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, 2020
☐
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.
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 as of August 14, 2020 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 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;
●
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; 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;
●
The effects on the
airline industry and the global economy of events such as public
health emergencies or natural disasters, such as the recent
coronavirus (COVID-19) outbreak;
●
Expectations about
the Company’s future liquidity, cash flow and capital
requirements;
●
The Company’s
ability to qualify for forgiveness on its PPP loan, or obtain
additional debt or equity financing to repay any of its
indebtedness;
●
The Company’s
ability to comply with its recently established 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;
●
The Company’s
ability to reach agreement with its special-purpose subsidiary term
loan lender regarding certain lessee payment defaults arising from
COVID-19 pandemic fallout;
●
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.
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 Company’s ability to comply with the
MUFG Loan Agreement, as amended, and achieve the milestones set
forth in the amended agreement for execution of strategic
transactions acceptable to the MUFG Lenders thereunder; 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 raise capital on
acceptable terms when needed and in desired amounts, or at all; 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; the
Company’s ability to retain its existing customers, or
attract replacement customers or prospective purchasers for
off-lease aircraft if and when existing customers are lost or
become unable to maintain lease compliance; 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; limited trading volume in
AeroCentury’s common 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.
TABLE OF
CONTENTS
PART I –
FINANCIAL INFORMATION
Item 1. Financial
Statements.
AeroCentury
Corp.
Condensed Consolidated Balance Sheets
(Unaudited)
|
ASSETS
|
||
|
|
June
30,
|
December
31,
|
|
|
2020
|
2019
|
|
Assets:
|
|
|
|
Cash
and cash equivalents
|
$1,531,300
|
$2,350,200
|
|
Restricted
cash
|
28,400
|
1,076,900
|
|
Accounts
receivable, including deferred rent of $906,200 and $828,000
at
June 30, 2020
and December 31, 2019,
respectively
|
3,379,100
|
1,139,700
|
|
Finance leases receivable, net of allowance for
doubtful accounts of $1,170,000 and $2,908,600 at June 30,
2020 and December 31, 2019,
respectively
|
2,880,000
|
8,802,100
|
|
Aircraft and aircraft engines held for lease, net
of accumulated depreciation of $35,508,100 and $31,338,700
at June 30, 2020 and December
31, 2019, respectively
|
97,692,500
|
108,368,600
|
|
Assets
held for sale
|
15,225,200
|
26,036,600
|
|
Property, equipment and furnishings, net of
accumulated depreciation of $13,000 and $9,600 at June 30,
2020 and December 31, 2019,
respectively
|
16,300
|
62,900
|
|
Office lease right of use, net of accumulated
amortization of $1,472,800 and $524,500 at June 30, 2020 and
December 31, 2019, respectively
|
-
|
948,300
|
|
Deferred
tax asset
|
1,962,200
|
517,700
|
|
Prepaid
expenses and other assets
|
476,500
|
292,800
|
|
Total
assets
|
$123,191,500
|
$149,595,800
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||
|
Liabilities:
|
|
|
|
Accounts
payable and accrued expenses
|
$799,100
|
$736,000
|
|
Accrued
payroll
|
142,400
|
164,200
|
|
Notes payable and accrued interest, net of
unamortized debt issuance costs of $2,717,700 and $3,825,700
at June 30, 2020 and December
31, 2019, respectively
|
112,693,400
|
111,638,400
|
|
Derivative
liability
|
1,053,200
|
1,824,500
|
|
Derivative
termination liability
|
3,075,300
|
-
|
|
Lease
liability
|
-
|
336,400
|
|
Maintenance
reserves
|
2,280,100
|
4,413,100
|
|
Accrued
maintenance costs
|
46,100
|
446,300
|
|
Security
deposits
|
666,000
|
1,034,300
|
|
Unearned
revenues
|
1,951,200
|
3,039,200
|
|
Deferred
income taxes
|
-
|
2,529,800
|
|
Income
taxes payable
|
150,900
|
175,000
|
|
Total
liabilities
|
122,857,700
|
126,337,200
|
|
Commitments
and contingencies (Note 8)
|
|
|
|
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, 1,545,884 shares outstanding at June 30, 2020
and December 31,
2019
|
1,800
|
1,800
|
|
Paid-in
capital
|
16,782,800
|
16,782,800
|
|
Retained
earnings
|
(12,814,000)
|
10,882,100
|
|
Accumulated
other comprehensive loss
|
(599,500)
|
(1,370,800)
|
|
|
3,371,100
|
26,295,900
|
|
Treasury stock at cost, 213,332 shares at
June 30, 2020 and
December 31, 2019, respectively
|
(3,037,300)
|
(3,037,300)
|
|
Total
stockholders’ equity
|
333,800
|
23,258,600
|
|
Total
liabilities and stockholders’ equity
|
$123,191,500
|
$149,595,800
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
AeroCentury Corp.
Condensed Consolidated Statements of Operations
(Unaudited)
|
|
For the
Six Months Ended
June
30,
|
For the
Three Months Ended
June
30,
|
||
|
|
2020
|
2019
|
2020
|
2019
|
|
Revenues
and other income:
|
|
|
|
|
|
Operating
lease revenue
|
$9,146,700
|
$14,114,200
|
$4,378,500
|
$6,966,000
|
|
Finance
lease revenue
|
56,300
|
496,200
|
-
|
260,100
|
|
Net
(loss)/gain on disposal of assets
|
(11,100)
|
277,900
|
13,100
|
99,600
|
|
Net
loss on sales-type leases
|
-
|
(170,600)
|
-
|
(170,600)
|
|
Other
(loss)/income
|
(23,200)
|
10,800
|
-
|
6,600
|
|
|
9,168,700
|
14,728,500
|
4,391,600
|
7,161,700
|
|
Expenses:
|
|
|
|
|
|
Interest
|
10,472,500
|
5,397,500
|
4,459,500
|
2,485,000
|
|
Impairment in value
of aircraft
|
16,381,500
|
1,568,400
|
9,726,600
|
160,000
|
|
Depreciation
|
4,172,800
|
6,170,700
|
2,002,400
|
2,970,000
|
|
Professional fees,
general and
administrative
and other
|
2,998,500
|
1,681,900
|
2,148,200
|
856,700
|
|
Bad debt
expense
|
1,170,000
|
-
|
-
|
-
|
|
Salaries and
employee benefits
|
1,034,700
|
1,219,800
|
517,700
|
620,900
|
|
Insurance
|
411,400
|
279,500
|
224,600
|
139,000
|
|
Maintenance
|
168,400
|
117,400
|
88,200
|
10,000
|
|
Other
taxes
|
51,100
|
63,200
|
25,600
|
25,600
|
|
|
36,860,900
|
16,498,400
|
19,192,800
|
7,267,200
|
|
Loss
before income tax benefit
|
(27,692,200)
|
(1,769,900)
|
(14,801,200)
|
(105,500)
|
|
Income
tax benefit
|
(3,996,100)
|
(384,100)
|
(1,283,500)
|
(27,900)
|
|
Net
loss
|
$(23,696,100)
|
$(1,385,800)
|
$(13,517,700)
|
$(77,600)
|
|
Loss per
share:
|
|
|
|
|
|
Basic
|
$(15.33)
|
$(0.90)
|
$(8.74)
|
$(0.05)
|
|
Diluted
|
$(15.33)
|
$(0.90)
|
$(8.74)
|
$(0.05)
|
|
Weighted
average shares used in
loss
per share computations:
|
|
|
|
|
|
Basic
|
1,545,884
|
1,545,884
|
1,545,884
|
1,545,884
|
|
Diluted
|
1,545,884
|
1,545,884
|
1,545,884
|
1,545,884
|
The
accompanying notes are an integral part of these condensed
consolidated financial statements.
AeroCentury Corp.
Condensed Consolidated Statements of Comprehensive
Loss
(Unaudited)
|
|
For the
Six Months Ended
June
30,
|
For the
Three Months Ended
June
30,
|
||
|
|
2020
|
2019
|
2020
|
2019
|
|
Net
loss
|
$(23,696,100)
|
$(1,385,800)
|
$(13,517,700)
|
$(77,600)
|
|
Other
comprehensive loss:
|
|
|
|
|
|
Unrealized
gains/(losses) on derivative instruments
|
(575,000)
|
(1,854,800)
|
-
|
(1,308,700)
|
|
Reclassification
of net unrealized losses on derivative
instruments
to interest expense
|
1,557,200
|
22,100
|
238,900
|
20,800
|
|
Tax
(expense)/benefit related to items of other
comprehensive
loss
|
(211,000)
|
393,600
|
(51,300)
|
276,600
|
|
Other
comprehensive income/(loss)
|
771,200
|
(1,439,100)
|
187,600
|
(1,011,300)
|
|
Total
comprehensive loss
|
$(22,924,900)
|
$(2,824,900)
|
$(13,330,100)
|
$(1,088,900)
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
AeroCentury Corp.
Condensed Consolidated Statements of Stockholders’
Equity
For the Three Months and Six Months Ended June 30, 2019 and June
30, 2020
(Unaudited)
|
|
Number of Common
Stock Shares Outstanding
|
Common
Stock
|
Paid-in
Capital
|
Retained
Earnings
|
Treasury
Stock
|
Accumulated Other
Comprehensive Loss
|
Total
|
|
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 (loss)
|
-
|
-
|
-
|
-
|
-
|
(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 (loss)
|
-
|
-
|
-
|
-
|
-
|
(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
|
|
|
|
|
|
|
|
|
|
|
Balance, December
31, 2019
|
1,545,884
|
$1,800
|
$16,782,800
|
$10,882,100
|
$(3,037,300)
|
$(1,370,800)
|
$23,258,600
|
|
Net
loss
|
-
|
-
|
-
|
(10,178,400)
|
-
|
-
|
(10,178,400)
|
|
Accumulated other
comprehensive income/(loss)
|
-
|
-
|
-
|
-
|
-
|
583,700
|
583,700
|
|
Balance, March 31,
2020
|
1,545,884
|
1,800
|
16,782,800
|
703,700
|
(3,037,300)
|
(787,100)
|
13,663,900
|
|
Net
loss
|
-
|
-
|
-
|
(13,517,700)
|
-
|
-
|
(13,517,700)
|
|
Accumulated other
comprehensive income/(loss)
|
-
|
-
|
-
|
-
|
-
|
187,600
|
187,600
|
|
Balance,
June 30,
2020
|
1,545,884
|
$1,800
|
$16,782,800
|
$(12,814,000)
|
$(3,037,300)
|
$(599,500)
|
$333,800
|
The accompanying notes are an integral part of these
condensed consolidated financial statements.
AeroCentury Corp.
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
For
the Six Months Ended
June 30,
|
|
|
|
2020
|
2019
|
|
Net cash
(used)/provided by operating activities
|
$(1,104,600)
|
$6,419,900
|
|
Investing
activities:
|
|
|
|
Proceeds from sale
of aircraft and aircraft engines held for lease,
net
of re-sale fees
|
-
|
1,710,500
|
|
Proceeds from sale
of assets held for sale, net of re-sale fees
|
3,167,500
|
2,181,600
|
|
Net cash provided
by investing activities
|
3,167,500
|
3,892,100
|
|
Financing
activities:
|
|
|
|
Issuance of notes
payable – Credit Facility
|
-
|
5,100,000
|
|
Repayment of notes
payable – Credit Facility
|
(1,165,000)
|
(40,100,000)
|
|
Issuance of notes
payable – Term Loans
|
-
|
44,310,000
|
|
Repayment of notes
payable – UK LLC SPE Financing
|
-
|
(9,211,100)
|
|
Repayment of notes
payable – Term Loans
|
(1,334,700)
|
(3,533,600)
|
|
Issuance of notes
payable – PPP Loan
|
276,400
|
|
|
Debt issuance
costs
|
(1,707,000)
|
(5,063,100)
|
|
Net cash used in
financing activities
|
(3,930,300)
|
(8,497,800)
|
|
Net
(decrease)/increase in cash, cash equivalents and restricted
cash
|
(1,867,400)
|
1,814,200
|
|
Cash, cash
equivalents and restricted cash, beginning of period
|
3,427,100
|
1,542,500
|
|
Cash, cash
equivalents and restricted cash, end of period
|
$1,559,700
|
$3,356,700
|
|
Non-cash financing
activities:
|
|
|
Non-cash
issuance of notes payable – Credit Facility
$1,149,200
|
$-
|
The
components of cash and cash equivalents and restricted cash at the
end of each of the periods presented consisted of:
|
|
June
30,
|
|
|
|
2020
|
2019
|
|
Cash and cash
equivalents
|
$1,531,300
|
$1,542,500
|
|
Restricted
cash
|
28,400
|
-
|
|
Total cash, cash
equivalents and restricted cash shown in the statement of cash
flows
|
$1,559,700
|
$1,542,500
|
During
the six months ended June 30,
2020 and 2019, the Company paid interest totaling $2,792,200 and
$4,119,300, respectively. The Company paid income taxes of $222,900
and $427,000 during the six months ended June 30, 2020 and 2019,
respectively.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
AeroCentury
Corp.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
June 30, 2020
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 “MUFG 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 (“Nord Loans”) made to ACY 19002, ACY 19003,
and two other newly formed special-purpose subsidiaries of
AeroCentury, ACY SN 15129 LLC (“ACY 15129”) and ACY
E-175 LLC (“ACY E-175”), which were formed for the
purpose of refinancing four of the Company’s aircraft using
the Nord Loans. See Note 6(b) for more information about the Nord
Loans.
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, 2020 are not necessarily
indicative of the results that may be expected for the year ending
December 31, 2020 or for any other period. All intercompany
balances and transactions have been eliminated in
consolidation.
(b) Going Concern
As
discussed in Note 4, the Company was in default under its MUFG
Credit Facility as of December 31, 2019 and March 31, 2020. On May
1, 2020, the Company and the MUFG Credit Facility Lenders
(“MUFG Lenders”) executed an amendment to the MUFG
Credit Facility (as amended, the “MUFG Loan Agreement”)
to convert the MUFG Credit Facility into a term loan
facility (as converted, the “MUFG Loan”). The amendment includes
certain requirements and establishment of deadlines for achievement
of milestones toward execution of Company strategic alternatives
for the Company and/or its assets acceptable to the MUFG Lenders.
The amendment cured the December and March defaults, but the
Company is currently in default under the MUFG Loan Agreement due
to non-payment of interest due on July 1, 2020 and August 3,
2020.
