders to agree on a mutually acceptable LIBOR
index for any debt outstanding if LIBOR is no longer published
after 2021 could cause the debt to be terminated and repayment of
the indebtedness being accelerated and immediately due and payable
to the Lender. This could also lead to substantial breakage fees
being payable by the Company in addition to the outstanding
principal of such debt.
Swap Counterparty Credit Risks.
The Company and its LLC Borrowers have
entered into certain interest rate swaps to hedge the interest rate
risk associated with a portion of the Credit Facility and all of
Borrower LLC’s Term Loan indebtedness. These interest
rate swap agreements effectively convert the variable rate interest
payments to a fixed rate. If an interest rate swap counterparty
cannot perform under the terms of the interest rate swap due to
insolvency, bankruptcy or other reasons, the Company would not
receive payments due from the counterparty under that swap, and,
depending on interest rate conditions at the time of such default,
that could render the Company unable to meet its variable interest
rate debt obligations, leading to a default under one or more loan
agreements. In such a case, the collateral securing the loan
indebtedness could be foreclosed upon, and/or the Company might
incur a loss on the fair market value of the interest rate swap
agreement.
Swap Breakage Fees.
To
reduce the amount of interest that accrues under the
Company’s Credit Facility and/or Term Loans, the Company
could choose to prepay certain amounts borrowed under such loans.
Because the Company has hedged its variable rate
indebtedness, in addition to prepayment fees that might be payable
to the lender under the underlying indebtedness, the Company may
also be obligated to pay certain swap breakage fees to the
swap counterparty in order to unwind the interest rate swap on the
indebtedness that is being prepaid. Thus interest rate swaps could
reduce the economic benefit that the Company might otherwise
achieve through prepayment or could render an otherwise
advantageous debt prepayment uneconomical.
Government Regulation.
There are a number of areas in which
government regulation may result in costs to the Company. These
include aircraft registration safety requirements, required
equipment modifications, maximum aircraft age, and aircraft noise
requirements. Although it is contemplated that the burden and cost
of complying with such requirements will fall primarily upon
lessees, there can be no assurance that the cost will not fall on
the Company. Additionally, even if lessees are responsible for the
costs of complying with these requirements, changes to the
requirements to make them more stringent or otherwise increase
these costs could negatively impact the Company’s
customers’ businesses, which could result in nonperformance
under their lease agreements or decreased demand for the
Company’s aircraft. Furthermore, future government
regulations could cause the value of any noncomplying equipment
owned by the Company to decline substantially. Moreover, any
failure by the Company to comply with the government regulations
applicable to it could result in sanctions, fines or other
penalties, which could harm the Company’s reputation and
performance.
31
Casualties and Insurance Coverage.
The Company, as an owner
of transportation equipment, may be named in a suit claiming
damages for injuries or damage to property caused by its assets. As
a triple-net lessor, the Company is generally protected against
such claims, because the lessee would be responsible for, insure
against and indemnify the Company for such claims. A “triple
net lease” is a lease under which, in addition to monthly
rental payments, the lessee is generally responsible for the taxes,
insurance and maintenance and repair of the aircraft arising from
the use and operation of the aircraft during the term of the
lease. Although the United States Aviation Act may
provide some additional protection with respect to the
Company’s aircraft assets, it is unclear to what extent such
statutory protection would be available to the Company with respect
to its assets that are operated in foreign countries where the
provisions of this law may not apply.
The
Company’s leases generally require a lessee to insure against
likely risks of loss or damage to the leased asset and liability to
passengers and third parties pursuant to industry standard
insurance policies, and require lessees to provide insurance
certificates documenting the policy periods and coverage amounts.
The Company has adopted measures designed to ensure these insurance
policies continue to be maintained, including tracking receipt of
the insurance certificates, calendaring their expiration dates, and
reminding lessees of their obligations to maintain such insurance
and provide current insurance certificates to the Company if a
replacement certificate is not timely received prior to the
expiration of an existing certificate.
