Notes to Consolidated Financial Statements
December 31, 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(c) 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”) based upon the continuation of the
business as a going concern. All intercompany balances and
transactions have been eliminated in consolidation.
(b) Going Concern
At December 31, 2020, the Company had total book assets of
approximately $93.4 million and total liabilities of $111.0
million, resulting in a negative book equity of $17.6 million. The
largest portion, $92.4 million, of the Company’s debt is owed
to Drake Asset Management Jersey Limited (“Drake”) and
was payable with accrued interest on March 31, 2021.
The
Company did not have the resources to meet its obligations to repay
the Drake debt when due on March 31, 2021, which is a principal
reason for its decision to file for protection under Chapter 11 of
the bankruptcy code, as discussed in Note 1(e). It has also
recognized that it requires additional funding to continue its
operations, and that it has not identified a source for such
funding to date. Although management plans include securing
additional funding, it cannot conclude that it is probable that
such plan will be achieved and mitigate the conditions that led to
substantial doubt about the Company’s ability to continue as
a going concern. The Company has suffered recurring losses from
operations, is in default of its debt obligations under the credit
facility, and has a net capital deficiency. The Company’s poor financial
position, including its poor short-term liquidity given the
impending maturity of the Drake debt, the amount of liability under
the Drake debt in relation to the fair value of the Company’s
assets and the uncertainty of generating sufficient funds over the
year after publication of its financial statements to continue
operations have led the Company to conclude that there is
substantial doubt about its ability to continue as a going
concern.
The accompanying audited consolidated financial statements have
been prepared assuming that the Company will continue as a going
concern and contemplate the realization of assets and the
satisfaction of liabilities in the normal course of business. The
Company’s ability to continue as a going concern is
contingent upon its ability to successfully implement a plan of
reorganization, among other factors, and the realization of assets
and the satisfaction of liabilities are subject to
uncertainty. Further, any plan of reorganization could materially
change the amounts of assets and liabilities reported in the
accompanying consolidated financial statements. 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 or as a
consequence of its Chapter 11 filing.
(c) Impact of COVID-19
In
March 2020, the World Health Organization (“WHO”)
declared the novel strain of coronavirus (“COVID-19”) a
pandemic, and COVID-19 has continued to have wide-ranging impacts
as the virus spreads globally (the “COVID-19
Pandemic”). The ongoing COVID-19 Pandemic 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. As discussed in Note 6(c), one of the
customers paid the deferred rent in September 2020 and purchased
the aircraft in October 2020. The Company permitted the second
customer, which leases two regional turboprop aircraft, to make
reduced payments totaling approximately $0.3 million in April, May,
June, November and December 2020 and the customer paid the reduced
amounts. As discussed in Notes 2 and 3, the Company recorded
impairments totaling $28.8 million during 2020.
In
addition, two other customers, each of which leases an aircraft
subject to a sales-type lease, did not make lease payments totaling
approximately $1.0 million, and the Company and the customers are
discussing remedies regarding the non-payment. As discussed in Note
2, the Company recorded bad debt allowances totaling $1,503,000
related to the two sales-type finance leases during
2020.
The
impact of the COVID-19 Pandemic has also led the Company to
determine that there is uncertainty related to rent, interest and
debt payments such that, as disclosed in Notes 6 and 7, the Company
de-designated its interest rate swaps as hedges in March 2020 since
the payments related to the swaps were deemed not probable to
occur. Additionally, in December 2020, the Company determined that
it was probable that certain future cash flows under its interest
rate swaps would not occur, and the Company consequently
reclassified accumulated other comprehensive income
(“AOCI”) associated with such cash flows into interest
expense.
(d) Company Indebtedness
As
discussed in Note 6, the Company was in default under its MUFG
Credit Facility as of December 31, 2019. 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 included 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 default, but the Company was in
default under the MUFG Loan Agreement due to non-payment of
interest due on July 1, 2020, August 3, 2020, September 1, 2020 and
October 1, 2020. As discussed in Notes 6 and 7, the Company was
also obligated to pay $3.1 million related to the termination of
the MUFG Swaps in March 2020. On October 30, 2020, the MUFG Lenders
sold the MUFG Loan and the obligation of the Company from
termination of the MUFG Swaps to Drake Asset Management Jersey
Limited (“Drake”), and the Company and Drake entered
into an amendment of the loan (as amended, the “Drake Loan
Agreement”) under which, among other things, the cash
component of interest due for March 2020 and thereafter for the
term of the loan will be capitalized and the requirement for
execution of a Strategic Alternative and related milestones was
deleted.
