Notes
to Consolidated Financial Statements
December
31, 2019
1. Organization and
Summary of Significant Accounting Policies
(a) The Company and Basis of
Presentation
AeroCentury
Corp. (“AeroCentury”) is a Delaware corporation
incorporated in 1997. AeroCentury together with its consolidated
subsidiaries is referred to as the
“Company.”
In
August 2016, AeroCentury formed two wholly-owned subsidiaries, ACY
19002 Limited (“ACY 19002”) and ACY 19003 Limited
(“ACY 19003”) for the purpose of acquiring aircraft
using a combination of cash and third-party financing (“UK
LLC SPE Financing” or “special-purpose
financing”) separate from AeroCentury’s credit facility
(the “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 Term Loans”) made to ACY 19002, ACY
19003, and two other newly formed special-purpose subsidiaries of
AeroCentury. See Note 6(b) for more information about the Nord Term
Loans.
On
October 1, 2018, AeroCentury acquired JetFleet Holding Corp.
(“JHC”) in a reverse triangular merger
(“Merger”) for consideration of approximately $2.9
million in cash and 129,217 shares of common stock of AeroCentury,
as determined pursuant to an Agreement and Plan of Merger (the
“Merger Agreement”) entered into by AeroCentury, JHC
and certain other parties in October 2017. JHC is the parent
company of JetFleet Management Corp. (“JMC”), which is
an integrated aircraft management, marketing and financing business
and the manager of the Company’s assets. Upon completion of
the Merger, JHC became a wholly-owned subsidiary of the Company,
and as a result, JHC's results are included in the Company's
consolidated financial statements beginning on October 1,
2018.
In
November 2018, AeroCentury formed two wholly-owned subsidiaries,
ACY SN 15129 LLC (“ACY 15129”) and ACY E-175 LLC
(“ACY E-175”), for the purpose of refinancing four of
the Company’s aircraft using the Nord Term Loans. Because the
Nord Term Loans did not close until February 2019, the subject
aircraft remained as collateral under the MUFG Credit Facility as
of December 31, 2018, and ACY 15129 and ACY E-175 had no activity
in 2018.
Financial
information for AeroCentury and its consolidated subsidiaries is
presented on a consolidated basis in accordance with accounting
principles generally accepted in the United States of America
(“GAAP”) based upon the continuation of the business as
a going concern. All intercompany balances and transactions have
been eliminated in consolidation.
(b) Going Concern
As discussed in
Note 6, the Company was in default under its MUFG Credit Facility
as of December 31, 2019. The MUFG Credit Facility lenders
(“Credit Facility Lenders”) have the right to exercise
any and all remedies for default under the MUFG Credit Facility
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
(including its obligation in connection with the termination of two
interest rate swaps entered into in connection with the MUFG Credit
Facility (the “MUFG Swaps”), 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. In addition, as
discussed in Note 15, the coronavirus pandemic has led to
significant cash flow issues for airlines, including some of the
Company’s customers, and some airlines may be 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 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 new defaults under
the Company’s 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 Company is
currently in negotiations with the Credit Facility Lenders to
convert the MUFG Credit Facility into a term loan facility (as
converted, the The Company is
currently in negotiations with the Credit Facility Lenders to
convert the MUFG Credit Facility into a term loan facility (as
converted, the “MUFG Term Loan” and, collectively with
the MUFG Credit Facility, “MUFG Indebtedness”). The
Company has engaged an investment banking advisor to assist in
obtaining additional debt or equity financing (the
“Recapitalization Plan”) which, if successful, would be
used to repay the MUFG Indebtedness. However, there is no
assurance that this will occur. This is further exacerbated
by the significance of the COVID-19 uncertainties discussed in Note
15.
The consolidated
financial statements presented in this Annual Report on Form 10-K
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) 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 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.
(d) Comprehensive Income/(Loss)
The Company
reflects changes in the fair value of its interest rate swap
derivatives that are designated as hedges in other comprehensive
income/(loss). Such amounts are reclassified into earnings in the
periods in which the hedged transaction occurs or when it is
probable that the hedged transactions will no longer occur, and are
included in interest expense.
(e) Cash, Cash Equivalents and Restricted
Cash
The Company
considers highly liquid investments readily convertible into known
amounts of cash, with original maturities of 90 days or less from
the date of acquisition, as cash equivalents.
The Company’s restricted cash is held in an account with the
agent for the Company’s MUFG Credit Facility and
disbursements from the account are subject to the control and
discretion of the agent for payment of principal on the MUFG Credit
Facility as well as for the Company’s operating
expenses.
(f) Securities
At December 31,
2018, the Company owned 121 shares of non-voting preferred stock in
a non-public company. The stock, which had a cumulative preferred
annual dividend of 10% and a liquidation value of $1,000 per share,
was sold during 2019.
(g) Lease Accounting, Favorable Lease Acquired and Lease Right
of Use Asset
In February 2016,
the Financial Accounting Standards Board ("FASB") issued Topic 842
- Leases in the Accounting
Standards Codification ("ASC"). Topic 842 substantially modifies
lessee accounting for leases, requiring that lessees recognize
lease assets and liabilities for leases extending beyond one year.
Leases will be classified as either finance or operating, with
classification affecting the pattern of expense recognition in the
income statement. The Company adopted Topic 842 on January 1, 2019,
electing to apply its provisions on the date of adoption and to
record the cumulative effect as an adjustment to retained earnings.
Lessor accounting under Topic 842 is similar to the prior
accounting standard and the Company has elected to apply practical
expedients under which the Company will not have to reevaluate
whether a contract is a lease, the classification of its existing
leases or its capitalized initial direct costs. In addition, the
Company, as lessor, has elected the practical expedient to combine
lease and non-lease components as one combined component for its
leased aircraft for purposes of determining whether that combined
component should be accounted for under Topic 606, which
establishes rules that affect the amount and timing of revenue
recognition for contracts with customers, or Topic
842.
The new standard
requires a lessor to classify leases as sales-type, finance, or
operating. A lease is treated as sales-type if it transfers all of
the risks and rewards, as well as control of the underlying asset,
to the lessee. If risks and rewards are conveyed without the
transfer of control, the lease is treated as a finance lease. If
the lessor does not convey risks and rewards or control, an
operating lease results. As a result of application of the
practical expedients, the Company was not required to alter the
classification or carrying value of its leased or finance lease
assets.
In connection with
the Company’s acquisition of JHC, as discussed in Note 10,
the Company recognized that the lease of its office facilities had
rents that were substantially below the market for such office
space. Consequently, the Company recorded $925,000 as the value of
below-market rents at the October 1, 2018 date of the JHC
acquisition, and amortized such amount on a level basis over the
remaining term of the office lease, including two one-year bargain
renewal options. The Company recorded $61,700 of amortization in
2018.
Lessee reporting
was changed by the new standard, requiring that the balance sheet
reflect a liability for most operating lease obligations as well as
a “right of use” asset. As such, in January 2019, the
Company was required to record a lease obligation of approximately
$610,000 in connection with the lease of its headquarters office,
and to increase the capitalized leasehold interest / right of use
asset by $610,000, as discussed in Note 8. There was no effect on
retained earnings recorded as a result of adoption of the standard.
The Company elected the lessee practical expedient to combine the
lease and non-lease components.