Despite
these requirements and procedures, there may be certain cases where
losses or liabilities are not entirely covered by the lessee or its
insurance. Although the Company believes the possibility of such an
event is remote, any such uninsured loss or liability, or insured
loss or liability for which insurance proceeds are inadequate,
might result in a loss of invested capital in and any profits
anticipated from the applicable aircraft, as well as potential
claims directly against the Company.
Compliance with Environmental Regulations.
Compliance with
environmental regulations may harm the Company’s business.
Many aspects of aircraft operations are subject to increasingly
stringent environmental regulations, and growing concerns about
climate change may result in the imposition by the U.S. and foreign
governments of additional regulation of carbon emissions, including
requirements to adopt technology to reduce the amount of carbon
emissions or imposing a fee or tax system on carbon emitters. Any
such regulation could be directed at the Company’s customers,
as operators of aircraft, at the Company, as an owner of aircraft,
and/or on the manufacturers of aircraft. Under the Company’s
triple-net lease arrangements, the Company would likely try to
shift responsibility for compliance to its lessees; however, it may
not be able to do so due to competitive or other market factors,
and there might be some compliance costs that the Company could not
pass through to its customers and would itself have to bear.
Although it is not expected that the costs of complying with
current environmental regulations will have a material adverse
effect on the Company’s financial position, results of
operations, or liquidity, there is no assurance that the costs of
complying with environmental regulations as amended or adopted in
the future will not have such an effect.
Cybersecurity Risks.
The Company believes that its main
vulnerabilities to a cyber-attack would be interruption of the
Company’s email communications internally and with third
parties, loss of customer and lease archives, and loss of document
sharing between the Company’s offices and remote workers.
Such an attack could temporarily impede the efficiency of the
Company’s operations; however, the Company believes that
sufficient replacement and backup mechanisms exist in the event of
such an interruption such that there would not be a material
adverse financial impact on the Company’s business. A
cyber-hacker could also gain access to and release proprietary
information of the Company, its customers, suppliers and employees
stored on the Company’s data network. Such a breach could
harm the Company’s reputation and result in competitive
disadvantages, litigation, lost revenues, additional costs, or
liability to third parties. While the Company believes that it has
sufficient cybersecurity measures in place commensurate with the
risks to the Company of a successful cyber-attack or breach of its
data security, its resources and technical sophistication may not
be adequate to prevent or adequately respond to and mitigate all
types of cyber-attacks.
Possible Volatility of Stock Price.
The market price of the
Company’s common stock is subject to fluctuations following
developments relating to the Company’s operating results,
changes in general conditions in the economy, the financial markets
or the airline industry, changes in accounting principles or tax
laws applicable to the Company or its lessees, or other
developments affecting the Company, its customers or its
competitors, or arising from other investor sentiment unknown to
the Company. Because the Company has a relatively small
capitalization of approximately 1.5 million shares outstanding,
there is a correspondingly limited amount of trading and float of
the Company’s shares. Consequently, the Company’s stock
price is more sensitive to a single large trade or a small number
of simultaneous trades along the same trend than a company with
larger capitalization and higher trading volume and float. This
stock price and trading volume volatility could limit the
Company’s ability to use its capital stock to raise capital,
if and when needed or desired, or as consideration for other types
of transactions, including strategic collaborations, investments or
acquisitions. Any such limitation could negatively affect the
Company’s performance, growth prospects and
liquidity.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk.
This
report does not include information described under Item 305 of
Regulation S-K pursuant to the rules of the Securities and Exchange
Commission that permit “smaller reporting companies” to
omit such information.
Item 4. Controls and Procedures.
CEO and CFO Certifications.
Attached as exhibits to this Quarterly
Report on Form 10-Q (the “Report”) are certifications
of the Company’s Chief Executive Officer (the
“CEO”) and the Company’s Chief Financial
Officer(the “CFO”), which are required pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section
302 Certifications”). This section of the Report includes
information concerning the evaluation of disclosure controls and
procedures referred to in the Section 302 Certifications and this
should be read in conjunction with the Section 302 Certifications
for a more complete understanding of the topics
presented.