The
MUFG Lenders have the right to exercise any and all remedies for
default under the MUFG Loan Agreement. Such remedies include, but
are not limited to, declaring the entire indebtedness immediately
due and payable and, if the Company were unable to repay such
accelerated indebtedness, foreclosing upon the assets of the
Company that secure the indebtedness under the MUFG Loan (the
“MUFG Indebtedness”), which consist of all of the
Company’s assets except for certain assets held in the
Company’s single asset special-purpose financing
subsidiaries. As discussed in Note 5, the Company is obligated to
pay $3.1 million related to the termination of the MUFG Swaps in
March 2020. As discussed in Note 4, the Company also defaulted on
payment under the Nord Loans.
The
COVID-19 pandemic has led to significant cash flow issues for
airlines, and some airlines, including some of the Company’s
customers, have been unable to timely meet their obligations under
their lease obligations with the Company unless government
financial support is received, of which there can be no assurance.
Any additional significant nonpayment or late payment of lease
payments by a significant lessee or combination of lessees could in
turn impose limits on the Company’s ability to fund its
ongoing operations as well as cause the Company to be unable to
meet its debt obligations, which in turn could lead to an immediate
acceleration of debt and foreclosure upon the Company’s
assets.
As a
result of these factors, there is substantial doubt regarding the
Company’s ability to continue as a going concern. The
condensed consolidated financial statements presented in this
Quarterly Report on Form 10-Q have been prepared on a going concern
basis and do not include any adjustments that might arise as a
result of uncertainties about the Company’s ability to
continue as a going concern.
(c) Impact of COVID-19
In
January 2020, the World Health Organization (“WHO”)
announced a global health emergency because of a new strain of
coronavirus and the risks to the international community as the
virus spreads globally (the “COVID-19 Outbreak”). In
March 2020, the WHO classified the COVID-19 Outbreak as a pandemic,
based on the rapid increase in exposure globally. The ongoing
COVID-19 Outbreak has had an overwhelming effect on all forms of
transportation globally, but most acutely for the airline industry.
The combined effect of fear of infection during air travel and
international and domestic travel restrictions has caused a
dramatic decrease in passenger loads in all areas of the world, not
just in those countries with active clusters of COVID-19, but in
airline ticket net bookings (i.e. bookings made less bookings
canceled) of flights as well. This has led to significant cash flow
issues for airlines, including some of the Company’s
customers. Two of the Company’s eight customers did not make
operating lease rent payments that were due in March, April, May
and June 2020, totaling approximately $3.5 million. The Company had
permitted one customer, which leases two regional jet aircraft, to
defer the quarterly payment of March 2020 rent to June 2020, but
the customer did not make the required deferred or current rent
payments due then. The Company permitted another customer, which
leases two regional turboprop aircraft, to make reduced payments
totaling approximately $0.3 million in April, May and June 2020 and
the customer has paid the reduced amounts. In addition, two other
customers, each of which leases an aircraft subject to a sales-type
lease, did not make lease payments totaling approximately $0.4
million, and the Company and the customers are discussing remedies
regarding non-payment of a portion of the lease payments due during
the first quarter of 2020 as well as the lease payments due during
the second quarter. As discussed in Note 3, the Company recorded
impairments of $9,726,600 and $16,381,500 during the three months
and six months ended June 30, 2020. The impact of COVID-19 has also
lead the Company to determine that there is uncertainty related to
rent, interest and debt payments such that, as disclosed in Notes 4
and 5, the Company dedesignated its interest rate swaps as hedges
in March 2020 since the payments related to the swaps were deemed
not probable to occur.
Furthermore,
for the duration of the pandemic and a period of financial recovery
thereafter, sale and acquisition transactions are likely to be
curtailed entirely or delayed while the industry returns to
financial stability, which could impact the Company’s ability
to implement a recapitalization plan (“Recapitalization
Plan”). The Company has made estimates of the impact of
COVID-19 within its financial statements and there may be changes
to those estimates in future periods. While the Company’s
results of operations, cash flows and financial condition would be
negatively impacted, the extent of the impact for the remainder of
2020 cannot be reasonably estimated at this time.
(d) Use of Estimates
The Company’s 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 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 consolidated
financial statements are the residual values and useful lives of
the Company’s long-lived assets, the current value of the
Company’s assets held for sale, 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.
(e) Comprehensive Income/(Loss)
The
Company accounts for former interest rate cash flow hedges by
reclassifying accumulated other comprehensive income into earnings
in the periods in which the expected transactions occur or when it
is probable that the hedged transactions will no longer occur, and
are included in interest expense.
(f) Finance Leases
As of
December 31, 2019, the Company had three aircraft subject to
sales-type leases and three aircraft subject to direct financing
leases. All six 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 classified each of these six 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 three sales-type leases, the Company
recognized as a gain or loss the amount equal to (i) the net
investment in the sales-type 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.
In the
first six months of 2020, the Company sold the underlying aircraft
in one of its sales-type leases and all three of its direct finance
leases to the lessees, resulting in net losses totaling $47,300.
The remaining two sales-type leases were substantially modified
and, as a result of payment delinquencies by the two customers, the
Company recorded a bad debt allowance of $1,170,000 during the
first quarter of 2020. The two leases remain treated as sales-type
leases.
(g) Taxes
As part
of the process of preparing the Company’s consolidated
financial statements, management estimates income taxes in each of
the jurisdictions in which the Company operates. This process
involves estimating the Company’s current tax exposure under
the most recent tax laws and assessing temporary differences
resulting from differing treatment of items for tax and GAAP
purposes. These differences result in deferred tax assets and
liabilities, which are included in the balance sheet. In
assessing the valuation of deferred tax assets, the Company
considers whether it is more likely than not that some portion or
all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation
of future taxable income or availability to carryback the losses to
taxable income during periods in which those temporary differences
become deductible. The Company considered several factors when
analyzing the need for a valuation allowance including the
Company's current five-year cumulative loss through June 30, 2020,
the impacts of the COVID-19 pandemic on the worldwide airline
industry and the need to rapidly refinance its debt or sell its
assets in accordance with the provisions of its MUFG Indebtedness.
Significant management judgment is required in determining
the Company’s future taxable income for purposes of assessing
the Company’s ability to realize any benefit from its
deferred taxes. Based on its analysis, the Company has
concluded that a valuation allowance is necessary for its U.S.
deferred tax assets not supported by either future taxable income
or availability of future reversals of existing taxable temporary
differences and has recorded a valuation allowance of $3,144,100
and $3,175,900 for the three months and six months ended June 30,
2020, respectively.
The
Company accrues non-income based sales, use, value added and
franchise taxes as other tax expense in the statement of
operations.
(h) 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 Nord Loan debt and a portion of the MUFG
Indebtedness. 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/(loss) and is
reclassified into earnings in the period in which the transaction
being hedged affects earnings.
If at
any time after designation of a cash flow hedge, such as those
entered into by the Company, it is no longer probable that the
forecasted cash flows will occur, hedge accounting is no longer
permitted and a hedge is “dedesignated.” After
dedesignation, if it is still considered reasonably possible that
the forecasted cash flows will occur, the amount previously
recognized in other comprehensive income/(loss) will continue to be
reversed as the forecasted transactions affect earnings. However,
if after dedesignation it is probable that the forecasted
transactions will not occur, amounts deferred in accumulated other
comprehensive income/(loss) will be recognized in earnings
immediately.
As
noted in Note 5, in October 2019 the Company became aware that, as
a result of certain defaults under its MUFG Credit Facility,
certain of the forecasted transactions related to its MUFG Credit
Facility interest rate swaps were no longer probable of occurring
and, hence, those swaps were dedesignated from hedge accounting at
that time. The two swaps related to the MUFG Credit Facility were
terminated in March 2020 and the Company incurred a $3.1 million
obligation in connection with such termination, payment of which is
due no later than the March 31, 2021 maturity of the MUFG Loan. As
a result of the forecasted transaction being not probable to occur,
accumulated other comprehensive loss of $117,000 and $1,387,300
related to the MUFG Swaps was recognized as interest expense in the
quarter and six months ended June 30, 2020,
respectively.
In
March 2020, the Company determined that the future hedged interest
payments related to its five remaining Nord Loan interest rate
hedges were no longer probable of occurring, and consequently
dedesignated all five swaps as hedges.
(i) Recent Accounting
Pronouncements
ASU 2016-13
The
FASB issued ASU 2016-13, Financial
Instruments – Credit Losses (Topic 326), in June 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
in the first quarter of 2023 for calendar-year SEC filers that are
smaller reporting companies as of the one-time determination date.
Early adoption is permitted beginning in 2019. The Company plans to
adopt the new guidance on January 1, 2023, and has not determined
the impact of this adoption on its consolidated financial
statements.
ASU 2019-12
In
December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), a new
accounting standard update to simplify the accounting for income
taxes. The new guidance removes certain exceptions for recognizing
deferred taxes for investments, performing intra-period allocation
and calculating income taxes in interim periods. It also adds
guidance to reduce complexity in certain areas, including
recognizing deferred taxes for tax goodwill and allocating taxes to
members of a consolidated group. This guidance will be effective
for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2020. The Company is currently
evaluating the impact of the new guidance on its consolidated
financial statements and related disclosures.
FASB Staff Guidance on Effects of COVID-19
In
April 2020, the FASB staff provided some relief from the
unprecedented effect of the COVID-19 pandemic. Under this guidance,
lessors may elect to treat lease concessions due to COVID-19 as if
they arose from enforceable rights and obligations that existed in
the lease contract, with the consequent effect that the concessions
would not be treated as a lease modification which could require
reclassification and remeasurement of the lease. Other guidance
released in April 2020 provides that when hedge accounting is
discontinued and it is probable that the forecasted transaction
that had been hedged will occur beyond two months after its
originally expected date as a result of the effects of COVID-19,
the reporting entity may still defer recognizing related AOCI
immediately and should defer recognition of such amounts until the
forecasted transactions actually occur.
(j) Reclassifications
Certain prior period amounts have been reclassified to conform with
the current period presentation.
2. Aircraft Lease Assets
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 leases contain a bargain purchase option at lease end
which the Company expects the lessees to exercise or require that
the lessee purchase the aircraft at lease-end for a specified
price.
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. 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 initial 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 totaling approximately $20
million at the end of their lease terms in the fourth quarter of
2020. Three additional aircraft are
subject to manufacturer residual value guarantees totaling
approximately $16 million at the end of their lease terms in the
second quarter of 2025. The Company considers the best
market for re-leasing and/or selling its assets at the end of its
leases, although it does not expect to retain ownership of the
assets under sales-type leases given the lessees’ bargain
purchase options or required purchase.
During the second quarter of 2020, the Company recorded impairment
losses totaling $6,706,600 for two of its aircraft held for lease,
which were written down based on estimated future cash flow. The
Company also recorded impairment losses totaling $3,020,000 on four
aircraft that are held for sale: (i) $2,870,000 for three regional
jet aircraft that were written down to fair value and (ii) $150,000
for a turboprop aircraft that was written down its estimated sales
price, less cost of sale.
(a) Assets Held for Lease
At June
30, 2020 and December 31, 2019,
the Company’s aircraft held for lease consisted of the
following:
|
|
June
30, 2020
|
December
31, 2019
|
||
|
Type
|
Number
Owned
|
% of
net book value
|
Number
owned
|
% of
net book value
|
|
Regional jet
aircraft
|
9
|
80%
|
9
|
80%
|
|
Turboprop
aircraft
|
2
|
20%
|
2
|
20%
|
The
Company did not purchase or sell any aircraft held for lease during
the first six months of 2020. None of the Company’s aircraft
held for lease were off lease at June 30, 2020.
As of
June
30, 2020, minimum future
lease revenue payments receivable under non-cancelable operating
leases were as follows:
|
Years ending
December 31
|
|
|
|
|
|
2020
|
$8,077,700
|
|
2021
|
10,343,800
|
|
2022
|
8,591,400
|
|
2023
|
8,591,400
|
|
2024
|
6,783,900
|
|
Thereafter
|
1,683,400
|
|
|
$44,071,600
|
The remaining weighted average lease term of the Company’s
assets under operating leases was 36 months and 41 months at
June
30, 2020 and December 31, 2019,
respectively.
(b) Sales-Type and Finance Leases
In
January 2020, the Company amended the leases for three of its
assets that were subject to sales-type leases. The amendments
provided for (i) the sale of one aircraft to the customer in
January 2020, which resulted in a gain of $12,700, (ii) application
of collected maintenance reserves and a security deposit held by
the Company to past due amounts for the other two aircraft, (iii)
payments totaling $585,000 in January for two of the leases and
(iv) the reduction of future payments due under the two leases.
As a
result of payment delinquencies by the two customers of these
aircraft, the Company recorded a bad debt allowance of $1,170,000
during the first quarter.
In
January 2020, the lessee for an aircraft leased pursuant to a
direct financing lease notified the
Company of its intention to exercise the lease-end purchase option
for the aircraft in March 2020. In February 2020, the Company and
the same lessee agreed to the early exercise of lease-end purchase
options for direct financing leases that were to expire in March
2021 and March 2022. All three aircraft were sold to the
lessee in March 2020, resulting in a loss of $52,000. During the
second quarter of 2020, the Company recorded additional legal
expenses totaling $8,000 related to the sale.
At
June 30, 2020 and December 31,
2019, the net investment included in sales-type leases and direct
financing leases receivable were as follows:
|
|
June 30,
2020
|
December
31,
2019
|
|
Gross minimum lease
payments receivable
|
$4,138,000
|
$9,096,400
|
|
Less unearned
interest
|
(88,000)
|
(286,600)
|
|
Allowance for
doubtful accounts
|
(1,170,000)
|
(7,700)
|
|
Finance leases
receivable
|
$2,880,000
|
$8,802,100
|
As of
June 30, 2020, minimum future
payments receivable under finance leases were as
follows:
|
Years ending
December 31
|
|
|
|
|
|
2020
|
$1,013,000
|
|
2021
|
1,284,000
|
|
2022
|
1,284,000
|
|
2023
|
557,000
|
|
|
$4,138,000
|
The remaining weighted average lease term of the Company’s
assets under sales-type and finance leases was 31 months and 20
months at June 30, 2020 and December 31, 2019,
respectively.