(h) Aircraft Capitalization and
Depreciation
The
Company’s interests in aircraft and aircraft engines are
recorded at cost, which includes acquisition costs. Since
inception, the Company has typically purchased only used aircraft
and aircraft engines. It is the Company’s policy to hold
aircraft for approximately twelve years unless market conditions
dictate otherwise. Therefore, depreciation of aircraft is initially
computed using the straight-line method over the anticipated
holding period to an estimated residual value based on appraisal.
For an aircraft engine held for lease as a spare, the Company
estimates the length of time that it will hold the aircraft engine
based upon estimated usage, repair costs and other factors, and
depreciates it to the appraised residual value over such period
using the straight-line method.
The
Company periodically reviews plans for lease or sale of its
aircraft and aircraft engines and changes, as appropriate, the
remaining expected holding period for such assets. Estimated
residual values are reviewed and adjusted periodically, based upon
updated estimates obtained from an independent appraiser. Decreases
in the fair value of aircraft could affect not only the current
value, discussed below, but also the estimated residual
value.
Assets that are
held for sale are not subject to depreciation and are separately
classified on the balance sheet. Such assets are carried at the
lower of their carrying value or estimated fair values, less costs
to sell.
(i) Property, Equipment
and Furnishings
The Company’s
interests in equipment are recorded at cost and depreciated using
the straight-line method over five years. The Company’s
leasehold improvements are recorded at cost and amortized using the
straight-line method
over the shorter of the lease term or the estimated useful lives of
the respective assets.
(j) Impairment of Long-lived Assets
The Company reviews
assets for impairment when there has been an event or a change in
circumstances indicating that the carrying amount of a long-lived
asset may not be recoverable. In addition, the Company routinely
reviews all long-lived assets for impairment semi-annually.
Recoverability of an asset is measured by comparison of its
carrying amount to the future estimated undiscounted cash flows
(without interest charges) that the asset is expected to generate.
Estimates are based on currently available market data and
independent appraisals and are subject to fluctuation from time to
time. If these estimated future cash flows are less than the
carrying value of an asset at the time of evaluation, any
impairment to be recognized is measured by the amount by which the
carrying amount of the asset exceeds its fair value. Fair
value is determined by reference to independent appraisals and
other factors considered relevant by management. Significant
management judgment is required in the forecasting of future
operating results that are used in the preparation of estimated
future undiscounted cash flows and, if different conditions prevail
in the future, material write-downs may occur.
As discussed in
Note 9, the Company recorded impairment losses totaling $31.0
million and $3.0 million in 2019 and 2018, respectively, as a
result of the Company’s determination that the carrying
values for certain aircraft were not recoverable.
The 2019 impairment
losses consisted of (i) $24.0 million resulting from appraised
values for four aircraft that are held for sale, assuming sale in a
reasonably short time (“Orderly Liquidation Value”) and
(ii) $7.0 million resulting from estimated or actual sales proceeds
for five assets held for sale, three of which were sold during
2019.
The 2018 impairment
losses consisted of (i) $2.7 million resulting from Orderly
Liquidation Values for four aircraft held for sale and (ii) $0.3
million resulting from writing a fifth aircraft down to its
appraised value.
(k) Deferred Financing Costs and Commitment Fees
Costs incurred in
connection with debt financing are deferred and amortized over the
term of the debt using the effective interest method or, in certain
instances where the differences are not material, using the
straight-line method. Costs incurred in connection with the MUFG
Credit Facility are deferred and amortized using the straight-line
method. Commitment fees for unused funds are expensed as
incurred.
(l) Security Deposits
The Company’s
leases are typically structured so that if any event of default
occurs under a lease, the Company may apply all or a portion of the
lessee’s security deposit to cure such default. If such
application of the security deposit is made, the lessee typically
is required to replenish and maintain the full amount of the
deposit during the remaining lease term. All of the security
deposits received by the Company are refundable to the lessee at
the end of the lease upon satisfaction of all lease
terms.
(m) 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. Management also assesses the
likelihood that the Company’s deferred tax assets will be
recovered from future taxable income, and, to the extent management
believes it is more likely than not that some portion or all of the
deferred tax assets will not be realized, the Company establishes a
valuation allowance. To the extent the Company establishes a
valuation allowance or changes the allowance in a period, the
Company reflects the corresponding increase or decrease within the
tax provision in the statement of operations. 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. After
considering the Company’s significant amounts of net deferred
tax liabilities which are future reversing taxable temporary
differences, the Company has determined that no valuation allowance
is required for its deferred tax assets.
The Company accrues
non-income based sales, use, value added and franchise taxes as
other tax expense in the statement of operations.
(n) Revenue Recognition, Accounts Receivable and Allowance for
Doubtful Accounts
Revenue from
leasing of aircraft assets pursuant to operating leases is
recognized on a straight-line basis over the terms of the
applicable lease agreements. Deferred payments are recorded as
accrued rent when the cash rent received is lower than the
straight-line revenue recognized. Such receivables decrease over
the term of the applicable leases. Interest income is recognized on
finance leases based on the interest rate implicit in the lease and
the outstanding balance of the lease receivable.
Maintenance
reserves retained by the Company at lease-end are recognized as
maintenance reserves revenue.
In instances where
collectability is not reasonably assured, the Company recognizes
revenue as cash payments are received. The Company estimates and
charges to income a provision for bad debts based on its experience
with each specific customer, the amount and length of payment
arrearages, and its analysis of the lessee’s overall
financial condition. If the financial condition of any of the
Company’s customers deteriorates, it could result in actual
losses exceeding any estimated allowances.
The Company had an
allowance for doubtful accounts of $2,908,600 and $0 at December
31, 2019 and 2018, respectively.
(o) Comprehensive Income
The Company
reflects changes in the fair value of its interest rate swap
derivatives that are designated as hedges in other comprehensive
income/(loss). Such amounts are reclassified into earnings in the
periods in which the hedged transaction occurs, and are included in
interest expense.
(p) Finance Leases
As of
December 31, 2019, the Company had three aircraft subject to
sales-type finance 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 has 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
finance leases, the Company recognized as a gain or loss the amount
equal to (i) the net investment in the sales-type finance lease
plus any initial direct costs and lease incentives less (ii) the
net book value of the subject aircraft at inception of the
applicable lease.
The Company
recognized interest earned on finance leases in the amount of
$852,600 and $1,251,000 in 2019 and 2018,
respectively. As a result of
payment delinquencies by two customers that lease three of the
Company’s aircraft subject to finance leases, the Company
recorded a bad debt allowance of $2,957,800 during
2019.
(q)
Maintenance Reserves and Accrued Maintenance Costs
Maintenance
costs under the Company’s triple net leases are generally the
responsibility of the lessees. Some of the Company’s leases
require payment of maintenance reserves, which are based upon
lessee-reported usage and billed monthly, and are intended to
accumulate and be applied by the Company toward reimbursement of
most or all of the cost of the lessees’ performance of
certain maintenance obligations under the leases. Such
reimbursements reduce the associated maintenance reserve
liability.
Maintenance
reserves are characterized as either refundable or non-refundable
depending on their disposition at lease-end. The Company retains
non-refundable maintenance reserves at lease-end, even if the
lessee has met all of its obligations under the lease, including
any return conditions applicable to the leased asset, while
refundable reserves are returned to the lessee under such
circumstances. Any reserves retained by the Company at lease-end
are recorded as revenue at that time.
Accrued
maintenance costs include (i) maintenance for work performed for
off-lease aircraft, which is not related to the release of
maintenance reserves received from lessees and which is expensed as
incurred, and (ii) lessor maintenance obligations assumed and
recognized as a liability upon acquisition of aircraft subject to a
lease with such provisions.