Evaluation of the Company’s Disclosure Controls and
Procedures.
Disclosure
controls and procedures (“Disclosure Controls”) are
controls and other procedures that are designed to ensure that
information required to be disclosed in the Company’s reports
filed or submitted under the Securities Exchange Act of 1934, such
as this Report, is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the
Securities and Exchange Commission and that such information is
accumulated and communicated to the Company’s management,
including the CEO and CFO, as appropriate, to allow timely
decisions regarding required disclosure.
32
In the
course of the review of the consolidated financial results of the
Company for the three months and six months ended June 30, 2018,
the Company identified a material weakness in its internal control
over financial reporting (“Internal Control”) at June
30, 2018 related to the Company’s incorrect accounting for
management fees and acquisition fees associated with the Management
Agreement between JHC and the Company. Although the Company
implemented controls over identifying the proper accounting
treatment over the JHC acquisition and those controls operated as
of December 31, 2018, the Company’s tax review control did
not identify a complex component resulting in an adjustment to the
tax expense in 2018. Management has determined that this deficiency
constitutes a material weakness as of June 30, 2019.
Management is in the process of enhancing the tax review control
related to unusual transactions the Company may
encounter.
The Company’s management, with the participation of the CEO
and CFO, evaluated the effectiveness of the Company’s
Disclosure Controls and concluded that the Company’s
Disclosure Controls were not effective as of June 30, 2019 due to
the material weakness described above.
Changes in Internal Control.
No
change in the Company’s Internal Control occurred during the
fiscal quarter ended
June 30, 2019
that has materially affected, or is reasonably
likely to materially affect, the Company’s Internal
Control.
Inherent Limitations of Disclosure Controls and Internal
Control.
In designing its
Disclosure Controls and Internal Control, the Company’s
management recognizes that any controls and procedures, no matter
how well-designed and operated, can provide only reasonable
assurance of achieving the desired control objectives. In addition,
the design of the Company’s controls and procedures must
reflect the fact that there are resource constraints, and
management necessarily applies its judgment in evaluating the
benefits of possible controls and procedures relative to their
costs. Because of these inherent limitations, the Company’s
Disclosure Controls and Internal Control may not prevent or detect
all instances of fraud, misstatements or other control issues. In
addition, projections of any evaluation of the effectiveness of
disclosure or internal controls to future periods are subject to
risks, including, among others, that controls may become inadequate
because of changes in conditions or that compliance with policies
or procedures may deteriorate.
Item 9B. Other Information.
None.
PART II – OTHER INFORMATION
Item 6. Exhibits.
|
Exhibit
Number
|
Description
|
|
Certification of
Michael G. Magnusson, Chief Executive Officer, pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
|
|
|
Certification of
Toni M. Perazzo, Chief Financial Officer, pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
|
|
|
32.1
*
|
Certification of
Michael G. Magnusson, Chief Executive Officer, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
|
|
32.2
*
|
Certification of
Toni M. Perazzo, Chief Financial Officer, pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
|
|
101.INS
|
XBRL Instance
Document
|
|
101.SCH
|
XBRL Schema
Document
|
|
101.CAL
|
XBRL Calculation
Linkbase Document
|
|
101.LAB
|
XBRL Label Linkbase
Document
|
|
101.PRE
|
XBRL Presentation
Linkbase Document
|
|
101.DEF
|
XBRL Definition
Linkbase Document
|
* These
certificates are furnished to, but shall not be deemed to be filed
with, the SEC.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, as amended, the registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
|
|
AEROCENTURY CORP.
|
|
|
Date: August
8,
2019
|
By:
|
/s/ Toni M. Perazzo
|
|
|
|
Name: Toni M. Perazzo
|
|
|
|
Title: Senior Vice President-Finance and
|
|
|
|
Chief Financial Officer
|
34
TABLE OF CONTENTS
Part I Financial InformationItem 1. Financial StatementsItem 2. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresItem 9B. Other InformationPart II Other InformationItem 6. Exhibits