The
following is a roll forward of the Company’s finance lease
receivable allowance for doubtful accounts from December 31, 2019
to June 30, 2020:
|
Balance, December
31, 2019
|
$2,908,600
|
|
Deductions upon
sale of assets
|
(735,200)
|
|
Deductions upon
lease amendments
|
(2,173,400)
|
|
Additions charged
to expense
|
1,170,000
|
|
Balance, June 30,
2020
|
$1,170,000
|
3. Assets Held for Sale
Assets
held for sale at June 30, 2020
included three regional jet aircraft, one turboprop aircraft, which
is subject to a short-term operating lease, and airframe parts from
two turboprop aircraft.
During the second quarter of 2020, the Company recorded losses
totaling $3,020,000 on four aircraft that are held for sale: (i)
$2,870,000 for three regional jet aircraft that were written down
to fair value and (ii) $150,000 for a turboprop aircraft that was
written down its estimated sales price, less cost of
sale.
During
the second quarter of 2020, the Company received $112,000 in cash
and accrued $30,100 in receivables for parts sales. These amounts
were accounted for as follows: $77,300 reduced accounts receivable
for parts sales accrued in the first quarter of 2020; $43,700
reduced the carrying value of the parts; and $21,100 was recorded
as gains in excess of the carrying value of the parts. 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.
4. Notes Payable and Accrued
Interest
At June 30, 2020 and December 31, 2019, the Company’s notes
payable and accrued interest consisted of the
following:
|
|
June 30,
2020
|
December 31,
2019
|
|
MUFG Credit
Facility and MUFG Loan:
|
|
|
|
Principal
|
$84,068,200
|
$84,084,100
|
|
Unamortized
debt issuance costs
|
(2,212,100)
|
(3,084,200)
|
|
Accrued
interest
|
1,407,800
|
376,200
|
|
Nord
Loans:
|
|
|
|
Principal
|
29,579,800
|
30,914,500
|
|
Unamortized
debt issuance costs
|
(505,600)
|
(741,500)
|
|
Accrued
interest
|
78,600
|
89,300
|
|
Paycheck Protection
Program Loan:
|
|
|
|
Principal
|
276,400
|
-
|
|
Accrued
interest
|
300
|
-
|
|
|
$112,693,400
|
$111,638,400
|
(a) MUFG Credit Facility
In
February 2019, the MUFG Credit Facility, which
was to expire on May 31, 2019, was extended to February 19, 2023,
and was amended in certain other respects. Also, four aircraft that
previously served as collateral under the MUFG Credit Facility and two
aircraft that previously served as collateral under special-purpose
subsidiary financings were refinanced in February 2019 using
non-recourse term loans (the “Nord Loans”) with an
aggregate principal of $44.3 million.
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 MUFG Credit Facility), the MUFG
Credit Facility agreement contained 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 not in compliance with various covenants contained in
the MUFG Credit Facility agreement, including those related to
interest coverage and debt service coverage ratios and a
no-net-loss requirement under the MUFG Credit Facility, at
September 30, 2019, December 31, 2019 and March 31,
2020.
On October 15, 2019, the agent bank for the MUFG Lenders delivered
a Reservation of Rights Letter to the Company which contained
notice of the Borrowing Base Default and a demand for repayment of
the amount of the Borrowing Base Deficit by January 13, 2020, and
also contained formal notices of default under the MUFG Credit
Facility relating to the alleged material adverse effects on the
Company’s business as a result of the early termination of
leases for three aircraft and potential financial covenant
noncompliance based on the Company’s financial projections
provided to the MUFG Lenders (the Borrowing Base Default and such
other defaults referred to as the “Specified
Defaults”). The Reservation of Rights Letter also informed
the Company that further advances under the MUFG Credit Facility
agreement would no longer be permitted due to the existence of such
defaults.
In
October, November and December 2019, the Company, agent bank and
the MUFG Lenders entered into a Forbearance Agreement and
amendments extending the Forbearance Agreement with respect to the
Specified Defaults under the MUFG Credit Facility. The Forbearance
Agreement (i) provided that the MUFG Lenders temporarily
forbear from exercising default remedies under the MUFG Credit
Facility agreement for the Specified Defaults, (ii) reduced the
maximum availability under the MUFG Credit Facility to $85 million
and (iii) extended the cure period for the Borrowing Base Deficit
from January 13, 2020 to February 12, 2020. The Forbearance
Agreement also allowed the Company to continue to use LIBOR as its
benchmark interest rate, but increased the margin on the
Company’s LIBOR-based loans under the MUFG Credit Facility
from a maximum of 3.75% to 6.00% and set the margin on the
Company’s prime rate-based loans at 2.75%, as well as added a
provision for paid-in-kind interest (“PIK Interest) of 2.5%
to be added to the outstanding balance of the MUFG Credit Facility
debt in lieu of a cash payment. The Company paid cash fees of
$406,250 in connection with the Forbearance Agreement and
amendments, as well as a fee of $832,100, which was added to the
outstanding balance of the MUFG Credit Facility debt in lieu of a
cash payment. The Forbearance Agreement was in effect until
December 30, 2019, after which the Company and the MUFG Lenders agreed not to
further amend the Forbearance Agreement. On February 12, 2020, the agent bank
for the MUFG Lenders delivered a Reservation of Rights Letter to
the Company which contained notice of the failure to cure the
Borrowing Base Default by February 12, 2020.
The unused amount of the MUFG Credit Facility was $915,900 as of
December 31, 2019. The weighted
average interest rate on the MUFG Credit Facility was 10.23% at December
31, 2019.
On May 1, 2020, the Company and the MUFG Lenders entered into a
Fourth Amended and Restated Loan and Security Agreement, which
amended and restated the existing agreement regarding the Company's
indebtedness to the MUFG Lenders and effected the following changes
to the terms and provisions of such indebtedness:
●
A forbearance of
the existing defaults and events of default under the MUFG Loan
Agreement until May 10, 2020, with a provision to extend such
forbearance to July 1, 2020 and August 15, 2020, if the Company is
still in compliance with the agreement at May 10, 2020 and July 1,
respectively;
●
Elimination of the
borrowing base collateral value covenant under the MUFG Loan
Agreement, and of the existing event of default under the Loan
Agreement for a borrowing base deficiency, along with cessation of
the default interest accrual on the outstanding loan
amount;
●
Conversion of the
revolving MUFG Credit Facility structure to a term loan structure
with an initial principal balance of $83,689,900.86 and a final
maturity date of March 31, 2021;
●
Interest accrual on
the indebtedness based on the Base Rate (defined as the greater of
(i) the rate of interest most recently announced by MUFG as to its
U.S. dollar “Reference Rate”, or (ii) the Federal Funds
Rate plus one-half of one percent (0.50%)), according to the
following schedule: (a) Base Rate + 525 bps (0 bps as cash interest
and 525 bps as payment in kind ("PIK")) until June 30, 2020, and
(b) Base Rate + 525 bps (100 bps as cash interest and 425 bps as
PIK) from and after July 1, 2020, subject to a Base Rate floor at
325 bps for both time periods;
●
Deferral of the
cash component of the interest payments (on the loan indebtedness
and swap termination payment obligation) that was due on April 1,
2020 and May 1, 2020, until the earlier of (i) the date of receipt
of net proceeds into the Company's restricted account held at MUFG
to hold sales proceeds (the "Restricted Account") from the sale of
certain enumerated aircraft assets and (ii) July 1,
2020;
●
Required sweep of
any unrestricted cash in the Company’s bank accounts in
excess of $1,000,000 at the end of each fiscal
quarter;
●
Addition of certain
default provisions triggered by certain defaults or other events
with respect to the Company’s aircraft leases for the
Company's aircraft that are collateral for the MUFG Loan Agreement
("Aircraft Collateral");
●
Provision for certain payments from the
Restricted Account to (i) the
Company’s investment banking advisor; (ii) payments due under
the agreement and for interest on the swap termination indebtedness
owed by the Company; and (iii) Lenders’ outside counsel and
consultants;
●
Addition of a
requirement for the Company's engagement of a Financial
Advisor/Consultant, at the Company’s expense, with a specific
scope of work as prescribed by the MUFG Loan
Agreement;
●
Revisions to the
Company’s required appraisal process for the Aircraft
Collateral; and
●
Establishment of
deadlines for achievement of milestones toward execution of Company
strategic alternatives for the Company and/or its assets with
respect to the MUFG Loan Agreement indebtedness ("Strategic
Alternatives") as follows: (a) obtaining indications of
interest for Strategic Alternatives by May 6, 2020, which was
subsequently extended to May 20, 2020 and was met by the Company at
that time; (b) obtaining a fully-executed (tentative or generally
non-binding) agreement on the terms and conditions for a Strategic
Alternative by June 29, 2020, which milestone has been met, and (c)
consummation of the selected strategic Alternative by August 15,
2020.
On July
8, 2020, the agent bank for the MUFG Lenders delivered a
Reservation of Rights Letter to the Company which contained notice
of defaults with respect to failure to deliver a lessee
acknowledgment of the MUFG Lender’s mortgage from one of the
Company’s lessees (which was delayed due to extended
negotiations between MUFG and the lessee relating to form of such
acknowledgment) and (ii) the failure to make a deferred interest
payment as required under the Loan Agreement that was due and
payable on the earlier of July 1, 2020 or the date of the sale of a
certain aircraft scheduled to be sold upon its return from its
lessee (the closing of which sale was delayed beyond July 1,
2020).
The borrowings under the MUFG Loan Agreement continue to be secured
by a first priority lien, which lien is documented in an amended
and restated mortgage and security agreement (the "Mortgage"), in
all of the Company's assets, including the
Company’s aircraft portfolio, except those aircraft that are
subject to special purpose financing held by subsidiaries of the
Company. The MUFG Loan Agreement and the Mortgage
(collectively the "MUFG Loan Documents") require the Company to
comply with certain covenants relating to payment of taxes,
preservation of existence, maintenance of property and insurance,
and periodic financial reporting. The MUFG Loan Documents
restrict 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 Loan
Agreement include failure to make a required payment within three
business days of a due date or to comply with other obligations
under the MUFG Loan Documents (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 under the Loan Agreement include acceleration
of the outstanding debt and exercise of any remedies available
under applicable law, including foreclosure on the collateral
securing the MUFG Loan Agreement debt.
The Company has engaged B. Riley FBR as an investment banking
advisor to help (i) formulate a Recapitalization Plan and analyze
various strategic financial alternatives to address the
Company’s capital structure, strategic and financing needs,
as well as corporate level transactions aimed at achieving maximum
value for the Company’s stockholders; and (ii) locate and
negotiate with potential lenders, investors or transaction partners
who would play a role in the Company’s Recapitalization
Plan. The Company’s ability to develop, obtain
approval for and achieve its Recapitalization Plan is subject to a
variety of factors. If the Company is not able to satisfy the
requirements under the Recapitalization Plan, maintain compliance
with its MUFG Indebtedness or raise sufficient capital to repay all
amounts owed under the MUFG Indebtedness, the Company’s
financial condition and liquidity would be materially adversely
affected and its ability to continue operations could be materially
jeopardized.
(b) Nord Loans
On
February 8, 2019, the Company, through four wholly-owned subsidiary
limited liability companies (“LLC Borrowers”), entered into a term
loan agreement NordDeutsche Landesbank Girozentrale, New York
Branch (“Nord”) that provides for six separate term
loans(“Nord Loans”) with an aggregate principal amount
of $44.3 million. Each of the Nord Loans is secured by a first
priority security interest in a specific aircraft (“Nord 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 among the LLC Borrowers and a security trustee, and
certain pledge agreements. Two of the Nord 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 Nord Loans vary by aircraft,
and are based on a fixed margin above either 30-day or 3-month
LIBOR. The proceeds of the Nord Loans were used to pay down the
MUFG Credit
Facility and pay off the UK LLC SPE Financing. The maturity of each
Nord Loan varies by aircraft, with the first Nord Loan maturing in
October 2020 and the last Nord Loan maturing in May 2025. The debt
under the Nord Loans is expected to be fully amortized by rental
payments received by the LLC Borrowers from the lessees of the Nord
Loan Collateral Aircraft during the terms of their respective
leases and remarketing proceeds.
The
Nord Loans include covenants that impose various restrictions and
obligations on the LLC Borrowers, including covenants that require
the LLC Borrowers to obtain Nord consent before they can take
certain specified actions, and certain events of default. If an
event of default occurs, subject to certain cure periods for
certain events of default, Nord would have the right to terminate
its obligations under the Nord Loans, declare all or any portion of
the amounts then outstanding under the Nord 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 Nord Loans. The Company was
in compliance with all covenants under the Nord Loans at December
31, 2019 but, as discussed below, was in default of its obligation
to make its quarterly payments due on March 24, 2020 and June 24,
2020.
As a
result of the COVID-19 Outbreak, in March and June 2020, one of the
Company’s customers, which leases two regional jet aircraft
subject to Nord Loan financing, did not make its quarterly rent
payments totaling approximately $2.8 million. The nonpayment led to
corresponding Nord Loan financing payment events of default under
the Nord Loans for each of the LLC Borrowers. In May 2020, with Nord’s consent,
the Company collected on the customer’s security letters of
credit and paid a portion of the March and June financing payments
due under the Nord Loans, and entered into an agreement with the
customer to defer payment of the remaining balance of the March
rent to June 2020. In June 2020, the Company agreed with the
customer to defer payment of the March and June rent to September
2020, and entered into an agreement with Nord to defer until
September 24, 2020 (i) payment of the principal amount due under
the respective Nord Loans for the two aircraft due in March and
June 2020 and (ii) payment of past due interest at the default
interest rate on the March and June 2020 overdue
payments.
The
customer also replaced the security letters of credit, and the
Company agreed not to collect on such new security letters of
credit unless and until the lessee failed to make its quarterly and
deferred payment due in June 2020. The Company has not collected on
the replacement letters of credit. As a result of the
customer’s non-payments in March and June 2020 and potential
consequent uncertainty concerning future interest payments under
the related Nord Loans, the Company dedesignated the related
derivative instruments as hedges during the first quarter of 2020
since the swapped interest was not deemed as probable to
occur.
After
discussions with the lessee for the remaining three swaps related
to the Nord Loans, the Company determined that there was sufficient
uncertainty related to rent payments and related debt payments, and
that the Company could not conclude that the payments related to
the swaps were probable of occurring, so that the Company
dedesignated those swaps as hedges in March 2020 as
well.