Drake
has the right to exercise any and all remedies for default under
the Drake Loan Agreement, which had a maturity date of March 31,
2021. 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 Drake Loan Agreement (the “Drake Loan”) and the
indebtedness for the terminated swaps (together, the “Drake
Indebtedness”), which consist of substantially 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 6, the Company also defaulted on payment under
two of the Nord Loans, but that default has since been remedied and
those Nord Loans were repaid in full.
(e) Voluntary Petitions for Bankruptcy
As
discussed in Note 12(c), in connection with the impending maturity
of the Drake Indebtedness and the continuing economic impact from
COVID-19, on March 29, 2021 (the "Petition Date"), the Company and
certain of its subsidiaries in the U.S. (collectively the "Debtors"
and the "Debtors- in-Possession") filed voluntary petitions for
relief (collectively, the "Petitions") under Chapter 11 of Title 11
("Chapter 11") of the U.S. Bankruptcy Code (the "Bankruptcy Code")
in the U.S. Bankruptcy Court for the District of Delaware (the
"Bankruptcy Court"). The Chapter 11 cases (the "Chapter 11 Case")
are being jointly administered under the caption In re: AeroCentury Corp., et al., Case No.
21-10636.
The
Bankruptcy Court has approved motions filed by the Debtors that
were designed primarily to mitigate the impact of the Chapter 11
Case on the Company’s operations, customers and employees.
The Debtors are authorized to conduct their business activities in
the ordinary course, and pursuant to orders entered by the
Bankruptcy Court, the Debtors are authorized to, among other things
and subject to the terms and conditions of such orders: (i) pay
employees’ wages and related obligations; (ii) pay certain
taxes; (iii) continue to maintain certain customer programs; (iv)
maintain their insurance program; (v) use cash collateral on an
interim basis; and (vi) continue their cash management
system.
(f) Debtors-In-Possession
The Debtors are currently operating as debtors-in-possession under
the jurisdiction of the Bankruptcy Court and in accordance with the
applicable provisions of the Bankruptcy Code and orders of the
Bankruptcy Court. In general, as debtors-in-possession under the
Bankruptcy Code, the Debtors are authorized to continue to operate
as an ongoing business but may not engage in transactions outside
the ordinary course of business without the prior approval of the
Bankruptcy Court.
(g) Automatic Stay
Subject to certain specific exceptions under the Bankruptcy Code,
the Petitions automatically stayed most judicial or administrative
actions against the Debtors and efforts by creditors to collect on
or otherwise exercise rights or remedies with respect to
obligations of the Debtors incurred prior to the Petition Date
("Pre-petition"). Absent an order from the Bankruptcy Court,
substantially all of the Debtors’ Pre-petition liabilities
are subject to settlement under the Bankruptcy
Code.
(h) Borrowing Capacity and
Availability
At December 31, 2020, the Company had no borrowing capacity or
availability under the Drake Loan Agreement. The filing of the
Chapter 11 Case constituted a default, termination events and/or
amortization event with respect to the Drake Indebtedness. As
discussed in Note 12, in March 2021, the Company sold its ownership
interest in ACY E-175 and the buyer assumed ACY E-175’s
indebtedness to Nord.
(i) 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.
(j) 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.
(k) 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 at December 31, 2020 was held
for sale and was held in an account with the agent for the
Company’s Nord Loans and disbursements from the account are
subject to the control and discretion of the agent for payment of
principal on the Nord Loans.
(l) 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.
ASC 842
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 on the adoption date.
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.
(m) 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.
(n) 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.
(o) 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 $28.8 million and $31.0 million in 2020 and 2019,
respectively, as a result of the Company’s determination that
the carrying values for certain aircraft were not
recoverable.
The 2020 impairment losses consisted of (i) $14.6 million for seven
of its aircraft held for lease, comprised of $7.0 million for two
aircraft that were written down to their sales prices, less cost of
sale, and $7.6 million for five aircraft that were written down
based on third-party appraisals, (ii) $11.3 million for a turboprop
aircraft and three regional jet aircraft that are held for sale and
that were written down based on third-party appraisals and (iii)
$2.8 million for three regional jet aircraft and two turboprop
aircraft that are being sold in parts based on their estimated
sales prices, less cost of sale, provided by the part-out
vendors.