(r) Interest Rate Hedging
During the first
quarter of 2019, the Company entered into certain derivative
instruments to mitigate its exposure to variable interest rates
under the Term Loans debt and a portion of the MUFG Credit Facility
debt. Hedge accounting is applied to such a transaction only if
specific criteria have been met, the transaction is deemed to be
“highly effective” and the transaction has been
designated as a hedge at its inception. Under hedge accounting
treatment, generally, the effects of derivative transactions are
recorded in earnings for the period in which the hedge transaction
affects earnings. A change in value of a hedging instrument is
reported as a component of other comprehensive income/(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 7,
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 are no longer probable of occurring and, hence,
those swaps were dedesignated from hedge accounting at that time.
As discussed in Note 15, 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.
(s) Recent Accounting
Pronouncements
ASU 2016-13
The FASB issued ASU
2016-13, Financial Instruments
– Credit Losses (Topic 326), in June of 2016
(“ASU 2016-13”). ASU 2016-13 provides that financial
assets measured at amortized cost are to be presented as a net
amount, reflecting a reduction for a valuation allowance to present
the amount expected to be collected (the “current expected
credit loss” model of reporting). As such, expected credit
losses will be reflected in the carrying value of assets and losses
will be recognized before they become probable, as is required
under the Company’s present accounting practice. In the case
of assets held as available for sale, the amount of the valuation
allowance will be limited to an amount that reflects the marketable
value of the debt instrument. This amendment to GAAP is
effective 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 intraperiod 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, 2021. The Company is currently
evaluating the impact of the new guidance on its consolidated
financial statements and related disclosures.
2. Aircraft Lease
Assets
As discussed in
Note 1, the Company adopted Topic 842 on January 1, 2019, and
elected to use certain practical expedients that resulted in
continuing the classification of capitalized indirect cost
associated with its operating and finance leases. As such, there
was no adjustment to its accounts related to the carrying value of
its sales-type and finance leases, assets held for lease or
capitalized initial direct costs, and its leases continue to be
accounted for in the same manner as they had been before adoption
of the new accounting standard.
The Company’s
leases are normally “triple net leases” under which the
lessee is obligated to bear all costs, including tax, maintenance
and insurance, on the leased assets during the term of the lease.
In most cases, the lessee is obligated to provide a security
deposit or letter of credit to secure its performance obligations
under the lease, and in some cases, is required to pay maintenance
reserves based on utilization of the aircraft, which reserves are
available for qualified maintenance costs during the lease term and
may or may not be refundable at the end of the lease. Typically,
the leases also contain minimum return conditions, as well as an
economic adjustment payable by the lessee (and in some instances by
the lessor) for amounts by which the various aircraft or engine
components are worse or better than a targeted condition set forth
in the lease. Some leases contain renewal or purchase options,
although the Company’s sales-type and finance leases all
contain a bargain purchase option at lease end which the Company
expects the lessees to exercise 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 under Topic 842. Certain lessee
payments of what would otherwise be lessor costs (such as insurance
and property taxes) are excluded from both revenue and
expense.
The Company
evaluates the expected return on its leased assets by considering
both the rents receivable over the lease term, any expected
additional consideration at lease end, and the residual value of
the asset at the end of the lease. In some cases, the Company
depreciates the asset to the expected residual value because it
expects to sell the asset at lease end; in other cases, it may
expect to re-lease the asset to the same or another lessee and the
depreciation term and related residual value will differ from the
initial lease term and 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 at the end of their lease terms in the
fourth quarter of 2020 and totaling approximately $20 million.
Three additional aircraft are subject
to residual value guarantees, but the Company expects to retain the
aircraft after the date of such guarantees and re-lease them to the
current or other lessees. The Company considers the best
market for managing and/or selling its assets at the end of its
leases, although it does not expect to retain ownership of the
assets under finance leases given the lessees’ bargain
purchase options or required purchase.
(a) Assets Held for Lease
At December
31, 2019 and December 31, 2018,
the Company’s aircraft and aircraft engines held for lease
consisted of the following:
|
|
|
Type
|
|
|
|
|
Regional jet
aircraft
|
9
|
80%
|
13
|
81%
|
Turboprop
aircraft
|
2
|
20%
|
4
|
18%
|
Engines
|
-
|
-%
|
1
|
1%
|
The Company did not
purchase any aircraft held for lease during 2019. During the third
quarter, the Company terminated the leases for four of its aircraft
held for lease as a result of significant past due payments from
the customer and repossessed the aircraft. The customer
subsequently ceased operations and declared bankruptcy. The Company
applied the security deposits and a portion of collected
maintenance reserves it held to the past due rent due from the
customer and recorded $16,968,400 of maintenance reserves revenue
for the balance of the collected maintenance reserves. The Company
also recorded impairment losses totaling $28,424,000 for the four
aircraft based on appraised values for three of the aircraft and
expected sales proceeds for the fourth aircraft, and reclassified
the four aircraft to held for sale. As a result of the lease
terminations, the appraised values were based on the
maintenance-adjusted condition of the aircraft, rather than the
previous basis, which reflected future cash flows under the leases.
One of the aircraft was sold during the fourth quarter of
2019.
None of the
Company’s aircraft held for lease were off lease at
December 31, 2019. As discussed
below, the Company has seven off-lease aircraft that are held for
sale: (i) two turboprop aircraft that were reclassified to held for
sale in the third quarter of 2018, one of which is subject to a
short-term lease, (ii) three regional jet aircraft that were
reclassified to held for sale during 2019 and (iii) two turboprop
aircraft that are being sold in parts.
As of December 31, 2019, minimum future lease
revenue payments receivable under non-cancelable operating leases
were as follows:
Years ending
December 31
|
|
|
|
2020
|
$17,650,900
|
2021
|
10,392,000
|
2022
|
8,639,600
|
2023
|
8,639,600
|
2024
|
6,826,100
|
Thereafter
|
1,683,300
|
|
$53,831,500
|
The
remaining weighted average lease term of the Company’s assets
under operating leases was 41 months and 58 months at December 31,
2019 and December 31, 2018, respectively.
(b) Sales-Type and Finance Leases
As a result of a lease amendment containing a
purchase option for an older aircraft at lease end during
the second quarter of 2019, the Company reclassified an asset that was previously held for
lease to a sales-type finance lease receivable and recorded a loss
of $170,600. The aircraft was sold to the lessee at lease
expiration during the fourth quarter.
During 2019, the Company also amended the
sales-type leases for two aircraft to accommodate the
lessee’s request to transfer a portion of future lease
payment obligations from one of the leases to the other, as well as
to assign one of the leases and related aircraft to a different
lessee. Payments for both leases were also amended to reflect a
higher implicit interest rate, such that the fair value of the
leases after amendment equaled the carrying value of the leases
before the amendment. No gain or loss was recognized as a result of
these lease modifications. As a result of
payment delinquencies by these two customers, the Company recorded
a bad debt allowance of $2,907,800. As discussed in Note 15, the
leases for these two aircraft were further amended in January 2020
and a third aircraft leased to one of the lessees was sold to the
lessee.