(c) Paycheck Protection Program Loan
On May
20, 2020, JetFleet Management Corp. (the “PPP
Borrower”), a subsidiary of AeroCentury Corp., was granted a
loan (the “PPP Loan”) from American Express National
Bank in the aggregate amount of $276,353, pursuant to the Paycheck
Protection Program (the “PPP”) under Division A, Title
I of the CARES Act, which was enacted March 27, 2020. The
application for these funds required the Company to, in good faith,
certify that the current economic uncertainty made the loan request
necessary to support the ongoing operations of the Company. This
certification further required the Company to take into account its
current business activity and its ability to access other sources
of liquidity sufficient to support ongoing operations in a manner
that is not significantly detrimental to the business. The receipt
of these funds, and the forgiveness of the loan attendant to these
funds, is dependent on the Company having initially qualified for
the loan and qualifying for the forgiveness of such loan based on
its future adherence to the forgiveness criteria.
The PPP
Loan, which was in the form of a Note dated May 18, 2020 issued by
the PPP Borrower and is included in the Company's notes payable and accrued
interest, matures on April 22, 2022 and bears interest at a
rate of 1.00% per annum, payable in 18 monthly payments commencing
on November 20, 2020. The Note may be prepaid by the PPP Borrower
at any time prior to maturity with no prepayment penalties. Funds
from the PPP Loan may only be used for payroll costs and any
payments of certain covered interest, lease and utility payments.
The Company intends to use the entire PPP Loan amount for
qualifying expenses. Under the terms of the PPP, certain amounts of
the Loan may be forgiven if they are used for qualifying expenses
as described in the CARES Act. Although the Company expects that
all or a significant portion of the PPP loan will be forgiven, no
assurance can be provided that the Company will obtain such
forgiveness.
5. Derivative Instruments
In the
first quarter of 2019, the Company entered into eight fixed
pay/receive variable interest rate swaps. The Company entered into
the interest rate swaps in order to reduce its exposure to the risk
of increased interest rates. With respect to the six interest rate
swaps entered into by the LLC Borrowers, the swaps were 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 Nord Loan
principal and interest payments, thereby preventing default so long
as the lessees met their lease rent payment obligations. The two
interest rate swaps entered into by AeroCentury were intended to
protect against the exposure to interest rate increases on $50
million of the Company’s MUFG 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 designated seven of its interest rate swaps as cash flow
hedges. Changes in the fair value of the hedged swaps are included
in other comprehensive income/(loss), which amounts are
reclassified into earnings in the period in which the transaction
being hedged affects earnings (i.e., with future settlements of the
interest rate swaps). One of the interest rate swaps was not
eligible under its terms for hedge treatment and was terminated in
2019 when the associated asset was sold and the related debt was
paid off. Changes in fair value of non-hedge derivatives are
reflected in earnings in the periods in which they
occur.
Six of
the interest rate swaps were entered into by the LLC Borrowers and
provided for reduced notional amounts that mirror the amortization
under the Nord Loans entered into by the LLC Borrowers, effectively
converting each of the six Nord Loans from a variable to a fixed
interest rate, ranging from 5.38% to 6.30%. Each of these six
interest rate swaps extended for the duration of the corresponding
Nord Loan. Two of the swaps have maturities in 2020 and three have
maturities in 2025. The sixth swap was terminated in the fourth
quarter of 2019 in connection with the sale of the related
aircraft,
As
discussed in Note 4, in March, the Company determined that the
future hedged interest payments related to its five remaining Nord
Loan interest rate hedges were no longer probable of occurring, and
consequently dedesignated all five swaps as hedges. As a result of
dedesignation, future changes in market value will be recognized in
ordinary income and AOCI will be reclassified to ordinary income as
the forecasted transactions occur. Accumulated other comprehensive
loss of $121,800 and $169,900 related to the Nord Swaps was
recognized as an expense in the second quarter and first six months
of 2020, respectively.
The
other two interest rate swaps (the “MUFG Swaps”),
related to the Company’s MUFG Credit Facility, were entered
into by AeroCentury and had notional amounts totaling $50 million
and were to extend through the maturity of the MUFG Credit Facility
in February 2023. Under the ISDA agreement for these interest rate
swaps, defaults under the MUFG Credit Facility give the swap
counterparty the right to terminate the interest rate swaps with
any breakage costs being the liability of the Company.
In
October 2019, the Company determined that it was no longer probable
that forecasted cash flows for its two interest rate swaps with a
nominal value of $50 million would occur as scheduled as a result
of the Company’s defaults under the MUFG Credit Facility.
Therefore, those swaps were no longer subject to hedge accounting
and changes in fair market value thereafter were recognized in
earnings as they occurred. As a result of the forecasted
transaction being not probable to occur, accumulated other
comprehensive loss of $117,000 and $1,387,300 related to the MUFG
Swaps was recognized as interest expense in the second quarter and
first six months of 2020, respectively.
The
Company has reflected the following amounts in its net
loss:
|
|
For the Six
Months Ended
June
30,
|
For
the Three Months Ended
June
30,
|
||
|
|
2020
|
2019
|
2020
|
2019
|
|
Change in value of
interest rate swaps
|
$1,990,400
|
$451,400
|
$82,200
|
$43,000
|
|
Reclassification
from other comprehensive income
|
389,500
|
(22,100)
|
238,800
|
(20,800)
|
|
Reclassification
from other comprehensive income –
forecasted
transaction not probable to occur
|
1,167,700
|
-
|
-
|
-
|
|
Included in
interest expense
|
$3,547,600
|
$429,300
|
$321,000
|
$22,200
|
|
|
|
|
|
|
|
The
following amount was included in other comprehensive income/(loss),
before tax:
|
|
|
||
|
|
|
|
|
|
|
Unrealized
gain/(loss) on derivative instruments
|
$(575,000)
|
$(1,810,600)
|
$-
|
$(1,267,100)
|
|
Reclassification
from other comprehensive income
|
389,500
|
(22,100)
|
238,800
|
(20,800)
|
|
Reclassification
from other comprehensive income –
forecasted
transaction not probable to occur
|
1,167,700
|
-
|
-
|
-
|
|
Change in value of
hedged interest rate swaps
|
$982,200
|
$(1,832,700)
|
$238,800
|
$(1,287,900)
|
Approximately
$331,200 of the current balance of accumulated other comprehensive
income is expected to be reclassified in the next twelve
months.
At
June 30, 2020, the fair value
of the Company’s interest rate swaps was as
follows:
|
Designated interest
rate hedges fair value
|
$-
|
|
Other interest rate
swaps
|
1,053,200
|
|
Total derivative
(liability)
|
$1,053,200
|
The Company evaluates the creditworthiness of the counterparties
under its hedging agreements. The swap counterparties for the
Company’s interest rate swaps are large financial
institutions in the United States that possess 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.
6. Lease Right of Use Asset and Liability
The
Company was a lessee under a lease of the office space it occupies
in Burlingame, California, which expired in June 2020. The lease
also provided for two, successive one-year lease extension options
for amounts that were substantially below the market rent for the
property. The lease provided for monthly rental payments according
to a fixed schedule of increasing rent payments. As a result of the
below-market extension options, the Company determined that it was
reasonably certain that it would extend the lease and, 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
included 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 were not allocated as a component of
the lease.
Effective
January 1, 2020, the Company reduced both the size of the office
space leased and the amount of rent payable in the future. As such,
the Company recognized a reduction in both the capitalized amount
related to the surrendered office space and a proportionate amount
of the liability associated with its future lease obligations. In
January 2020, the Company recorded a loss of $160,000 related to
the reduction in its ROU Asset, net of the reduction in its
operating lease liability, and expected to recognize amortization
of $308,100, $317,600 and $162,600 in 2020, 2021 and the first half
of 2022, respectively.
In
March 2020, the Company elected not to exercise the extension
options for its office lease. The lease liability associated with
the office lease was calculated at March 31, 2020 and December 31,
2019 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. As a
result of non-exercise of its extension option, the Company reduced
the lease liability to reflect only the three remaining rent
payments in the second quarter of 2020. The Company estimated that
the maturities of operating lease base rent of its office space
were as follows as of June 30, 2020 and December 31, 2019:
|
|
June
30,
2020
|
December 31,
2019
|
|
2020
|
$-
|
$145,000
|
|
2021
|
-
|
147,200
|
|
2022
|
-
|
74,700
|
|
|
-
|
366,900
|
|
Discount
|
-
|
(30,500)
|
|
Lease
liability
|
$-
|
$336,400
|
During
the quarter ended June 30,
2020, the Company recognized amortization, finance costs and other
expense related to the office lease as follows:
|
Fixed rental
expense during the quarter
|
$440,800
|
|
Variable lease
expense
|
1,700
|
|
Total lease expense
during the quarter
|
$442,500
|
In July
2020, the lease for the Company’s office lease was extended
for one month to July 31, 2020 at a rate of $10,000. The Company
has signed a lease for a smaller office suite in the same building
effective August 1, 2020. The lease provides for a term of 30
months expiring on January 31, 2023, at a monthly base rate of
approximately $7,400, with no rent due during the first six
months.
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.
Assets and Liabilities Measured and Recorded at Fair Value on a
Recurring Basis
As of
June 30, 2020, the Company measured the fair value of its interest
rate swaps of $27,516,900 (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 interest rate swaps had a net fair value
liability of $1,053,200 as of
June 30, 2020. In the quarter and six months ended June 30, 2020,
$82,200 and $1,990,400 was realized through the income statement as
an increase in interest expense.
As of
December 31, 2019, the Company measured the fair value of its
interest rate swaps of $80,914,500 (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 interest rate swaps had a net fair value
liability of $1,824,500 as of December 31, 2019. In the year ended
December 31, 2019, $255,200 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,
2020 and December 31, 2019:
|
|
June
30, 2020
|
December
31, 2019
|
||||||
|
|
Total
|
Level
1
|
Level
2
|
Level
3
|
Total
|
Level
1
|
Level
2
|
Level
3
|
|
Money
market
funds
|
$-
|
$-
|
$-
|
$-
|
$400
|
$400
|
$-
|
$-
|
|
Derivatives
|
(1,053,200)
|
-
|
(1,053,200)
|
-
|
(1,824,500)
|
-
|
(1,824,500)
|
-
|
|
Total
|
$(1,053,200)
|
$-
|
$(1,053,200)
|
$-
|
$(1,824,100)
|
$400
|
$(1,824,500)
|
$-
|
There
were no transfers between Level 1 and Level 2 during the second
quarters of 2020 or 2019, 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. During the second
quarter of 2020, the Company recorded impairment losses totaling
$6,706,600 for two of its aircraft held for lease, which were
written down to their estimated sales prices, less cost of sale.
The Company also recorded losses totaling $3,020,000 on four
aircraft that are held for sale: (i) $2,870,000 for three regional
jet aircraft that were written down to fair value and (ii) $150,000
for a turboprop aircraft that was written down its estimated sales
price, less cost of sale. 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 $2,340,00
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, 2020 and December
31, 2019:
|
|
Assets
Written Down to Fair Value
|
Total
Losses
|
||||||||
|
|
June
30, 2020
|
December
31, 2019
|
For the
Six Months Ended June 30,
|
|||||||
|
|
|
Level
|
|
Level
|
|
|||||
|
Total
|
1
|
2
|
3
|
Total
|
1
|
2
|
3
|
2020
|
2019
|
|
|
Assets
held for lease
|
$17,300,000
|
$-
|
$-
|
$17,300,000
|
$-
|
$-
|
$-
|
$-
|
$6,706,600
|
$-
|
|
Assets
held for sale
|
12,820,000
|
-
|
-
|
12,820,000
|
25,880,700
|
-
|
$-
|
25,880,700
|
9,674,900
|
1,568,400
|
|
Total
|
$30,120,000
|
$-
|
$-
|
$30,120,000
|
$25,880,700
|
$-
|
$-
|
$25,880,700
|
$16,381,500
|
$1,568,400
|
There
were no transfers between Level 1 and Level 2 and no transfers into
or out of Level 3 in either of the second quarters or six-month
periods ended June 30, 2020 or 2019.
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 MUFG Credit Facility, notes payable
under special-purpose financing, its derivative termination
liability 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 maturity. The fair value of finance lease receivables
approximates the carrying value as discussed in Note 1(f). 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 MUFG Credit Facility bore floating rates
of interest that reset periodically to a market benchmark rate plus
a credit margin. The same is true of the MUFG Loan. The Company
believes the effective interest rate under the MUFG Credit Facility
approximated then current market rates for such indebtedness at
December 31, 2019 and, under the MUFG Loan, approximates current
market rates, and therefore that the outstanding principal and
accrued interest of $85,476,000 and $84,460,300 at June 30, 2020
and December 31, 2019, respectively, approximate their fair values
on such dates. The fair value of the Company’s outstanding
balance of its MUFG Credit Facility and MUFG Loan are categorized
as a Level 3 input under the GAAP fair value
hierarchy.
Before
their repayment in February 2019 in connection with the Nord 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 discussed above, during February 2019, the UK
LLC SPE Financing and four assets that previously served as
collateral under the MUFG Credit Facility were refinanced using the
Nord 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 consolidated balance
sheets, and therefore that the outstanding principal and accrued
interest of $29,658,400 and $31,003,800 approximate their fair
values at June 30, 2020 and December 31, 2019, 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 second quarters or six months
ended June 2020 or 2019.
8. 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.
9. Income Taxes
The
Company recorded an income tax benefit of $1,283,600 in the second
quarter of 2020, or 8.7%% of pre-tax loss, compared to a $27,800
income tax benefit, or 26.4% of pre-tax loss in the second quarter
of 2019. The difference in the effective federal income tax rate
from the normal statutory rate was primarily related to the
recording of a valuation allowance of $3.1 million in the second
quarter on U.S. deferred tax assets not supported by either future
taxable income or availability of future reversals of existing
taxable temporary differences, partially offset by deferred foreign
tax assets that are supported by existing temporary
differences.
The
Company recorded an income tax benefit of $4.0 million for the six
months ended June 30, 2020, or 14.4% of pre-tax loss, compared to a
$384,200 income tax benefit, or 21.7% of pre-tax loss, for the six
months ended June 30, 2019. The difference in the effective federal
income tax rate from the normal statutory rate was primarily
related to the recording of a valuation allowance of $3.2 million
for the six months ended June 30, 2020 on U.S. deferred tax assets
not supported by either future taxable income or availability of
future reversals of existing taxable temporary differences,
partially offset by deferred foreign tax assets that are supported
by existing temporary differences.