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 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 and one of
which was sold in 2020.
(p) Deferred Financing Costs and Commitment Fees
Costs
incurred in connection with debt financing are deferred and
amortized over the term of the debt. Costs incurred in connection
with the MUFG Credit Facility were deferred and amortized using the
straight-line method until the MUFG Credit Facility debt converted
to a term loan in May 2020, after which costs are amortized using
the effective interest method. Costs incurred in connection with
the Nord Loans are amortized using the effective interest method.
Commitment fees for unused funds under the MUFG Credit Facility
were expensed as incurred.
(q) 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.
(r) 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 three-year cumulative loss through December 31,
2020, the impacts of 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 Drake 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 $7,493,800
for the year ended December 31, 2020, including some of its foreign
deferred tax assets that are not expected to be realized based on
limitations on the utilization of its foreign net operating losses
of $718,000 for the year ended December 31, 2020.
The
Company accrues non-income based sales, use, value added and
franchise taxes as other tax expense in the consolidated statement
of operations.
(s) 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 $1,503,000 and
$2,908,600 at December 31, 2020 and 2019,
respectively.
(t) Finance Leases
As of
December 31, 2019, the Company had three sales-type leases and
three direct financing leases secured by aircraft. 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
2020, the customer under one of the Company’s sales-type
leases exercised a purchase option for $215,000, resulting in a
gain of $12,700. Another customer exercised purchase options
totaling $3,536,500 under the Company’s three direct finance
leases. A total of $2,734,600, representing security deposits and
maintenance reserves paid by the customer during the lease terms
was applied to the amounts due under the purchase options. Losses
totaling $60,600 were recorded at the time the purchase options
were exercised.
The
Company’s remaining two sales-type leases were substantially
modified to reduce the amount of monthly payments and purchase
option amounts due under the leases. Although the modifications
would ordinarily have given rise to income or loss resulting from
the changed term of the agreements, the lessee’s poor
compliance with the lease terms has led the Company to value the
sales-type leases at the fair value of the collateral and, as such,
the modifications did not give rise to any effect on income other
than that related to the collateral value of the financed aircraft.
As a result of payment delinquencies by the two customers, the
Company recorded a bad debt allowance of $1,503,000 during 2020.
The two leases remain treated as sales-type leases.
(u) 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.
(v) 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 “de-designated.” After
de-designation, 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 de-designation 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 were no longer probable of occurring
and, hence, those swaps were de-designated 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
was due no later than the March 31, 2021 maturity of the Drake
Loan. As a result of the forecasted transaction being not probable
to occur, accumulated other comprehensive loss of $1,421,800
related to the MUFG Swaps was recognized as interest expense in
2020.
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
de-designated all five swaps from hedge accounting. Additionally,
in December 2020, the Company determined that the interest cash
flows that were associated with its three remaining swaps were
probable of not occurring after February 2021, and consequently
reclassified $600,400 of accumulated other comprehensive income
into interest expense.
(w) 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), 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 does not expect that adoption of ASU 2019-12 will
have a material impact on its consolidated financial
statements.
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 and to either
recognize income during the deferral period or to treat deferred
rent as variable rent during the period. 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. The Company has elected to treat certain lease
concessions to lessees as if they arose from rights initially in
the lease contracts and so did not give rise to modifications of
the leases, and to treat deferrals as variable rent during the
period of the deferral, reducing income during such
period.
(x) Reclassifications
Certain prior period amounts have been reclassified to conform with
the current period presentation. These reclassifications had no
impact on previously reported net income or cash
flows.
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.
Three
of the Company’s operating lease assets are subject to manufacturer residual value
guarantees totaling approximately $13.7 million at the end of their
lease terms in the second quarter of 2027. 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 2020, the Company recorded impairment losses totaling
$14,639,900 for seven of its aircraft held for lease, comprised of
(i) $7,006,600 for two aircraft that were written down to their
sales prices, less cost of sale and (ii) $7,633,300 for five
aircraft that were written down based on third-party
appraisals.
(a) Assets Held for Lease
At
December 31, 2020 and December
31, 2019, the Company’s aircraft held for lease consisted of
the following:
|
|
|
Type
|
|
|
|
|
Regional jet
aircraft
|
4
|
67%
|
9
|
80%
|
Turboprop
aircraft
|
2
|
33%
|
2
|
20%
|
The
Company did not purchase any aircraft held for lease during 2020
and sold two aircraft that had been held for lease, resulting in a
gain of $118,500.