At December 31, 2019 and December 31, 2018,
the net investment included in sales-type finance leases and direct
financing leases receivable were as follows:
|
|
|
Gross minimum lease
payments receivable
|
$9,096,400
|
$17,107,100
|
Less unearned
interest
|
(286,600)
|
(1,856,200)
|
Difference between
minimum lease payments receivable and collateral value of
leases
|
(7,700)
|
-
|
Finance leases
receivable
|
$8,802,100
|
$15,250,900
|
As of
December 31, 2019, minimum
future payments receivable under finance leases were as
follows:
Years ending
December 31
|
|
|
|
2020
|
$3,817,200
|
2021
|
2,608,200
|
2022
|
2,114,000
|
2023
|
557,000
|
|
$9,096,400
|
The
remaining weighted average lease term of the Company’s assets
under sales-type and finance leases was 20 months and 32 months at
December 31, 2019 and December 31, 2018, respectively.
As
discussed in Note 15, the customer for three of the Company’s
aircraft that are subject to direct financing leases purchased the
aircraft in March 2020.
The following is a
roll forward of the Company’s allowance for doubtful accounts
from December 31, 2018 to December 31, 2019:
Balance, December
31, 2018
|
$-
|
Additions charged
to expense
|
2,908,600
|
Balance, December
31, 2019
|
$2,908,600
|
3. Assets Held for
Sale
As discussed in
Note 2(a), during 2019, the Company reclassified four regional jet
aircraft that had been held for lease to held for sale after
repossession from a customer. One of the aircraft was sold during
2019.
Assets held for
sale at December 31, 2019
included three of the regional jet aircraft that were repossessed
and two turboprop aircraft, one of which is subject to a short-term
operating lease, and airframe parts from two turboprop aircraft.
During 2019, the Company recorded an impairment loss of $1,000,000 related to
the airframe parts from one of the aircraft, based on estimated
sales proceeds.
During 2019, the
Company received $820,800 in cash and accrued $117,400 in
receivables for parts sales. These amounts were accounted for as
follows: $133,100 reduced accounts receivable for parts sales
accrued in the fourth quarter of 2018; $731,700 reduced the
carrying value of the parts; and $73,400 was recorded as gains in
excess of the carrying value of the parts. During 2018, the Company
received $1,280,100 in cash and accrued $133,100 in receivables for
parts sales. These amounts were accounted for as follows: $779,700
reduced accounts receivable for parts sales accrued in 2017,
$543,200 reduced the carrying value of the parts, and $90,300 was
recorded as gains in excess of the carrying value of the
parts.
4. Operating Segments
The
Company operates in one business segment, the leasing of regional
aircraft to foreign and domestic regional airlines, and therefore
does not present separate segment information for lines of
business.
Approximately
30% and 28% of the Company’s operating lease revenue was
derived from lessees domiciled in the United States during 2019 and
2018, respectively. All revenues relating to aircraft leased and
operated internationally, with the exception of rent payable in
Euros for two of the Company’s aircraft, are denominated and
payable in U.S. dollars.
The tables below set forth geographic information
about the Company’s operating lease revenue and net book
value for leased aircraft and aircraft equipment, grouped by
domicile of the lessee:
|
For
the Years Ended December 31,
|
Operating
Lease Revenue
|
|
|
|
|
|
Europe and United
Kingdom
|
$15,174,900
|
$16,258,800
|
North
America
|
10,119,100
|
10,119,100
|
Asia
|
315,000
|
1,259,600
|
|
$25,609,000
|
$27,637,500
|
|
|
Net
Book Value of Aircraft and Aircraft Engines Held for
Lease
|
|
|
|
|
|
Europe and United
Kingdom
|
$44,569,000
|
$110,069,000
|
North
America
|
63,799,600
|
68,485,400
|
Asia
|
-
|
5,465,500
|
|
$108,368,600
|
$184,019,900
|
The table below sets forth geographic information
about the Company’s finance lease revenue, grouped by
domicile of the lessee:
|
For
the Years Ended December 31,
|
Finance
Lease Revenue
|
|
|
|
|
|
Africa
|
$487,000
|
$832,800
|
Europe and United
Kingdom
|
365,600
|
418,200
|
|
$852,600
|
$1,251,000
|
5. Concentration of Credit
Risk
Financial
instruments that potentially subject the Company to concentrations
of credit risk consist principally of cash deposits and
receivables. The Company places its deposits with financial
institutions and other creditworthy issuers and limits the amount
of credit exposure to any one party.
For the year ended
December 31, 2019, the Company had seven significant customers,
five of which individually accounted for 23%, 23%, 16%, 14% and
10%, respectively, of operating lease revenue and two of which
accounted for 57% and 38%, respectively, of finance lease revenue.
For the year ended December 31, 2018, the Company had five
significant customers, four of which individually accounted for
30%, 21%, 15% and 13%, respectively, of operating lease revenue and
one of which accounted for 67% of finance lease
revenue.
At
December 31, 2019, the Company had receivables from one customer
totaling $828,000 related to rents for 2019, representing 74% of
the Company’s total accounts receivable, all of which was for
accrued rent that is due in March 2020. At December 31, 2018, the
Company had receivables from three customers totaling $3,413,500,
representing 87% of the Company’s total accounts
receivable.
6. Notes Payable and Accrued
Interest
At
December 31, 2019 and December 31, 2018, the Company’s notes
payable and accrued interest consisted of the
following:
|
|
|
MUFG Credit
Facility:
|
|
|
Principal
|
$84,084,100
|
$122,400,000
|
Unamortized
debt issuance costs
|
(3,084,200)
|
(674,300)
|
Accrued
interest
|
376,200
|
139,300
|
Special-purpose
financing:
|
|
|
Principal:
|
|
|
UK
SPE Financing
|
-
|
9,211,200
|
Nord
Term Loans
|
30,914,500
|
-
|
Unamortized
debt issuance costs
|
(741,500)
|
-
|
Accrued
interest
|
89,300
|
16,000
|
|
$111,638,400
|
$131,092,200
|
(a) MUFG Credit Facility
The unused amount
of the MUFG Credit Facility was $915,900 and $47,600,000 as of
December 31, 2019 and December
31, 2018, respectively. The weighted average
interest rate on the MUFG Credit Facility was
10.23% and 5.92% at December 31, 2019 and
December
31, 2018
respectively.
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 contains financial covenants with which the
Company must comply, including, but not limited to, positive
earnings requirements, minimum net worth standards and certain
ratios, such as debt to equity ratios.
As of December 31,
2018, the Company was not in compliance with the interest coverage,
debt service coverage, no-net-loss and revenue concentration
covenants under the MUFG Credit Facility
agreement. The noncompliance resulted primarily from the Company
recording aircraft impairment charges and losses on sales of
aircraft totaling $3.4 million during 2018. The amendments included
in the MUFG
Credit Facility agreement in February 2019 discussed below cured
the December 31, 2018 noncompliance and revised the compliance
requirements through the extended maturity date of the 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 Term Loans)
with an aggregate principal of $44.3 million.
During the third
quarter of 2019 as a result of significant past due payments from
the customer, the Company terminated the leases for, and
repossessed, four of its aircraft held for lease The customer, a
European regional airline and one of the Company’s largest
customers based on operating lease revenue, subsequently ceased
operations and declared bankruptcy. The Company applied the
security deposits and a portion of collected maintenance reserves
it held against past due rent due from the customer. The remaining
balance of collected maintenance reserves equal to $17.0 million
was recognized as maintenance reserves revenue. The Company also
recorded impairment losses totaling $22.3 million for the four
aircraft, one of which was sold during the fourth quarter, based on
appraised values for three of the aircraft and expected sales
proceeds for the fourth. As a result of the lease terminations, the
three aircraft were newly appraised based on the
maintenance-adjusted condition of the aircraft, rather than the
basis previously used for their appraisal, which considered future
cash flows under the leases.