In
March of 2020, the Coronavirus Aid, Relief, and Economic Security
Act (the “CARES Act”) became law. The CARES Act
included tax provisions under which net operating losses from 2018,
2019 and 2020 can be carried back for five years, modifying the law
that had previously not permitted any carryback, and also increased
the amount of deductible interest from 30% to 50% of adjusted
taxable income for the 2019 and 2020 years. These changes have not
had any effect on the Company’s expected cash tax
expenditures or income tax expense. The CARES Act also accelerated
the ability to receive refunds of alternative minimum tax credits
from prior years, which will allow the Company to accelerate
$11,400 of the refund of such credit into its 2019
return.
10. Computation of Loss Per Share
Basic and diluted loss per share are calculated as
follows:
|
|
For the Six
Months
Ended June
30,
|
For the Three
Months
Ended June
30,
|
||
|
|
2020
|
2019
|
2020
|
2019
|
|
Net
loss
|
$(23,696,100)
|
$(1,385,800)
|
$(13,517,700)
|
$(77,600)
|
|
Weighted average
shares outstanding for the period
|
1,545,884
|
1,545,884
|
1,545,884
|
1,545,884
|
|
Basic
loss
|
$(15.33)
|
$(0.90)
|
$(8.74)
|
$(0.05)
|
|
Diluted loss per
share
|
$(15.33)
|
$(0.90)
|
$(8.74)
|
$(0.05)
|
Basic loss per common share is
computed using net loss and the
weighted average number of common shares outstanding during the
period. Diluted loss 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. There were no
anti-dilutive shares outstanding during the three months or six
months ended June 30, 2020 or 2019.
11. Subsequent
Events
In
August 2020, an older turboprop aircraft that is held for sale and
had been on a short-term lease was returned by the customer. At the
time of return, the Company recorded $222,000 of maintenance
reserves revenue related to maintenance reserves retained by the
Company.
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 annual
report on Form 10-K for the fiscal year ended December 31, 2019 and
the audited consolidated financial statements and notes included
therein (collectively, the “2019 Annual Report”), as
well as the Company’s unaudited
condensed consolidated financial statements and the related notes
included in this report. Pursuant to Instruction 2 to
paragraph (b) of Item 303 of Regulation S-K promulgated by the SEC,
in preparing this discussion and analysis, the Company has presumed
that readers have access to and have read the disclosure under the
same heading contained in the 2019 Annual 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
customer base of eight airlines in six 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, and the interest rate of its
debt, as well as asset sales.
The COVID-19 pandemic has led to significant cash flow issues for
airlines, and some of the Company’s customers were unable to
timely meet their obligations under their lease obligations with
the Company during the first and second quarters of 2020.
This in turn has caused lessees to make requests for lease payment
concessions and/or deferrals from the Company, which requires the
Company to reach accommodations with its lenders to allow the
Company corresponding concessions under its debt financings. The
Company expects these circumstances to continue for the foreseeable
future.
The
Company did not purchase or sell any aircraft during the second
quarter of 2020. The Company ended the quarter with a total of
eleven aircraft held for lease, with a net book value of
approximately $98 million. This represents a 10% decrease compared
to the net book value of the Company’s aircraft and engines
held for lease at December 31, 2019. In addition to the aircraft
held for lease at quarter-end, the Company held two aircraft
subject to finance leases and held four aircraft and airframe parts
from two aircraft held for sale.
Average
portfolio utilization was approximately 91% and 99% during the
second quarters of 2020 and 2019, respectively. The year-to-year
decrease was due to aircraft that were on lease in the 2019 period,
but off lease in the 2020 period.
Net
loss for the second quarters of 2020 and 2019 was $13.5 million and
$1.3 million, respectively, resulting in basic and diluted loss per
share of $(8.74) and $(0.85), respectively. Pre-tax profit margin
(which the Company calculates as its (loss)/income before income
tax (benefit)/provision as a percentage of its revenues and other
income) was (308%) in the second quarter of 2020 compared to (1%)
for the second quarter of 2019.
As discussed above, on
May 1, 2020, the Company and the MUFG Lenders entered into a Fourth
Amended and Restated Loan and Security Agreement (the "MUFG
Loan Agreement") that amended and restated the existing agreement
regarding the Company's indebtedness to the MUFG
Lenders. The Company has engaged B. Riley FBR as an
investment banking advisor to help (i) formulate and analyze
various strategic financial alternatives to address the
Company’s capital structure, strategic and financing needs,
as well as corporate level transactions aimed at achieving maximum
value for the Company’s stockholders; and (ii) locate and
negotiate with potential lenders, investors or transaction partners
who would play a role in the Company’s plan
(“Recapitalization Plan”). There is no assurance that
such a Recapitalization Plan will be executed.
Until
the MUFG Loan and the swap termination payment obligation are
repaid, the Company’s cash flow will be subject to monitoring
and approval by the MUFG Lenders. Because the MUFG Loan Agreement
requires any accumulation of cash held by AeroCentury Corp. and
JetFleet Management Corp. in excess of $1 million as of each
quarter end to be used to pay down the balance of the MUFG Loan,
the Company’s ability to meet unanticipated cash payment
obligations may be wholly dependent upon obtaining approval from
the MUFG Lenders to access the restricted cash account that is
controlled by the MUFG Lenders. As of the date of this filing, the
restricted account balance is zero and will increase only if and
when aircraft are sold.
In addition, two of the Company’s special purpose
subsidiaries that are borrowers under the Nord Loans are in default
of their loan obligations due to their failure to fully pay the
March and June quarterly payments when due, which was in turn the
result of their lessee’s failure to make its
quarterly lease payment in March and June. The special
purpose entities do not themselves have sufficient free cash to
cure such defaults, nor is the Company permitted to direct funds to
the special purpose subsidiaries without the consent of the MUFG
Lenders. The special purpose subsidiaries’
ability to cure their loan default is therefore likely dependent
solely on the lessee’s cure of its overdue March and June
rent payment obligations. The special purpose
subsidiaries collected on the lessee’s letters of credit to
partially fund the overdue lease payments, and the leases with
the lessee have been amended to permit the lessee to cure the
remainder of its March and June lease payment default when it makes
its upcoming September quarterly payment. Nord has agreed to defer
payment of its corresponding loan installments due in March and
June 2020 until the September quarterly payment date. There is no
assurance that the lessee will be able to comply with its agreement
to pay the March and June lease rental along with its September
lease rental obligation, which will in turn give the special
purpose borrowers the ability to pay the deferred payment
obligations from March and June along with its September loan
payment installment.
As a
result of these factors, there is substantial doubt regarding the
Company’s ability to continue as a going
concern.
Fleet Summary
(a) Assets Held for Lease
Key
portfolio metrics of the Company’s aircraft held for lease as
of June 30, 2020 and December
31, 2019 were as follows:
|
|
June 30,
2020
|
December 31,
2019
|
|
Number of aircraft
and engines held for lease
|
11
|
11
|
|
|
|
|
|
Weighted average
fleet age
|
12.3
years
|
11.8
years
|
|
Weighted average
remaining lease term
|
36
months
|
41
months
|
|
Aggregate fleet net
book value
|
$97,692,500
|
$108,368,600
|
|
|
For
the Six Months
Ended June 30,
|
For
the Three Months
Ended June 30,
|
||
|
|
2020
|
2019
|
2020
|
2019
|
|
Average portfolio
utilization
|
88%
|
98%
|
91%
|
99%
|
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, 2020
and December 31, 2019:
|
|
June
30, 2020
|
December 31,
2019
|
||
|
Type
|
Number
owned
|
% of
net book value
|
Number
owned
|
% of
net book value
|
|
Turboprop
aircraft:
|
|
|
|
|
|
Bombardier
Dash-8-400
|
2
|
22%
|
2
|
20%
|
|
|
|
|
|
|
|
Regional jet
aircraft:
|
|
|
|
|
|
Embraer
175
|
3
|
29%
|
3
|
26%
|
|
Canadair
CRJ-1000
|
2
|
14%
|
2
|
21%
|
|
Canadair
CRJ-700
|
3
|
21%
|
3
|
20%
|
|
Canadair
CRJ-900
|
1
|
14%
|
1
|
13%
|
During
the second quarter and first six months of 2020, the Company did
not purchase or sell any aircraft that are held for lease. During
the first six months of 2020, the Company sold one aircraft that
had been held for sale, one aircraft that had been held under a
sales-type lease and three aircraft that had been held under direct
financing leases, and sold certain aircraft parts that were held
for sale.
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.
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, 2020 and
December 31, 2019 in the indicated regions (based on the domicile
of the lessee):
|
|
June
30, 2020
|
December 31,
2019
|
||
|
Region
|
Net
book value
|
%
of
net
book value
|
Net
book value
|
%
of
net
book value
|
|
North
America
|
$62,351,600
|
64%
|
$63,799,600
|
59%
|
|
Europe
|
35,340,900
|
36%
|
44,569,000
|
41%
|
|
|
$97,692,500
|
100%
|
$108,368,600
|
100%
|
For the
three months ended June 30,
2020, approximately 44%, 33% and 13% of the Company’s
operating lease revenue was derived from customers in the United
States, Spain and Canada, 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,
|
||||||
|
|
2020
|
2019
|
2020
|
2019
|
||||
|
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
|
3
|
45%
|
4
|
62%
|
3
|
42%
|
4
|
64%
|
|
North
America
|
3
|
55%
|
4
|
36%
|
3
|
58%
|
3
|
36%
|
|
Asia
|
-
|
-%
|
1
|
2%
|
-
|
-%
|
-
|
-%
|
At
June 30, 2020 and December 31,
2019, the Company also had two aircraft and six aircraft,
respectively, subject to finance leases. The Company did not record
any finance lease revenue during the quarter ended June 30, 2020.
(b) Assets Held for Sale
Assets
held for sale at June 30, 2020
consisted of three Canadair 900 aircraft, one Bombardier Dash-8-300
aircraft and airframe parts from two turboprop
aircraft.
Results of Operations
(a) Quarter ended June 30, 2020 compared to the quarter ended
June 30, 2019
(i) Revenues and Other Income
Revenues
and other income decreased by 39% to $4.4 million in the second
quarter of 2020 from $7.2 million in the second quarter of 2019.
The decrease was primarily a result of decreased operating lease
and finance lease revenues in the second quarter of 2020, the
effects of which were partially offset by increased gains on sale
of assets.
Operating
lease revenue decreased by 37% to $4.4 million in the second
quarter of 2020 from $7.0 million in the second quarter of 2019,
primarily due to reduced rent income resulting from the early
termination of four aircraft leases with one of the Company’s
customers in the third quarter of 2019 and reduced rent for two
assets in the 2020 period as a result of lease amendments related
to the COVID-19 Outbreak.
The
Company recorded no finance lease revenue in the second quarter of
2020, compared to $0.3 million in the second quarter of 2019, as a
result of the sale of three assets that were subject to direct
finance leases during the first quarter of 2020 and the
Company’s cash-basis accounting for its two sales-type leases
in 2020.
During
the second quarter of 2020, the Company recorded $21,100 of gains
on the sale of aircraft parts. Such gains were partially offset by
legal costs totaling $8,000 related to three aircraft that were
sold during the first quarter. 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.
(ii) Expenses
Total
expenses increased by 164% to $19.2 million in the second quarter
of 2020 from $7.3 million in the second quarter of 2019. The
increase was primarily a result of increases in asset impairment
losses, interest
expense and professional fees and general and administrative
expenses, the effects of which were partially offset by a decrease
in depreciation.
During
the second quarter of 2020, the Company recorded impairment charges
of (i) $6.7 million on two assets held for lease, based on
estimated future cash flow,
(ii) $2.9 million on three assets held for sale, based on appraised
values and (iii) $0.1 million on a fourth asset held for sale,
based on expected net sales proceeds. During the second quarter of
2019, the Company recorded an impairment charge of $0.2 million for
an asset held for sale, based on appraised value.
The
Company’s interest expense increased by 79% to $4.5 million
in the second quarter of 2020 from $2.5 million in the second
quarter of 2019, primarily as a result of a higher average interest
rate and a $1.5 million write-off of a portion of the
Company’s unamortized debt issuance costs related to the MUFG
Credit Facility, the effects of which were partially offset by a
lower average debt balance.
Professional
fees, general and administrative and other expenses increased 151%
to $2.1 million in the second quarter of 2020 from $0.9 million in
the second quarter of 2019, primarily due to increased legal fees
related to the May 2020 MUFG Indebtedness amendment and litigation
brought by an activist shareholder, consulting fees related to the
May 2020 MUFG Indebtedness amendment and increased amortization
related to the Company’s office lease right of
use.
Depreciation
expense decreased 33% to $2.0 million in the second quarter of 2020
from $3.0 million in the second quarter of 2019 primarily as a
result of the reclassification of four aircraft from held for lease
to held for sale during the third quarter of 2019.
The
Company had a tax benefit of $1,283,500 in the second quarter of
2020 compared to a tax benefit of $27,800 in the second quarter of
2019. The effective tax rate for the second quarter of 2020 was a
8.7% tax benefit compared to a 26.4% tax benefit in the second
quarter of 2019. The difference in the effective income tax rate
from the normal statutory rate was primarily related to recording a
$3.1 million valuation allowance in the current period on the
Company’s U.S. deferred tax assets after concluding that a
valuation allowance is necessary for the Company’s net U.S.
deferred tax assets not supported by either future taxable income
or availability of future reversals of existing taxable temporary
differences.
In
March of 2020, the Coronavirus Aid, Relief, and Economic Security
Act (the “CARES Act”) became law. The CARES Act
included tax provisions under which net operating losses from 2018,
2019 and 2020 can be carried back for five years, modifying the law
that had previously not permitted any carryback, and also increased
the amount of deductible interest from 20% to 30% of adjusted
taxable income for the 2019 and 2020 years. These changes have not
had any effect on the Company’s expected cash tax
expenditures or income tax expense. The CARES Act also accelerated
the ability to receive refunds of alternative minimum tax credits
from prior years, which will allow the Company to accelerate
$11,400 of the refund of such credit into its 2019
return.
(b) Six months ended June 30, 2020 compared to the six months
ended June 30, 2019
(i) Revenues and Other Income
Revenues
and other income decreased by 38% to $9.2 million in the first six
months of 2020 from $14.7 million in the same period of 2019. The
decrease was primarily a result of decreased operating lease and
finance lease revenues in the 2020 period, as well as decreased
gains on sale of assets.