None of
the Company’s aircraft held for lease were off lease at
December 31, 2020. As discussed
below, the Company has nine aircraft that are held for sale: (i)
three regional jet aircraft that are on lease and were sold in
March 2021; (ii) three off-lease regional jet aircraft; (iii) one
off-lease turboprop aircraft and (iv) two turboprop aircraft that
are being sold in parts.
As of
December 31, 2020, minimum future lease revenue
payments receivable under non-cancelable operating leases were as
follows:
Years ending
December 31
|
|
|
|
2021
|
$14,262,600
|
2022
|
12,510,200
|
2023
|
12,510,200
|
2024
|
10,850,300
|
2025
|
4,696,600
|
Thereafter
|
2,160,000
|
|
$56,989,900
|
The remaining weighted average lease term of the Company’s
assets under operating leases was 29 months and 41 months at
December 31, 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 with two customers.
The amendments provided for (i) the exercise of a purchase option
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 2020 for two of the leases and (iv) the
reduction of future payments due under the two finance leases.
Because of the uncertainty of
collection of amounts receivable under the finance leases, the
Company does not recognize interest income on the finance lease
receivables (i.e., they are accounted for on a non-accrual basis)
and their asset value is based on the collateral value of the
aircraft that secure the finance leases, net of projected sales
costs. The Company recorded bad debt allowances totaling $1,503,000
related to the two sales-type leases during
2020.
In
January 2020, the customer 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 customer 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 purchase options were
exercised in March 2020, resulting in a loss of
$60,600.
At
December 31, 2020 and December
31, 2019, the net investment included in sales-type leases and
direct financing leases receivable were as follows:
|
|
|
Gross minimum lease
payments receivable
|
$4,138,000
|
$12,772,300
|
Less unearned
interest
|
(88,000)
|
(1,053,900)
|
Allowance for
doubtful accounts
|
(1,503,000)
|
(2,908,600)
|
Difference between
minimum lease payments receivable and collateral value of
leases
|
-
|
(7,700)
|
Finance leases
receivable
|
$2,547,000
|
$8,802,100
|
As of
December 31, 2020, minimum
future payments receivable under finance leases were as
follows:
Years ending
December 31
|
|
|
|
2021
|
$2,297,000
|
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 25 months and 20
months at December 31, 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 December 31,
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
|
1,503,000
|
Balance,
December 31, 2020
|
$1,503,000
|
3. Assets and Liabilities Held for
Sale
Assets
held for sale at December 31,
2020 included (i) three regional jet aircraft owned by ACY E-175
LLC, (ii) three off-lease regional jet aircraft, (iii) one
off-lease turboprop aircraft and (iv) airframe parts from two
turboprop aircraft.
(a) ACY E-175 LLC
As discussed in Note 12(a), in March 2021, the Company sold
its 100% percent membership interest in ACY E-175 LLC, which owned
three Embraer E-175 aircraft on lease to a U.S. regional airline.
At December 31, 2020, the Company classified the assets and
liabilities of ACY E-175 LLC as held for sale and recorded an
impairment loss of $2,649,800. The table below sets for the assets
and liabilities that were classified as held for sale at December
31, 2020:
Cash and cash
equivalents
|
$345,900
|
Restricted
cash
|
2,346,300
|
Aircraft
|
24,550,000
|
Notes payable and
accrued interest, net of unamortized debt issuance costs of
$313,400
|
13,836,900
|
Derivative
liability
|
767,900
|
The
pre-tax loss of ACY E-175 LLC for the year ended December 31, 2020
was $1,976,200.
(b) Off-lease aircraft
During 2020, the Company recorded impairment losses of $11,337,200
for an off-lease turboprop aircraft and three off-lease regional
jet aircraft that are held for sale and that were written down
based on third-party appraisals and $124,900 for a turboprop
aircraft that is being sold in parts based on estimated sales
proceeds, less cost of sale, provided by the part-out
vendors.
(c) Part-out Assets
The Company owns two aircraft being sold in parts (“Part-out
Assets”). During
2020, the Company received $391,800 in cash and accrued $34,400 in
receivables related to the Part-out Assets. These amounts were
accounted for as follows: $117,400 reduced accounts receivable for
parts sales accrued in the fourth quarter of 2019; $239,900 reduced
the carrying value of the parts; and $68,900 was recorded as gains
in excess of the carrying value of the parts. 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.