During the third
quarter of 2019, the Company also recorded impairment losses of
$15,000 on another of its aircraft held for sale and $1.0 million
related to airframe parts that are held for sale, both of which
were based on estimated
sales proceeds. As a result of
payment delinquencies by two other customers that lease three of the Company’s
aircraft subject to finance leases, the Company also recorded a bad
debt allowance of $2.9 million during 2019. As a result of the aforementioned
impairment losses and bad debt allowance, as of September 30, 2019,
the Company was in default of its borrowing base covenant under the
MUFG Credit Facility (the “Borrowing Base Default”),
due to the outstanding balance under the MUFG Credit Facility
exceeding the required minimum collateral value coverage set forth
in the MUFG Credit Facility (a “Borrowing Base
Deficit”) by approximately $9.4 million. Subsequent
updated appraisal values for assets included in the borrowing base
of the MUFG
Credit Facility resulted in an increase in the Borrowing Base
Deficit to $29.8 million at December 31, 2019. At that time, the
Company reclassified two aircraft that were repossessed during the
third quarter from held for lease to held for sale. The Company
also reduced its bad debt allowance during the fourth quarter based
on payments received in January.
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 and at
December 31, 2019.
On
October 15, 2019, the agent bank for the Credit Facility 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 Credit Facility 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 Credit
Facility 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 Credit Facility 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 Credit Facility Lenders
agreed not to further amend the Forbearance Agreement. On February 12, 2020, the agent bank
for the Credit Facility 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 Company is
currently in negotiations with the Credit Facility Lenders to
convert the MUFG Credit Facility into the MUFG Term Loan.
Therefore, the MUFG Credit Facility is expected to no longer be a
source of acquisition financing. The Company has engaged 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 Term
Loans
On February 8,
2019, the Company, through four wholly-owned subsidiary limited
liability companies (“LLC Borrowers”), entered into a
term loan agreement with the U.S. branch of a German bank
(“Term Loan Lender”) that provides for six separate
term loans with an aggregate principal amount of $44.3 million.
Each of the Nord Term Loans is secured by a first priority security
interest in a specific aircraft (“Term Loan Collateral
Aircraft”) owned by an LLC Borrower, the lease for such
aircraft, and a pledge by the Company of its membership interest in
each of the LLC Borrowers, pursuant to a Security Agreement (the
“Security Agreement”) among the LLC Borrowers and a
security trustee, and certain pledge agreements. Two of the Term
Loan Collateral Aircraft that are owned by the Company’s two
UK special-purpose entities were previously financed using
special-purpose financing. The interest rates payable under the
Nord Term Loans vary by aircraft, and are based on a fixed margin
above either 30-day or 3-month LIBOR. The proceeds of the Nord Term
Loans were used to pay down the MUFG Credit Facility and pay
off the UK LLC SPE Financing. The maturity of each Nord Term Loan
varies by aircraft, with the first Nord Term Loan maturing in
October 2020 and the last Nord Term Loan maturing in May 2025. The
debt under the Term Loans is expected to be fully amortized by
rental payments received by the LLC Borrowers from the lessees of
the Term Loan Collateral Aircraft during the terms of their
respective leases and remarketing proceeds.
The Nord Term Loans
include covenants that impose various restrictions and obligations
on the LLC Borrowers, including covenants that require the LLC
Borrowers to obtain the Term Loan Lender’s consent before
they can take certain specified actions, and certain events of
default. If an event of default occurs, subject to certain cure
periods for certain events of default, the Term Loan Lender would
have the right to terminate its obligations under the Term Loans,
declare all or any portion of the amounts then outstanding under
the Term Loans to be accelerated and due and payable, and/or
exercise any other rights or remedies it may have under applicable
law, including foreclosing on the assets that serve as security for
the Nord Term Loans. The Company was in compliance with all
covenants under the Nord Term Loans at December 31,
2019.
One of the aircraft
that was subject to Nord Term Loan financing was sold during the
fourth quarter of 2019 and the related interest rate swap was
terminated.
As discussed in
Note 15, in March 2020, one of the Company’s customers, which
leases two regional jet aircraft subject to Nord Term Loan
financing, did not make its quarterly rent payment which, in turn,
resulted in a loan payment default by the Company’s
special-purpose subsidiary that owns the aircraft. The Company is
currently discussing remedies with both the customer and
Nord.
7. Derivative
Instruments
The Company was not
party to any derivative instruments in 2018.
In the first
quarter of 2019, the Company entered into eight fixed pay/receive
variable interest rate swaps.
Six of the interest
rate swaps were entered into by the LLC Borrowers, one of which
terminated in the fourth quarter of 2019 in connection with the
sale of the related aircraft, and provided for reduced notional
amounts that mirror the amortization under the Nord Term Loans
entered into by the LLC Borrowers, effectively converting each of
the six Nord Term 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 Term Loan, with
maturities from 2020 through 2025.
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. The counterparty agreed under the
Forbearance Agreement and subsequent amendments to refrain from
exercising any termination or other remedies as a result of the
Company’s defaults under the MUFG Credit Facility during the
forbearance period under the Forbearance Agreement. In March 2020,
the Company was notified that the counterparties had terminated the
MUFG 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 Term 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.
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 discussed in Note 15, the MUFG Swaps
were terminated in the first quarter of 2020 and the amount of
accumulated other comprehensive income/(loss) related to such cash
flows will be recognized as an expense at such time in the first
quarter of 2020.
The
Company has reflected the following amounts in its net
loss:
|
For the Years
Ended December 31,
|
|
|
|
Change in value of
interest rate swaps
|
$255,200
|
$-
|
Other
items
|
147,400
|
-
|
Included in
interest expense
|
$402,600
|
$-
|
|
|
|
The following amount
was included in other comprehensive income/(loss), before
tax
|
|
|
|
Unrealized loss on
derivative instruments
|
$(1,932,100)
|
$-
|
Other
items
|
186,400
|
-
|
Change in value of
hedged interest rate swaps
|
$(1,745,700)
|
$-
|
Before the
termination of the MUFG Swaps discussed in Note 15, approximately
$575,000 of the current balance of accumulated other comprehensive
income/(loss) was expected to be reclassified in the next twelve
months, although certain additional amounts may be recognized in
the event the Company determines that some of the forecasted cash
flows that are intended to be hedged under the interest rate swaps
related to its MUFG Credit Facility are probable of not
occurring.
At December 31, 2019, the fair value of the
Company’s interest rate swaps was as follows:
Designated interest
rate hedges fair value
|
$(570,900)
|
Other interest rate
swaps
|
(1,253,600)
|
Total derivative
(liability)
|
$(1,824,500)
|
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.
8. Lease
Right of Use Asset and Liability
The Company is a
lessee under a lease of the office space it occupies in Burlingame,
California, which expires in June of 2020, but also provides for
two, successive one-year lease extension options for amounts that
are substantially below the market rent for the property. The lease
provides for monthly rental payments according to a fixed schedule
of increasing rent payments. As a result of the below-market
extension options, the Company determined that it was reasonably
certain that it would extend the lease and has, therefore, included
such extended term in its calculation of the right of use asset
(“ROU Asset”) and lease liability recognized in
connection with the lease.
In addition to a
fixed monthly payment schedule, the office lease also includes an
obligation for the Company to make future variable payments for
certain common areas and building operating and lessor costs, which
have been and will be recognized as expense in the periods in which
they are incurred. As a direct pass-through of applicable expense,
such costs have not been allocated as a component of the
lease.