Operating
lease revenue decreased by 35% to $9.1 million in the first six
months of 2020 from $14.1 million in the same period of 2019,
primarily due to reduced rent income resulting from the early
termination of four aircraft leases with one of the Company’s
customers in the third quarter of 2019 and reduced rent for two
assets in the 2020 period as a result of lease amendments related
to the COVID-19 Outbreak, as well as the sale of an asset in the
first quarter of 2019 that had been on lease until the time of
sale
Finance
lease revenue decreased by 89% to $0.1 million in the first six
months of 2020, compared to $0.5 million in the same period of
2019, as a result of the sale of three assets that were subject to
direct finance leases during the first quarter of 2020 and the
Company’s cash-basis accounting for its two sales-type
leases, for which it received no payments in the 2020
period.
During
the six months ended June 30, 2020, the Company recorded losses
totaling $47,300 on the sale of four aircraft and a loss of $2,500
for legal work related to the sale of an aircraft that the Company
expects to occur in the fourth quarter of 2020. Such losses were
partially offset by gains totaling $38,700 on the sale of aircraft
parts. 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.
(ii) Expenses
Total
expenses increased by 123% to $36.9 million in the first six months
of 2020 from $16.5 million in the same period of 2019. The increase
was primarily a result of increases in asset impairment
losses, interest
expense, bad debt expense and professional fees and general and
administrative expenses, the effects of which were partially offset
by a decrease in depreciation.
During
the six months ended June 30, 2020, the Company recorded impairment
charges of (i) $6.7 million on two assets held for lease, based on
estimated future cash flow and
(ii) $9.7 million on five assets held for sale, based on appraised
values or expected sales proceeds. During the six months ended June
30, 2019, the Company recorded an impairment charge of $0.2 million
for an asset held for sale, based on appraised value.
The
Company’s interest expense increased by 94% to $10.5 million
in the first six months of 2020 from $5.4 million in the same
period of 2019, primarily as a result of a higher average interest
rate, $2.0 million of valuation charges related to the
Company’s interest rate swaps and a $2.0 million write-off of
a portion of the Company unamortized debt issuance costs related to
the MUFG Credit Facility, the effects of which were partially
offset by a lower average debt balance.
As a result of payment delinquencies by two of the Company’s
customers under its two sales-type leases and decreases in the
appraised values of the underlying assets, the Company recorded a
bad debt expense of $1.2 million in the first six months of 2020.
The Company recorded no bad debt expense during the first six
months of 2019.
Professional
fees, general and administrative and other expenses increased 78%
to $3.0 million in the first six months of 2020 from $1.7 million
in the first six months of 2019, primarily due to increased legal
fees related to the May 2020 MUFG Indebtedness amendment and
litigation relating to an activist shareholder, consulting fees
related to the May 2020 MUFG Indebtedness amendment and increased
amortization related to the Company’s office lease right of
use.
Depreciation
expense decreased 32% to $4.2 million in the six months ended June
30, 2020 from $6.2 million in the six months ended June 30, 2019
primarily as a result of the reclassification of four aircraft from
held for lease to held for sale during the third quarter of 2019
and the sale of an asset during the 2019 period.
The
Company had a tax benefit of $4.0 million for the six months ended
June 30, 2020 compared to a tax benefit of $384,000 for the six
months ended June 30, 2019. The effective tax rate for the six
months ended June 30, 2020 was a 14.4% tax benefit compared to a
21.7% tax benefit for the six months ended June 30, 2019. The
difference in the effective income tax rate from the normal
statutory rate was primarily related to recording a $3.2 million
valuation allowance in the current period on the Company’s
U.S. deferred tax assets after concluding that a valuation
allowance is necessary for the Company’s net U.S. deferred
tax assets not supported by either future taxable income or
availability of future reversals of existing taxable temporary
differences.
Liquidity and Capital Resources
As a
result of the factors discussed below, there is substantial doubt
regarding the Company’s ability to continue as a going
concern.
(a) MUFG Credit Facility
On May 1, 2020, the Company and the MUFG Lenders entered into a
Fourth Amended and Restated Loan and Security Agreement (the
"MUFG Loan Agreement"), which, amended and restated the existing
agreement regarding the Company's indebtedness to the MUFG Lenders
and effected the following changes to the terms and provisions of
such indebtedness:
●
A forbearance of
the existing defaults and events of default under the MUFG Loan
Agreement until May 10, 2020, with a provision to extend such
forbearance to July 1, 2020 and August 15, 2020, if the Company is
still in compliance with the agreement at May 10, 2020 and July 1,
2020, respectively;
●
Elimination of the
borrowing base collateral value covenant under the MUFG Loan
Agreement, and of the existing event of default under the Loan
Agreement for a borrowing base deficiency, along with cessation of
the default interest accrual on the outstanding loan
amount;
●
Conversion of the
revolving MUFG Credit Facility structure to a term loan structure
with an initial principal balance of $83,689,900.86 and a final
maturity date of March 31, 2021;
●
Interest accrual on
the indebtedness based on the Base Rate (defined as the greater of
(i) the rate of interest most recently announced by MUFG as to its
U.S. dollar “Reference Rate”, or (ii) the Federal Funds
Rate plus one-half of one percent (0.50%)), according to the
following schedule: (a) Base Rate + 525 bps (0 bps as cash interest
and 525 bps as payment in kind ("PIK")) until June 30, 2020, and
(b) Base Rate + 525 bps (100 bps as cash interest and 425 bps as
PIK) from and after July 1, 2020, subject to a Base Rate floor at
325 bps for both time periods;
●
Deferral of the
cash component of the interest payments (on the loan indebtedness
and swap termination payment obligation) that was due on April 1,
2020 and May 1, 2020, until the earlier of (i) the date of receipt
of net proceeds into the Company's restricted account held at MUFG
to hold sales proceeds (the "Restricted Account") from the sale of
certain enumerated aircraft assets and (ii) July 1,
2020;
●
Required sweep of
any unrestricted cash in the Company’s bank accounts in
excess of $1,000,000 at the end of each fiscal
quarter;
●
Addition of certain
default provisions triggered by certain defaults or other events
with respect to the Company’s aircraft leases for the
Company's aircraft that are collateral for the MUFG Loan Agreement
("Aircraft Collateral");
●
Provision for certain payments from the
Restricted Account to (i) the
Company’s investment banking advisor; (ii) payments due under
the agreement and for interest on the swap termination indebtedness
owed by the Company; and (iii) Lenders’ outside counsel and
consultants;
●
Addition of a
requirement for the Company's engagement of a Financial
Advisor/Consultant, at the Company’s expense, with a specific
scope of work as prescribed by the MUFG Loan
Agreement;
●
Revisions to the
Company’s required appraisal process for the Aircraft
Collateral; and
●
Establishment of
deadlines for achievement of milestones for execution of Company
strategic alternatives with respect to the MUFG Indebtedness
acceptable to the MUFG Lenders ("Strategic Alternatives") as
follows: (a) obtaining indications of interest for Strategic
Alternatives by May 20, 2020 and was met by the Company at that
time; (b) obtaining a fully-executed (tentative or generally
non-binding) agreement on the terms and conditions for a Strategic
Alternative by June 29, 2020, which has been met; and (c)
consummation of the selected strategic Alternative by August 15,
2020.
On July
8, 2020, the agent bank for the MUFG Lenders delivered a
Reservation of Rights Letter to the Company which contained notice
of defaults with respect to failure to deliver a lessee
acknowledgment of the MUFG Lender’s mortgage from one of the
Company’s lessees (which was delayed due to extended
negotiations between MUFG and the lessee relating to form of such
acknowledgment) and (ii) the failure to make a deferred interest
payment as required under the Loan Agreement that was due and
payable on the earlier of July 1, 2020 or the date of the sale of a
certain aircraft scheduled to be sold upon its return from its
lessee (the closing of which sale has been delayed beyond July 1,
2020).
The borrowings under the MUFG Loan Agreement continue to be secured
by a first priority lien, which lien is documented in an amended
and restated mortgage and security agreement (the "Mortgage"), in
all of the Company's assets, including the
Company’s aircraft portfolio, except those aircraft that are
subject to special purpose financing held by subsidiaries of the
Company. The MUFG Loan Agreement and the Mortgage
(collectively the "MUFG Loan Documents") require the Company to
comply with certain covenants relating to payment of taxes,
preservation of existence, maintenance of property and insurance,
and periodic financial reporting. The MUFG Loan Documents
restrict 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 MUFG
Loan Agreement include failure to make a required payment within
three business days of a due date or to comply with other
obligations under the MUFG Loan Documents (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 under the Loan Agreement
include acceleration of the outstanding debt and exercise of any
remedies available under applicable law, including foreclosure on
the collateral securing the MUFG Loan Agreement debt.
Substantially
all of the Company’s proceeds from sale of assets is required
to be deposited in its restricted cash account, disbursements from
which are directed by the MUFG Lenders for payment of certain
costs, or otherwise to reduce the outstanding MUFG Indebtedness.
Unless and until the MUFG Indebtedness is refinanced on different
terms with a new lender, substantially all of the Company’s
excess unrestricted cash will be required to be applied toward
repayment of the MUFG Indebtedness, unless the Lenders approve
other uses of such funds. There is no assurance that a refinancing
under more favorable terms will be consummated or that the Lenders
will approve excess funds to be used for purposes other than
repayment of the MUFG Indebtedness.
In March 2019, the Company entered into interest rate swaps (the
“MUFG Swaps”) with respect to the variable interest
rate payment amounts due for $50 million of the $84 million of
outstanding MUFG Credit Facility debt. On
March 12, 2020, MUFG notified the Company that it had terminated
the MUFG Swaps. The Company incurred a liability to the swap
counterparties of $3.1 million in connection with such termination,
payment of which is due no later than the March 31, 2021 maturity
of the MUFG Loan. As a result of the forecasted transaction being
not probable to occur, accumulated other comprehensive loss of
$1,167,700 related to the MUFG Swaps was recognized as interest
expense in the first quarter of 2020.
The
Company has engaged B. Riley FBR as an investment banking advisor
to assist in obtaining debt or equity financing which, if
successful, would be used to repay the MUFG
Indebtedness.
The
Company’s ability to develop, obtain approval for and achieve
its Recapitalization Plan is subject to a variety of factors, as
discussed in Liquidity and Capital
Resources—MUFG Credit Facility. If the Company is not
able to maintain compliance with the MUFG Loan Agreement and raise
sufficient capital or refinancing debt to repay all amounts owed
under the MUFG Indebtedness, then the Company’s financial
condition and liquidity would be materially adversely affected and
its ability to continue operations could be materially
jeopardized.
If the
Company does not achieve its Recapitalization Plan and its
anticipated results, the Lenders would thereafter have the right to
exercise any and all remedies for default under the applicable MUFG
Loan Agreement. Such remedies include, but are not limited to,
declaring the entire indebtedness immediately due and payable, and
if the Company were unable to repay such accelerated indebtedness,
foreclosing upon the assets of the Company that secure the MUFG
Indebtedness, which consist of all of the Company’s assets
except for certain assets held in the Company’s single asset
special-purpose financing subsidiaries.
(b) Special-purpose Financing and Nord
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 MUFG Credit Facility.
In
February 2019, the UK LLC SPE Financing was repaid as part of a
refinancing involving the Nord Loans, which were made to
special-purpose subsidiaries of AeroCentury (the “LLC
Borrowers”). Under the Nord Loans, four aircraft that
previously served as collateral under the MUFG 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 Nord
Loans.
All of
the Nord Loans
contain cross-default provisions, so that any default by a lessee
of any of the subject aircraft could result in the Nord exercising its remedies
under the Nord
Loan agreement, including, but not limited to, possession of
the aircraft that is subject to a lessee default. Currently, the
Nord Loans are fully performing and were unaffected by the
Company’s default under the MUFG Credit
Facility.
Collectively,
the LLC Borrowers entered into six interest rate derivatives, or
interest rate swaps. Each such interest rate swap has a notional
amount that mirrors the amortization under the corresponding
Nord Loan entered
into by the LLC Borrowers, effectively converting each of the six
Nord Loans from a
variable to a fixed interest rate. Each of these six interest rate
swaps extend for the length of the corresponding Nord Loan, with maturities
from 2020 through 2025. One of the aircraft that was subject
to Nord Loan financing was sold during the fourth quarter of 2019
and the related Nord Loan and interest rate swap were terminated.
Accumulated other comprehensive loss of $48,100 related to the Nord
Swaps was recognized as an expense in the first quarter of
2020.
In
March and June 2020, one of the Company’s customers, which
leases two regional jet aircraft subject to Nord Loan financing,
did not timely make its quarterly rent payments. As a result, the
special-purpose subsidiary borrowers that hold the aircraft did not
have sufficient cash to meet the corresponding quarterly Nord Loan
payment installments. The parent corporation was not permitted to
fund the special-purpose subsidiary borrower’s loan payment
obligations due to restrictions under the MUFG Credit Facility. The
late payment by the lessee constituted events of default under the
Term Loan on March 19 and June 19, 2020, and the Term Loan
nonpayment constituted events of default under the Nord Loan
for the LLC Borrowers on March 27 and June 27, 2020. The lessee was
severely impacted by the COVID-19 pandemic, and was required to
cease operations as part of its country’s lockdown, but has
indicated to the Company that it intends to honor its lease
commitments in due course when able. In April 2020, the Company
fully drew on the letters of credit that served as security
deposits under the leases in order to fund partial repayments of
the overdue lease rentals which was then used by the Company to
make partial payments on the Nord Loan installment payments. In May
2020, with the consent of Nord, the Company and the customer
entered into a deferral agreement whereunder the customer agreed to
issue replacement letter of credits as required under its lease,
and the Company agreed to waive the default for failing to fully
pay the March 2020 quarterly lease payment when due, and to defer
the required payment date for the unpaid balance of the March lease
rental payment until the June 2020 quarterly payment date so long
as no other defaults under the leases arise prior to such date. The
Company further agreed not to collect under the newly issued
replacement letters of credit during such forbearance period. In
June 2020, the Company entered into another agreement with the
customer to defer payment of the March and June rent to September
2020, and Nord agreed to defer payment
of its corresponding loan installments due in March and June 2020
until the September quarterly payment date.