The ROU Asset
includes the amortized value of both the amount of liability
recognized at January 1, 2019 upon adoption of Topic 842 and the
amount attributable to the below market lease component recognized
upon acquisition of JHC on October 1, 2018.
The lease liability
associated with the office lease was calculated by discounting the
fixed, minimum lease payments over the remaining lease term,
including the below-market extension periods, at a discount rate of
7.25%, which represents the Company’s estimate of the
incremental borrowing rate for a collateralized loan for the type
of underlying asset that was the subject of the office lease at the
time the lease liability was evaluated. The Company estimates that
the maturities of operating lease base rent of its office space
were as follows as of December
31, 2019:
|
|
2020
|
$145,000
|
2021
|
147,200
|
2022
|
74,700
|
|
366,900
|
Discount
|
(30,500)
|
Lease liability at
December 31, 2019
|
$336,400
|
At
December 31, 2018, the Company estimated that the future minimum
lease commitments for its office space, including both the base
rent and operating expenses, and storage facility were as
follows:
|
|
2019
|
$193,500
|
2020
|
196,400
|
2021
|
199,300
|
2022
|
101,100
|
|
$
690,300
|
Discount
|
|
Lease liability at
December 31, 2019
|
|
During the year
ended December 31, 2019, the
Company recognized amortization, finance costs and other expense
related to the office lease as follows:
Fixed rental
expense during the year
|
$443,500
|
Variable lease
expense
|
116,000
|
Total lease expense
during the year
|
$559,500
|
The Company expects
that the variable lease expense will total approximately $7,500 per
month through the end of the lease, including the two extension
periods.
9. 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 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 December 31, 2019
and December 31, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
Money
market funds
|
$400
|
$400
|
$-
|
$-
|
$656,400
|
$656,400
|
$-
|
$-
|
Derivatives
|
(1,824,500)
|
-
|
(1,824,500)
|
-
|
-
|
-
|
-
|
-
|
Total
|
$(1,824,100)
|
$400
|
$(1,824,500)
|
$-
|
$656,400
|
$656,400
|
$-
|
$-
|
There were no
transfers between Level 1 and Level 2 during 2019 or 2018, and
there were no transfers into or out of Level 3 during the same
periods.
Assets Measured and Recorded at Fair Value on a Nonrecurring
Basis
The Company determines fair value of long-lived
assets held and used, such as aircraft and aircraft engines held
for lease and these and other assets held for sale, by reference to
independent appraisals, quoted market prices (e.g., offers to
purchase) and other factors. These are considered Level 3 within
the fair value hierarchy. An impairment charge is recorded when the
Company believes that the carrying value of an asset will not be
recovered through future net cash flows and that the asset’s
carrying value exceeds its fair value. The Company recorded impairment charges totaling
$31,007,400 (of which $5,351,300 was related to assets sold in
2019) on nine of its assets held for sale in 2019, which had an
aggregate fair value of $25,880,700. The impairment charges were
comprised of (i) $7,031,300 based on estimated sales amounts and
(ii) $23,976,100 based on third-party appraisals. The Company
recorded impairment charges totaling $2,673,300 on four of its
aircraft held for sale in 2018, which had an aggregate fair value
of $9,900,000. The Company also recorded an impairment charge of
$298,200 on one of its aircraft held for lease in
2018.
As
discussed in Note 8, in December 2019, the Company adjusted its ROU
Asset valuation and lease liability balance to reflect a reduction
in lease space and rent effective January 1, 2020. The effects of
the adjustment were reductions of $119,100 to the ROU asset and
lease liability balance.
The following table
shows, by level within the fair value hierarchy, the
Company’s assets at fair value on a nonrecurring basis as of
December 31, 2019 and December
31, 2018:
|
Assets
Written Down to Fair Value
|
|
|
|
|
For the
Years Ended December 31,
|
|
|
|
|
|
|
|
1
|
2
|
3
|
|
1
|
2
|
3
|
2019
|
2018
|
Assets
held for sale
|
$25,880,700
|
$-
|
$-
|
$25,880,700
|
$5,800,000
|
$-
|
$-
|
$5,800,000
|
$25,656,100
|
$837,500
|
There were no
transfers between Level 1 and Level 2 in 2019, and there were no
transfers into or out of Level 3 during the same
periods.
Fair Value of Other Financial Instruments
The Company’s
financial instruments, other than cash and cash equivalents,
consist principally of finance leases receivable, amounts borrowed
under the MUFG Credit Facility, notes payable under special-purpose
financing and its derivative instruments. The fair value of
accounts receivable, accounts payable and the Company’s
maintenance reserves and accrued maintenance costs approximates the
carrying value of these financial instruments because of their
short-term maturity. The fair value of finance lease receivables
approximates the carrying value as discussed in Note 1(p). The fair value of the
Company’s derivative instruments is discussed in Note 7 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 bear floating rates of
interest that reset periodically to a market benchmark rate plus a
credit margin. The Company believes the effective interest rate
under the MUFG Credit Facility 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 $84,460,300 and $122,539,300 at December 31, 2019 and
December 31, 2018, respectively, approximate their fair values on
such dates. The fair value of the Company’s outstanding
balance of its MUFG Credit Facility is categorized as a Level 3
input under the GAAP fair value hierarchy.
Before their
repayment in February 2019 in connection with the Term Loans
refinancing, the amounts payable under the UK LLC SPE Financing
were payable through the fourth quarter of 2020 and bore a fixed
rate of interest. As 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
Term Loans. The Company believes the effective interest rate under
the special-purpose financings approximates current market rates
for such indebtedness at the dates of the consolidated balance
sheets, and therefore that the outstanding principal and accrued
interest of $31,003,800 and $9,227,200 approximate their fair
values at December 31, 2019 and December 31, 2018, respectively.
Such fair value is categorized as a Level 3 input under the GAAP
fair value hierarchy.
There were no
transfers in or out of assets or liabilities measured at fair value
under Level 3 during 2019 and 2018.
10. Acquisition
of Management Company
In October 2017,
AeroCentury, JHC and certain other parties entered into the Merger
Agreement for the acquisition of JHC by AeroCentury for
consideration of approximately $2.9 million in cash and 129,217
shares of common stock of AeroCentury, as determined pursuant to
the Merger Agreement. JHC is the sole shareholder of JMC, which is
the manager of the Company’s assets as described in Note 14
below. The Merger was consummated on
October 1, 2018.
As a subsidiary of
the Company, JHC’s results are included in the
Company’s consolidated financial statements beginning on
October 1, 2018. In April 2018, subsequent to the
execution of the Merger Agreement for the acquisition of JHC, which
was signed in October 2017, the Company, JHC and JMC entered into a
waiver and reimbursement agreement (the “Waiver/Reimbursement
Agreement”), pursuant to which JHC and JMC agreed to waive
their right to receive management and acquisition fees
(“Contract Fees”) otherwise owed by the Company to JMC
pursuant to the Management Agreement for all periods after March
31, 2018 and until the consummation of the Merger, and in return,
the Company agreed to reimburse JMC for expenses incurred in
providing management services set forth under the Management
Agreement. As a result of the Waiver/Reimbursement Agreement, the
Company became
responsible for all expenses incurred by JMC in managing the
Company as of April 1, 2018, including employee salaries, office
rent and all other general and administrative expenses. As a result
of the Merger, the Company assumed all of JHC’s assets,
comprised primarily of securities, prepaid expenses and an office
lease, as well as liabilities of approximately $0.9
million.