(c) Paycheck Protection Program Loan
On May
20, 2020, JetFleet Management Corp. (the “PPP
Borrower”), a subsidiary of AeroCentury Corp., was granted a
loan (the “PPP Loan”) from American Express National
Bank in the aggregate amount of $276,353, pursuant to the Paycheck
Protection Program (the “PPP”) under Division A, Title
I of the CARES Act, which was enacted March 27, 2020. The
application for these funds required the Company to, in good faith,
certify that the current economic uncertainty made the loan request
necessary to support the ongoing operations of the Company. This
certification further required the Company to take into account its
current business activity and its ability to access other sources
of liquidity sufficient to support ongoing operations in a manner
that is not significantly detrimental to the business. The receipt
of these funds, and the forgiveness of the loan attendant to these
funds, is dependent on the Company having initially qualified for
the loan and qualifying for the forgiveness of such loan based on
its future adherence to the forgiveness criteria.
The PPP
Loan, which was in the form of a Note dated May 18, 2020 issued by
the PPP Borrower, matures on April 22, 2022 and bears interest at a
rate of 1.00% per annum, payable in 18 monthly payments commencing
on November 20, 2020. The Note may be prepaid by the PPP Borrower
at any time prior to maturity with no prepayment penalties. Funds
from the PPP Loan may only be used for payroll costs and any
payments of certain covered interest, lease and utility payments.
The Company intends to use the entire PPP Loan amount for
qualifying expenses. Under the terms of the PPP, certain amounts of
the Loan may be forgiven if they are used for qualifying expenses
as described in the CARES Act. Although the Company expects that
all or a significant portion of the PPP loan will be forgiven, no
assurance can be provided that the Company will obtain such
forgiveness.
(d) 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) principal and
interest due under the MUFG Indebtedness and the Nord Loans, (ii),
salaries, employee benefits and general and administrative
expenses, (iii) maintenance expense and (iv) reimbursement to
lessees from collected maintenance reserves.
As discussed above, on
May 1, 2020, the Company and the MUFG Lenders entered into a Fourth
Amended and Restated Loan and Security Agreement, which
amended and restated the existing agreement regarding the Company's
indebtedness to the MUFG Lenders. The Company has engaged B. Riley as an investment
banking advisor to help (i) formulate and analyze various strategic
financial alternatives to address the Company’s capital
structure, strategic and financing needs, as well as corporate
level transactions aimed at achieving maximum value for the
Company’s stockholders; and (ii) locate and negotiate with
potential lenders, investors or transaction partners who would play
a role in the Company’s Recapitalization
Plan.
Until
the MUFG Indebtedness is repaid, the Company’s cash flow will
be subject to monitoring and approval by the MUFG Lenders. Because
the MUFG Loan agreement requires any accumulation of cash in excess
of $1 million as of each quarter end to be used to pay down the
balance of the MUFG Loan, the Company’s ability to meet
unanticipated cash payment obligations may be wholly dependent upon
obtaining approval from the MUFG Lenders to access the restricted
cash account that is controlled by the MUFG Lenders.
The
Company’s ability to develop, obtain approval for and achieve
its Recapitalization Plan is subject to a variety of factors, as
discussed under Liquidity and
Capital Resources—MUFG Credit Facility. If the Company
is not able to either satisfy the requirements under the
Recapitalization Plan, maintain compliance with its MUFG
Indebtedness or raise sufficient capital to repay all amounts owed
under the MUFG Indebtedness, then the Company’s financial
condition and liquidity would be materially adversely affected and
its ability to continue operations could be materially
jeopardized.
In that case, the Company may need to curtail certain of its
operations, including any asset acquisition or other growth plans,
cut costs in other ways, incur additional debt or sell equity or
certain of its revenue-producing assets in order to raise capital
(which it may not be able to do on reasonable terms, or at all), or
be forced into bankruptcy or liquidation.
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 has
in the past borrowed additional funds under the MUFG Credit
Facility to provide funding for these payments. Such funding is no
longer available under the MUFG Loan and the Company will need to
use excess cash flow or obtain permission from the MUFG Lenders to
use funds in its restricted account. As of the date of this filing,
the restricted account balance is zero.
The
amount of interest paid by the Company depends primarily on the
outstanding balance of the MUFG Indebtedness and Nord Loans and any
future debt incurred in connection with the Company’s
Recapitalization Plan.
The
entire Nord Loan indebtedness is covered by interest rate swaps,
and therefore, the Company has effectively converted the Nord Loan
interest payments to fixed rate payments. The swaps were initially treated
as interest rate hedges under which changes in market value were
reflected in AOCI and were reclassified to ordinary income when the
forecasted interest rate payments occurred. However, as a result of
the default on two of the Nord Loans and likely rent deferrals,
reductions or abatements on the leases related to the other three
Nord Loans, all five swaps were dedesignated in March 2020, AOCI
already accrued will be reflected in ordinary income as the
forecasted transactions occur, and future changes in market value
will be reflected in ordinary income.
A
portion of the Company’s indebtedness, as well as related
interest rate swaps, 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 on or after December 31, 2021, or to perform
differently than in the past. Although the consequences of these
developments cannot be entirely predicted, they could affect cash
flow, as they may require the Company to pay increased costs for
its LIBOR debt or even cause an acceleration of maturity of such
debt if a suitable replacement index cannot be agreed upon or is
not available.
Actual results could deviate substantially from the assumptions
management has made in forecasting the Company’s future cash
flow. As discussed in Liquidity and Capital
Resources – (a) Credit Facility and 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 for more
information about financing risks and
limitations.
(i) Operating activities
The
Company’s cash flow from operations decreased by $7.5 million
in the first six months of 2020 compared to the first six months of
2019. 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 interest.
(A)
Payments for rent
Receipts
from lessees for rent decreased by $7.0 million in the first six
months of 2020 compared to the same period of 2019, primarily due
to delinquencies related to one of the Company’s customers,
the sale of an aircraft during each of the first and fourth
quarters of 2019, and the repossession of four aircraft during the
third quarter of 2019.
(B) Payments
for maintenance
reserves
Receipts
from lessees for maintenance reserves decreased by $1.4 million in
the first six months of 2020 compared to the first six months of
2019, primarily due to the repossession of four aircraft during the
third quarter of 2019.
(C) Payments for interest
Payments
made for interest decreased by $1.3 million in the first six months
of 2020 compared to the first six months of 2019 as a result the
deferral of a portion of the interest due on the Company’s
MUFG Indebtedness.
(ii) Investing activities
The Company did not acquire any aircraft during the first six
months of 2020 and 2019. During the same periods, the Company
received net cash of $3.2 million and $3.9 million, respectively,
from asset sales.
(iii) Financing activities
During the first six months of 2020 and 2019, the Company borrowed
$1.1 million, in the form of paid-in-kind interest that was added
to the outstanding principal balance, and $5.1 million,
respectively, under the MUFG Indebtedness. During the same periods,
the Company repaid $1.2 million and $40.1 million, respectively, of
its total outstanding debt under the MUFG Credit Facility. Such
repayments were funded by excess cash flow, the sale of assets and,
in the 2019 period, a portion of the $44.3 million in proceeds from
the Nord Loans. During the first six months of 2020 and 2019, the
Company’s special-purpose entities repaid $1.3 million and
$9.2 million, respectively, of UK LLC SPE Financing. During the
2019 period, the Company also repaid $3.5 million of principal
under the Nord Loans. During the first six months of 2020 and 2019,
the Company paid approximately $1.7 million and $5.1 million,
respectively, for debt issuance and amendment fees.
(iv) Off balance sheet arrangements
The Company has no material off -balance sheet
arrangements.
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
and the Company’s consolidated financial statements in the
2019 Annual Report.
Outlook
MUFG Indebtedness. As discussed in Overview and Liquidity and
Capital Resources, the Company, with the assistance of B.
Riley FBR as the Company’s investment banking advisor, in May
2020, entered into an amendment and restatement of its loan
agreement with the MUFG Lenders to convert the MUFG Indebtedness
from a revolving credit facility into a term loan facility. The
Company’s future financial condition and prospects are now
almost wholly dependent on three critical factors: (i) the
Company’s ability to maintain compliance with such MUFG
Indebtedness and achieve the milestones set forth thereunder to
repay and/or refinance such indebtedness; (ii) the MUFG
Lenders’ willingness to forbear from exercising remedies upon
any default under the MUFG Loan Agreement by the Company; and (iii)
the Company’s ability to obtain new debt and/or equity
capital to fund its asset growth. If any of these factors is not
achieved, the Company’s financial condition and liquidity
would be materially adversely affected and its ability to continue
long-term operations could be materially jeopardized.
The
MUFG Loan provides for certain required milestones that the Company
is required to achieve a strategic corporate transaction with
respect to the MUFG Indebtedness satisfactory to the MUFG Lenders
by August 15, 2020, which is the final of three milestones under
the MUFG Loan Agreement. The first two milestones, submission of
indications of interest from third parties acceptable for such a
strategic transaction and obtaining a fully-executed
(tentative or generally non-binding) agreement on the terms and
conditions for a Strategic Alternative, have been
met.
Nord Loan Default. As discussed in Overview
and Liquidity and Capital Resources, due to
nonpayment of quarterly lease payments due in March and June 2020
by the lessee of two aircraft, and the corresponding Nord Loan
payment default by the Company’s special-purpose subsidiary
borrowers, an event of default has occurred under the Nord Loans
for each of the LLC Borrowers. The lease payment default by the
lessee, which is a well-established major regional European carrier
that has been consistently in compliance with its lease obligations
over the history of its lease with the Company, was a direct result
of the COVID-19 pandemic and the catastrophic impact of the
pandemic and the ensuing governmental response on the airline
industry. The Company covered a portion of the defaulted March
payment by collecting on the letters of credit that acted as a
security deposit under the Lease. The Company has since entered
into an agreement with the customer to defer payment of the March
and June rent to September 2020, and Nord agreed to defer payment of its corresponding
loan installments due in March and June 2020 until the September
quarterly payment date.
COVID-19 Pandemic. As discussed
below, in Factors that May Affect Future
Results and Liquidity -- Impact of COVID-19
Pandemic, the COVID-19 pandemic
has had and will continue to have a significant impact on the
Company’s financial circumstances mainly due to the impact on
the Company’s primary customers, regional airlines. The
COVID-19 pandemic has resulted in a loss of revenue for such
customers. This in turn has caused four of the Company’s
eight customers to make requests for lease payment concessions
and/or deferrals from the Company. The Company has so far been able
to reach accommodations with its lenders to allow the Company with
certain of its lessees to keep its leases with such lessees intact
while giving such lessees short-term deferrals on lease
obligations. If the financial fallout from the COVID-19 pandemic
continues, and the Company receives additional requests from
lessees for further concessions, then the Company may not be able
to gain the agreement of its lenders for further corresponding
concessions under its debt financings. If that occurs, then the
Company may be required to terminate such leases and attempt to
resell or release such assets, or the lenders themselves may
foreclose upon such assets, and take possession of such assets as a
remedy for default under the Company’s debt agreements.
Beyond this short-term effect of the COVID-19 pandemic, there will
be a medium-term effect on the Company through the lowered demand
for aircraft capacity due to governmental health and safety
protocols, shelter-in-place restrictions, passenger appetite for
travel and discretionary spending. The onset of the COVID-19
pandemic reduced passenger air travel to a small fraction of what
it was in prior years. This in turn has reduced the airlines’
need for aircraft capacity, resulting in a current excess supply of
aircraft relative to demand for leased aircraft such as those owned
by the Company. Some airlines may be forced to cease operations,
which will further exacerbate the oversupply of aircraft for lease
or sale. Even if the global economy quickly rebounds to
pre-COVID-19 levels, the Company anticipates that it may take much
longer for passenger air travel and demand for aircraft capacity to
return to such levels and then grow beyond such levels that
additional aircraft capacity is required, and uncertainties in our
industry may prevent us from accessing the equity or debt capital
markets on attractive terms or at all for a period of time, which
could have an adverse effect on our liquidity position. To the
extent that the Company is able to retain its aircraft on lease
with lessees during this recovery period, this oversupply in the
medium-term may not have a significant impact on the
Company’s financial circumstances, other than a potential
reduction in appraised values of the Company’s portfolio when
it receives its periodic appraisals. If, however, at the time that
the Company is required to repossess an aircraft upon termination
or expiration of its lease, demand for aircraft for lease or
purchase is still depressed, then the Company may experience
substantial difficulty in locating a new lessee or purchaser for
such aircraft.
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.
Impact of COVID-19 Pandemic.
The ongoing COVID-19 pandemic has had an overwhelming adverse
effect on the Company during the first six months of 2020, as it
has had on all forms of transportation globally, but most acutely
for the airline industry. The combined effect of fear of infection
during air travel, quarantines, and international and domestic
travel restrictions has caused a dramatic decrease in passenger
loads in all areas of the world, not just in those countries with
active clusters of COVID-19, as well as in airline ticket net
bookings (i.e., bookings made less bookings canceled) of
flights. This has led to significant cash flow issues for airlines,
including some of the Company’s customers, and some airlines
have been unable to timely meet their obligations under their lease
obligations with the Company. For example, the Company has
permitted one customer, which leases two regional jet aircraft, to
defer quarterly payment of March and June 2020 rent to September
2020, and the Company has permitted another customer to reduce the
amounts due in April, May and June 2020. In addition, the Company
and two other customers, each of which leases an aircraft subject
to a sales-type lease, are discussing remedies regarding
non-payment of a portion of the lease payments due during the first
and second quarters of 2020. Since the Company’s aircraft are
financed with debt, rent payments fund the Company’s
repayment of debt obligations, and any default under the leases by
lessees will generally lead to a default by the Company under its
loan obligations, and require the lender and the Company to agree
to a financial workout with respect to such debt obligations. The
Company has thus far been able to achieve such accommodations from
its lenders with respect to lessees that have been unable to remain
current in their obligations, but there is no assurance that if
such lessees do not return to compliance in the near term, or other
lessees who are now current in their obligations fall out of
compliance, that the Company will be able to obtain concessions or
a workout from its lenders with respect to the Company’s
obligations under its debt agreements. Any significant nonpayment
or late payment of lease payments by a significant lessee or
combination of lessees could in turn impose limits on the
Company’s ability to fund its ongoing operations as well as
cause the Company to be unable to meet its debt obligations, which
in turn could lead to an immediate acceleration of debt and
foreclosure upon the Company's assets. If this were to occur, we
may be prevented from accessing the equity or debt capital markets
on attractive terms or at all for a period of time, given the
volatility in securities and financial markets caused by the
COVID-19 pandemic. Furthermore, for the duration of the pandemic
and a period of financial recovery thereafter, sale transactions
are likely to be curtailed entirely or delayed while the industry
returns to financial stability, which could impact the
Company’s ability to implement any aspects of its
Recapitalization Plan that require disposition of its
assets.
Noncompliance with MUFG Indebtedness. The Company’s
primary acquisition financing had been the MUFG Credit Facility,
which was secured by a blanket lien on all assets of the Company,
including its ownership interests in the Nord Loan-financed
special-purpose
subsidiaries. The
Company converted the MUFG Credit Facility into a term loan on May
1, 2020.
The
Company is currently in default of its obligation to make a
deferred interest payment to the MUFG Lenders, which payment was to
be funded by sale of an aircraft, the closing for which has been
delayed. The existence of such default entitles the MUFG Lenders to
exercise remedies, including foreclosure on the collateral securing
the MUFG Loan, as there is not currently a forbearance agreement in
place with respect to such default. The MUFG Lenders have, to date,
chosen not to exercise remedies for such default, but there is no
assurance they will continue to do so in the future. If the Company
fails to comply with any other of the new MUFG Loan requirements
with respect to the MUFG Indebtedness in the timeframes required
under the MUFG Loan Agreement or otherwise acceptable to the MUFG
Lenders, the MUFG Lenders may then declare a
default and accelerate the indebtedness and foreclose upon the
Company’s assets. Such requirements include achievement of a
final milestone that requires consummation of a strategic
alternative satisfactory to the MUFG Lenders.
Nord Payment Default. As discussed in Overview and Liquidity
and Capital Resources, due to nonpayment of quarterly lease
payments due on March 17, 2020 by the lessee of two aircraft and
the corresponding Nord Loan payment default by the Company’s
special-purpose subsidiary borrowers, an event of default has
occurred under the Nord Loans for each of the LLC Borrowers.
The parent company is not in a financial position to cure
such default and is prohibited from doing so in any event under the
MUFG Indebtedness. The Company covered a portion of the defaulted
payment by collecting on the letters of credit that acted as
security deposits under the leases. The lessee has since
replaced the letters of credit and, with Nord’s consent,
entered into a workout agreement with the Company to defer
payment of the March rent until June 2020. The lessee did not
meet the terms of the workout agreement, but is in negotiations
with the Company regarding resolution of the arrearages by the
September quarterly rent payment date. The LLC Borrowers have
entered into an agreement with Nord to defer until September 24,
2020 (i) payment of the principal amount due under the respective
Nord Loans for the two aircraft due in March and June 2020 and (ii)
payment of past due interest at the default interest rate on the
March and June 2020 overdue payments. If the lessee
does not return to full compliance with its lease obligations by
making the overdue and current rent due in September 2020, which
would allow the Company to return to compliance with the Nord Loan
obligations, the Company may need to exercise repossession remedies
with its lessee, which would require the cooperation of Nord to
accommodate the Company under the Nord Loan, while the Company
attempts to remarket the repossessed aircraft or refinance the Nord
Loan. Failure to reach such an accommodation could lead to
repossession of all five aircraft owned by the Company’s
special-purpose subsidiaries, and may have a significant impact on
the Company’s financial circumstances, including the
Company’s ability to consummate a strategic alternative as
required under the MUFG Loan.
Availability of Financing. The Company converted the MUFG Credit
Facility into the MUFG Loan, and that debt facility is no longer
available to fund acquisition of aircraft assets. The
Company will need to find a new source of acquisition funding,
either through equity investment proceeds, a new revolving credit
facility, or new asset-specific financing, or a combination of any
of the three. Until the final Recapitalization Plan is executed the
Company will not have any means to acquire new aircraft assets.
There can be no assurance that the Company will be able to obtain
such additional capital when needed, in the amounts desired or on
favorable terms.
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, as
demand for air travel generally decreases during slow or no-growth
periods, and thus demand by airlines for aircraft capacity is also
decreased. As discussed above, the COVID-19 pandemic has caused
significant disruptions to the global supply chain, the stock
market and consumer and business-to-business commerce, the effects
of which may endure well beyond the current pandemic’s life
cycle and result in low or negative growth in future periods.
According to current reports, scheduled airline flights have been
significantly reduced. While lower demand for air travel may
actually lead to business opportunities as airlines turn to smaller
aircraft to right-size capacity, it also presents potential
challenges for the Company as it may impact the values of aircraft
in the Company’s portfolio, lower market rents for aircraft
that are being offered for lease by the Company, cause Company
customers to be unable to meet their lease obligations, or reduce
demand by airlines that would be potential customers for additional
or replacement regional aircraft offered by the
Company.
Because
the Company’s portfolio is not globally diversified and is
focused on North America and Europe, a localized downturn in one of
these two regions in which the Company leases assets could have a
significant adverse impact on the Company. Each of these regions
has seen a significant impact from the COVID-19 pandemic and may be
heading into recession due to both COVID-19 effects and normal
business cycles. The Company’s significant sources of
operating lease revenue by region are summarized in Fleet Summary – Assets Held for
Lease.
A
downturn in the Chinese domestic or export economy that reduces
demand for imported raw materials, such as an extended period of
economic slowdown associated with the COVID-19 pandemic, could have
a significant negative longer-term impact on the demand for
business and regional aircraft in developing countries, including
in some of the markets in which the Company seeks to do
business.
Furthermore,
instability arising from new U.S. sanctions or trade wars against
U.S. trading partners, and the global reaction 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 or pandemic 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.
Nord Loan Risks. The special-purpose subsidiaries that own
the five aircraft serving as collateral for the Nord Loans are the
named borrowers, and each Nord Loan is secured by the corresponding
aircraft owned by the applicable LLC Borrower. AeroCentury, as the
parent corporation of each LLC Borrower, is not a party to the Term
Loan agreements, but has entered into agreements with lessees of
the LLC Borrowers to guarantee certain obligations to such lessees
under each lessee’s lease agreement with an LLC Borrower and
with Nord to guarantee certain representations, warranties and
covenants delivered by the LLC Borrowers to the Nord 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 LLC Borrowers’ obligations under
the Term Loans and the related lease agreements pursuant to these
guaranty arrangements. Moreover, any noncompliance under the Term
Loans by any LLC Borrower could negatively affect the liquidity,
aircraft portfolio and reputation of the Company as a
whole.
The
required payments under each Nord Loan are expected to be funded by
the operating lease rental revenue received from the lessee of and
sales proceeds from the corresponding aircraft, and each LLC
Borrower’s continued compliance with its Nord Loan will
depend upon the lessee’s compliance with its lease payment
obligations. One of the lessees of two aircraft securing the Nord
Loans defaulted on its March and June 2020 quarterly lease payment
obligations, but the LLC Borrowers, with Nord’s consent, each
agreed to defer the unpaid lease payment obligations until
September 2020, and Nord agreed to
defer payment of its corresponding loan installments due in March
and June 2020 until the September quarterly payment date.
Failure by that lessee to return to compliance in September, or any
other payment default by the other lessee of aircraft securing the
Nord Loans to make timely payments could result in a default under
the applicable Nord Loan and could result in an acceleration of all
Nord Loan indebtedness of the applicable LLC Borrower or
foreclosure by Nord on all aircraft securing the Nord
Loan.
Nord Swap Hedging Dedesignation. In March 2020, the Company
determined that it was no longer probable that the interest
payments related to the Nord Loans would occur; consequently, the
swaps were dedesignated and no longer were eligible for hedge
accounting. As a result of dedesignation, future changes in market
value will be recognized in ordinary income and AOCI will be
reclassified to ordinary income as the forecasted transactions
occur. If a default on the underlying debt related to such swaps
were to occur, the counterparty to the swaps could terminate the
swaps and demand immediate payment of the termination value of such
swaps, which the Company or the related subsidiaries may not have
the funds to pay.
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, including the
European regional airline that ceased operations and declared
bankruptcy after the Company terminated its leases and repossessed
the four aircraft subject to the leases in the third quarter of
2019. 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.
Concentration of Lessees. For the quarter ended June 30,
2020, the Company’s two largest customers accounted for
approximately 33% and 24% of the Company’s monthly operating
lease revenue. A lease default by or collection problem with one or
a combination of any of the Company’s customers could have a
disproportionately negative impact on the Company’s financial
results, and, therefore, the Company’s operating results are
especially sensitive to any negative developments with respect to
these customers in terms of lease compliance.
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
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.
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 as recently as the fourth
quarter of 2019 and the first six months of 2020 and may be
required to record asset impairment charges in the future as a
result of the impact of COVID-19 on the aviation industry,
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. As a result of the termination of the
MUFG Swaps, the amount of interest paid by the Company under the
MUFG Indebtedness will fluctuate depending on prevailing interest
rates. Consequently, interest rate increases could materially
increase the Company’s interest payment obligations under its
MUFG Indebtedness and thus could have a material adverse effect on
the Company’s liquidity and financial condition. 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.
Concentration of Aircraft Type. Although 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, most of these types are used
extensively by regional airlines. 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.
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. This can 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.
Competitors
in the niche that have lower costs of capital than the Company
could gain have a significant advantage over the Company. Lower
capital costs allow competitors to offer lower lease rates to
carriers and/or the prices the competitor is able to pay for a
leased asset. Due to the Company’s recent defaults under its
MUFG Indebtedness, locating debt financing in line with the
Company’s historical cost of capital in the short term could
be difficult thereby exacerbating the competitive disadvantage of
the Company with respect to cost of capital, until the Company
re-establishes its financial stability following execution of its
Recapitalization Plan.
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.
International Risks. The Company leases some assets in
overseas markets. Leases with foreign lessees, however, may present
different risks than those with domestic lessees.
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.
Level of Portfolio Diversification. The Company intends to
continue to focus solely on regional aircraft. Assuming a
successful implementation of its Recapitalization Plan, 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 for the Nord
Loans of the LLC Borrower
subsidiaries. Beginning in 2008, concerns were expressed that some
of the member banks surveyed by the British Bankers’
Association 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 could affect the
Company’s indebtedness, 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,
if any of its
indebtedness remains based on LIBOR when LIBOR is no longer
published after 2021 and the
Company and its lenders are unable to agree on a mutually acceptable LIBOR
alternative for any outstanding
debt indexed to LIBOR,
the debt agreements could
be terminated and repayment of the
indebtedness could be accelerated to become immediately due and payable to the
lender. This outcome
could also lead to substantial
breakage fees being payable by the Company in addition to the
outstanding principal of such debt. If any of these risks
were to occur, the Company could experience material cash
shortfalls or be forced into bankruptcy or
liquidation.
Swap Counterparty Credit Risks. AeroCentury and its LLC Borrowers have entered into certain
interest rate swaps to hedge the interest rate risk
associated the Nord Loan indebtedness. These interest rate swap agreements
effectively convert the variable interest rate payments under the LLC Borrower Term Loan
indebtedness to fixed rate payments. 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 interest rate
swap agreement, in which case,
depending on interest rate conditions at the time of such default,
the Company could be unable to
meet its variable interest rate debt obligations and may
default under one or more loan
agreements. In such a case, the debt under the loan
agreement could be accelerated and become immediately due and
payable, 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. Any such outcome could have a material
adverse effect on the Company’s performance, liquidity and
ability to continue operations.
Swap Breakage Fees. To reduce
the amount of interest that accrues under its indebtedness, the
Company could choose to prepay certain amounts borrowed under such
loans. If the Company has hedged its variable interest
rate indebtedness, in addition to
prepayment fees that might be payable to the lender of
the underlying indebtedness, the
Company may also be obligated to pay certain swap breakage fees to
the interest rate swap counterparty in order to unwind the interest
rate swap related to the
indebtedness that is being prepaid. Thus, the
Company’s 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.
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 1.55 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.
Disclosure
under this item has been omitted pursuant to the rules of the SEC
that permit smaller reporting companies to omit such
information.
Item 4. Controls and
Procedures.
CEO and CFO Certifications. Attached as exhibits to this 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 Item 4 includes
information concerning the evaluation of disclosure controls and
procedures referred to in the Section 302 Certifications and 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 Exchange Act, such as this
report, is recorded, processed,
summarized and reported within the time periods specified in the
rules and forms of the SEC 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.
In the
course of the review of the consolidated financial results of the
Company for the three months and nine months ended September 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. A material
weakness is a deficiency, or combination of deficiencies, in
internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the
Company’s annual or interim financial statements will not be
prevented or detected on a timely basis. Although the Company
implemented controls over identifying the proper accounting
treatment for the JHC acquisition and those controls operated as of
December 31, 2018, the Company’s tax review control did not
identify a complex component of the acquisition accounting,
resulting in an adjustment to the Company’s tax expense in
2018. Management has determined that this deficiency continues to
constitute a material weakness as of June 30, 2020. 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 as of June 30, 2020. Based on this evaluation,
the CEO and CFO concluded that the Company’s Disclosure
Controls were not effective as of June 30, 2020 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, 2020 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.
PART II – OTHER
INFORMATION
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
Under
the Credit Facility agreement, the Company is not permitted to pay
dividends on any shares of its capital stock without the consent of
the MUFG Lenders.
Item
6. Exhibits.
|
Exhibit
Number
|
Description
|
|
10.1
|
|
|
10.2
|
|
|
10.3
|
Deferral Agreement (MSNs 19002 and 19003) dated
June 23, 2020 among ACY SN 19002 Limited, ACY SN 19003 Limited, and
ACY E-175 LLC, Norddeutsche Landesbank Girozentrale, as swap
counterparty (the “Swap Counterparty”), Norddeutsche
Landesbank Girozentrale, New York Branch, as agent and participant
and Wilmington Trust Company, as security trustee, incorporated by
reference to Exhibit 10.1 to the Company’s Report on Form 8-K
filed with the Securities Exchange Commission on June 26,
2020.
|
|
31.1
|
|
|
31.2
|
|
|
32.1*
|
|
|
32.2*
|
|
|
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.
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 14, 2020
|
By:
|
/s/ Harold M. Lyons
|
|
|
|
Name: Harold M. Lyons
|
|
|
|
Title: Senior Vice President-Finance and
|
|
|
|
Chief Financial Officer
|