During the year
ended December 31, 2018, the Company accrued $485,000 of expenses
related to the Merger transaction. Such expenses are included in
professional fees, general and administrative and other in the
Company’s consolidated statements of operations.
During the fourth quarter of 2018,
the Company also recorded a settlement loss of $2,527,000 related
to the Merger. The settlement
loss amount was estimated using an income approach. The Company
assessed the contractual terms and conditions of the previous
management agreement between the company and JMC (the
“Management Agreement”) as compared to current market
conditions and the historical and expected financial performance of
the Company and JMC. Based on the analysis performed, the Company
determined that the contractual payment terms were above market
rates. The present value of the expected differential between
payments previously required by the Management Agreement and those
that would be required if the contract reflected current market
terms was calculated over the Management Agreement contractual
term. As the management fee previously paid by the Company was
deemed to be above market and the settlement of this pre-existing
relationship resulted in a loss, the loss was recognized in the
consolidated statement of operations at the acquisition date and
reduced the estimated purchase consideration
transferred.
The
Company did not recognize any goodwill on its acquisition of JHC
because the only customer relationship JHC had was through its
contract with the Company for management of the Company’s
assets and the Company cannot recognize goodwill attributable to
its relationship with itself.
The
following table shows the allocation of the purchase price paid by
the Company for its acquisition of JHC, the assets and liabilities
that were assumed as a result of the Merger and calculation of the
settlement loss.
Consideration paid in the merger:
|
|
Cash consideration
|
$ 2,915,000
|
ACY stock consideration
|
2,003,000
|
|
4,918,000
|
|
|
Fair value of assets acquired/(liabilities assumed):
|
|
Cash
|
40,000
|
Securities
|
121,000
|
Accounts & note receivable
|
28,000
|
Prepaid expenses
|
157,000
|
Property, equipment and furnishings
|
79,000
|
Office leasehold
|
925,000
|
Accounts payable
|
(85,000)
|
Accrued vacation
|
(93,000)
|
Taxes payable
|
(722,000)
|
Deferred taxes
|
(138,000)
|
|
312,000
|
|
|
Excess of consideration paid over net assets acquired
|
4,606,000
|
|
|
Waiver of JMC Margin payable
|
(1,517,000)
|
Settlement of payable to JMC
|
(562,000)
|
|
|
Settlement Loss on Management Agreement with JMC
|
$ 2,527,000
|
11. 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.
12. Income Taxes
The
items comprising the income tax provision are as
follows:
|
For the
Years Ended December 31,
|
|
|
|
Current
tax provision:
|
|
|
Federal
|
$(34,100)
|
$-
|
State
|
3,300
|
3,200
|
Foreign
|
418,300
|
414,000
|
Current
tax provision
|
387,500
|
417,200
|
Deferred
tax benefit:
|
|
|
Federal
|
(4,553,700)
|
(1,270,400)
|
State
|
(78,800)
|
(26,100)
|
Foreign
|
(262,800)
|
(93,500)
|
Deferred tax
benefit
|
(4,895,300)
|
(1,390,000)
|
Total
income tax benefit
|
$(4,507,800)
|
$(972,800)
|
Total
income tax benefit differs from the amount that would be provided
by applying the statutory federal income tax rate to pretax
earnings as illustrated below:
|
For the
Years Ended December 31,
|
|
|
|
|
|
|
Income
tax benefit at statutory federal income tax rate
|
$(4,444,900)
|
$(1,901,400)
|
State
tax benefit, net of federal benefit
|
(75,900)
|
(44,500)
|
Non-deductible
Merger expenses
|
-
|
647,200
|
Non-deductible
management and acquisition fees
|
7,600
|
325,900
|
Other
non-deductible expenses
|
5,400
|
-
|
Total
income tax benefit
|
$(4,507,800)
|
$(972,800)
|
Temporary
differences and carry-forwards that give rise to a significant
portion of deferred tax assets and liabilities as of December 31,
2019 and 2018 were as follows:
|
|
|
|
|
Deferred tax
assets:
|
|
|
Current and prior
year tax losses
|
$4,980,100
|
$4,065,100
|
Foreign tax
credit
|
758,400
|
611,900
|
Deferred interest
expense
|
269,800
|
81,800
|
Maintenance
reserves
|
470,000
|
3,100,800
|
Deferred derivative
losses
|
452,100
|
-
|
Deferred
maintenance, bad debt allowance and other
|
19,800
|
92,500
|
Alternative minimum
tax credit
|
11,400
|
45,500
|
Deferred
tax assets
|
6,961,600
|
7,997,600
|
Deferred tax
liabilities:
|
|
|
Accumulated
depreciation on aircraft and aircraft engines
|
(8,666,700)
|
(14,773,800)
|
Deferred
income
|
(175,600)
|
(320,600)
|
Leasehold
interest
|
(131,400)
|
(185,400)
|
Net deferred tax
liabilities
|
$(2,012,100)
|
$(7,282,200)
|
|
|
Reported
as:
|
|
|
Deferred
tax asset
|
$517,700
|
$254,900
|
Deferred
income taxes (liability)
|
(2,529,800)
|
(7,537,100)
|
Net
deferred tax liabilities
|
$(2,012,100)
|
$(7,282,200)
|
Consolidated
deferred federal income taxes arise from temporary differences
between the valuation of assets and liabilities as determined for
financial reporting purposes and federal income tax purposes and
are measured at enacted tax rates. The Company’s deferred tax
items are measured at an effective federal tax rate of 21% as of
December 31, 2019 and December 31, 2018. Although realization is
not assured, management believes it is more likely than not that
the entire deferred federal income tax asset will be realized. The
amount of the deferred federal income tax assets considered
realizable could be reduced in the near term if estimates of future
taxable income are reduced.
The Company is
required to include on its U.S. income tax return its global
intangible low-taxed income (“GILTI”) in excess of an
allowable return on its foreign subsidiaries’ tangible
assets. Per guidance issued by the FASB, companies can either
account for deferred taxes related to GILTI or treat tax arising
from GILTI as a period cost. Both are acceptable methods subject to
an accounting policy election. On December 31, 2018, the Company
finalized its policy and has elected to use the period cost method
for GILTI. In 2018 and 2019, the Company did not include any GILTI
from its Canadian subsidiary because all the subsidiary’s
income was exempt from GILTI.
In addition, interest deductions are
limited to 30% of the Company’s adjusted taxable
income. The Company’s adjusted taxable income is
computed without regard to any: (1) item of income, gain, deduction
or loss, which is not allocable to its trade or business; (2)
business interest income or expense; (3) net operating loss
deduction; and (4) depreciation, amortization or depletion for tax
years beginning before January 1, 2022, but taking into account
depreciation, amortization, and depletion thereafter. The amount of
interest deferred under this provision may be carried forward and
deducted in years with excess positive adjusted taxable income. The
Company had total disallowed interest expense for the years ended
December 31, 2019 and 2018, of $583,300 and $380,900, respectively.
The cumulative deferred interest expense of $964,200 may be carried
forward indefinitely until the Company has excess positive adjusted
taxable income against which it can deduct the deferred interest
balance.
The current year
federal operating loss carryovers of approximately $23.6 million
will be available to offset 80% of annual taxable income in future
years. Approximately $16 million of federal net operating loss
carryovers may be carried forward through 2037 and the remaining
$7.6 million federal net operating loss carryovers may be carried
forward indefinitely. The current year state operating loss
carryovers of approximately $385,300 will be available to offset
taxable income in the two preceding years and in future years
through 2039. The Company expects to utilize the net
operating loss carryovers remaining at December 31, 2019 in future
years.
During the year
ended December 31, 2019, the Company had pre-tax loss from domestic
sources of approximately $100,000 and pre-tax loss from foreign
sources of approximately $21.1 million. The Company had pre-tax
loss from domestic sources of approximately $6.0 million and
pre-tax loss from foreign sources of approximately $3.1 million for
the year ended December 31, 2018. The foreign tax credit carryover
will be available to offset federal tax expense in future years
through 2029.
The Tax Cuts and Jobs Act of 2017
repealed the corporate alternative minimum tax for tax years
beginning after 2017. In addition, beginning in 2018, the
Company’s alternative minimum tax credit (“MTC”)
was available to offset federal tax expense and is refundable in an
amount equal to 50% of the excess MTC for the tax year over the
amount of the credit allowable for the year against regular tax
liability. In 2021, any remaining MTC will be fully
refundable.
The Company and its
subsidiaries file income tax returns in the U.S. federal
jurisdiction and various state and foreign jurisdictions. With few
exceptions, the Company is no longer subject to U.S. federal, state
and local, or non-U.S. income tax examinations by tax authorities
for years before 2015. At December 31, 2019, the Company had a
balance of accrued tax, penalties and interest totaling $94,400
related to unrecognized tax benefits on its non-U.S. operations
included in the Company’s accounts and taxes payable. The
Company does not anticipate any significant changes to the
unrecognized tax benefits within twelve months of this reporting
date. A reconciliation of the beginning and ending amount of
unrecognized tax benefits is as follows:
|
|
|
|
|
Balance at January
1
|
$85,400
|
-
|
Additions for prior
years’ tax positions
|
9,000
|
85,400
|
Balance at December
31
|
$94,400
|
$85,400
|
The Company
accounts for interest related to uncertain tax positions as
interest expense, and for income tax penalties as tax
expense.
All of the
Company's tax years remain open to examination other than as barred
in the various jurisdictions by statutes of
limitation.
13. Computation of Loss Per Share
Basic
and diluted earnings per share are calculated as
follows:
|
For the Years
Ended
December
31,
|
|
|
|
Net
loss
|
$(16,658,500)
|
$(8,081,200)
|
Weighted average
shares outstanding for the period
|
1,545,884
|
1,449,261
|
Basic loss per
share
|
$(10.78)
|
$(5.58)
|
Diluted loss per
share
|
$(10.78)
|
$(5.58)
|
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 2019
or 2018.
14. Related Party Transactions
See the description
of the Merger Agreement between the Company and JHC in Note 10,
pursuant to which the Company acquired JHC in the Merger and JHC
became a wholly-owned subsidiary of the Company on October 1,
2018.
Before completion
of the Merger, the Company’s portfolio of aircraft assets was
managed and administered under the terms of a management agreement
with JMC (the “Management Agreement”). Certain officers
of the Company were also officers of JHC and JMC and held
significant ownership positions in both JHC and the Company, and
JHC was also a significant stockholder of AeroCentury. Under the
Management Agreement, JMC received a monthly management fee based
on the net asset value of the Company’s assets under
management. JMC also received an acquisition fee for locating
assets for the Company. Acquisition fees were included in the cost
basis of the asset purchased. JMC also received a remarketing fee
in connection with the re-lease or sale of the Company’s
assets. Remarketing fees were amortized over the applicable lease
term or included in the gain or loss on sale.
In April 2018,
subsequent to the execution of the Merger Agreement for the
acquisition of JHC, JHC agreed to waive its right to receive
management and acquisition fees (“Contract Fees”)
otherwise owed by the Company to JHC pursuant to the Management
Agreement for all periods after March 31, 2018 and until the
earlier of the consummation of the Merger or August 15, 2018. In
return, the Company agreed to reimburse JMC for expenses
(“Management Expense”) incurred in providing management
services set forth under the Management Agreement. In July 2018,
JHC agreed to extend the expiration of this agreement (the
“Waiver and Reimbursement Agreement”) through October
15, 2018. Thus, if the Merger Agreement was terminated on or before
October 15, 2018 or the Merger did not close by October 15, 2018,
the Company would have become obligated to pay JMC any excess (the “JMC
Margin”) of (i) the Contract Fees that would have been paid
to JMC since April 1, 2018 in the absence of the Waiver and
Reimbursement Agreement over (ii) the Management Expenses actually
paid by the Company to JMC since April 1, 2018. For the nine
months ended September
30, 2018, Contract Fees exceeded the reimbursed Management
Expense by $1,023,000 of management fees and $494,000 of
acquisition fees. Notwithstanding the Waiver and Reimbursement
Agreement, until the closing or termination of the Merger
Agreement, the Company accrued as an expense the total Contract
Fees that would have been due under the Management Agreement.
Because the Merger closed on October 1, 2018, the Waiver and
Reimbursement Agreement for the period from April 1, 2018 through
September 30, 2018 was considered in the acquisition accounting for
the calculation of the settlement loss recognized by the Company
when the Merger was consummated.
The Company
incurred management fees and acquisition fees of $4,482,800 and
$494,400, respectively, during 2018.
15. Subsequent Events
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, in
2020 the Company will recognize 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 will recognize
amortization of $308,100, $317,600 and $162,600 in 2020, 2021 and
the first half of 2022, respectively.
In January 2020,
the Company amended the leases for three of its assets that are
subject to sales-type finance leases. The amendments provided for
(i) the sale of one aircraft to the customer in January 2020, (ii)
application of collected maintenance reserves and a security
deposit held by the Company to past due amounts for the other two
aircraft, (iii) required payments totaling $585,000 in January for
two of the leases and (iv) reduced the amount of future payments
due under the two leases.
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.
In March 2019, the
Company entered into two interest rate derivative instruments in
connection with the MUFG Credit Facility. In March 2020, the
counterparties to the MUFG Swaps terminated the MUFG Swaps and the
Company became obligated to pay $3.1 million to the
counterparties.
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, and some airlines
may be 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 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 new defaults under the Company’s debt obligations,
which in turn could lead to an immediate acceleration of debt and
foreclosure upon the Company’s assets. 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 its Recapitalization Plan. No impairments were
recorded as of the balance sheet date as no triggering events or
changes in circumstances had occurred as of year-end; however, due
to significant uncertainty surrounding the situation, management's
judgment regarding this could change in the future. In addition,
while the Company’s results of operations, cash flows and
financial condition could be negatively impacted, the extent of the
impact cannot be reasonably estimated at this time.
However, as a
result of the COVID-19 Outbreak, in March 2020, one of the
Company’s customers, which leases two regional jet aircraft
subject to Nord Term Loan financing, did not make its quarterly
rent payment of approximately $1.4 million. The nonpayment led to a
corresponding Nord Term Loan financing payment event of default
under the Nord Term Loans for each of those subsidiaries. The
Company is currently reviewing its options for remedies against the
lessee. It has also entered into negotiations with Nord regarding a
workout for the corresponding overdue Nord Term Loan payments.
As a result of the non-payment on the two regional jets by the
Company’s customer and potential consequent uncertainty
concerning future interest payments under the related Nord Term
Loans, as well as potential uncertainty related to rent payments
and related debt payments on the other three Nord Term Loans, the
Company is reevaluating its hedge accounting for the five interest
rate derivatives associated with those loans.