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 50% and 30% of the Company’s operating lease
revenue was derived from lessees domiciled in the United States
during 2020 and 2019, 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
|
|
|
|
|
|
North
America
|
$10,119,100
|
$10,119,100
|
Europe
|
5,349,000
|
15,174,900
|
Asia
|
-
|
315,000
|
|
$15,468,100
|
$25,609,000
|
|
|
Net
Book Value of Aircraft and Aircraft Engines Held for
Lease
|
|
|
|
|
|
North
America
|
$30,433,100
|
$63,799,600
|
Europe and United
Kingdom
|
15,330,000
|
44,569,000
|
|
$45,763,100
|
$108,368,600
|
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
|
|
|
|
|
|
Europe and United
Kingdom
|
$56,200
|
$365,600
|
Africa
|
-
|
487,000
|
|
$56,200
|
$852,600
|
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, 2020, the Company had six significant
customers, five of which individually accounted for 27%, 23%, 19%,
15% and 14%, respectively, of operating lease revenue and one of
which accounted for 100% of finance lease revenue. 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.
At December 31, 2020, the Company had receivables from two
customers totaling $179,700 related to maintenance reserves for
2020, representing 70% of the Company’s total accounts
receivable. 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.
6. Notes Payable and Accrued
Interest
At December 31, 2020 and December 31, 2019, the Company’s
notes payable and accrued interest consisted of the
following:
|
|
|
MUFG Credit
Facility/Drake Loan:
|
|
|
Principal
|
$88,557,000
|
$84,084,100
|
Unamortized
debt issuance costs
|
(780,900)
|
(3,084,200)
|
Accrued
interest
|
739,000
|
376,200
|
Nord
Loans:
|
|
|
Principal
|
-
|
30,914,500
|
Unamortized
debt issuance costs
|
-
|
(741,500)
|
Accrued
interest
|
-
|
89,300
|
Paycheck Protection
Program Loan:
|
|
|
Principal
|
276,400
|
-
|
Accrued
interest
|
1,700
|
-
|
|
$88,793,200
|
$111,638,400
|
Nord Loans held for
sale:
|
|
|
Principal
|
$14,091,300
|
$-
|
Unamortized
debt issuance costs
|
(313,400)
|
-
|
Accrued
interest
|
59,000
|
-
|
|
$13,836,900
|
$-
|
(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, beginning
in the third quarter of 2019.
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,
2020, respectively;
●
Elimination of the
borrowing base collateral value covenant under the MUFG Loan
Agreement, and of the existing event of default under the MUFG 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).
(b) MUFG’s Sale of Indebtedness to Drake
On
October 30, 2020, Drake purchased from the MUFG Lenders all of the
outstanding indebtedness of the Company under such loan, totaling
approximately $87.9 million as well as all of the Company's
indebtedness to MUFG Bank, Ltd. of approximately $3.1 million for
termination of interest rate swaps entered into with respect to
such Loan Agreement indebtedness (such total indebtedness with
Drake as Lender referred to as the “Drake
Indebtedness”). The purchase and sale was consented to
by the Company pursuant to a Consent and Release Agreement of
Borrower Parties, entered into by the Company and its
subsidiaries. The closing of this debt purchase
transaction satisfied the requirement under the Loan Agreement for
execution of a Strategic Alternative with respect to the MUFG Loan
indebtedness satisfactory to the MUFG Lenders.
On the
same day, the Company entered into an Amendment No. 1 to the Loan
Agreement (“Amendment No. 1”) with Drake and UMB Bank,
N.A., the replacement Administrative Agent under the Loan
Agreement, to amend the Loan Agreement (such Loan Agreement as
amended, with Drake as Lender thereunder, referred to as the
“Drake Loan Agreement”) as follows:
●
Deferral of the
cash component of the interest payments due under the Drake Loan
Agreement, commencing with the payments due for March 2020, and
continuing on each consecutive month thereafter, which deferred
interest is to be capitalized and added to the principal balance of
the indebtedness on each respective interest payment due date,
until such time as the indebtedness is
repaid.
●
Deletion of the
requirement for the Company's execution of a Strategic Alternative
and of the milestones therefor;
●
Deletion of the
requirement for the Company's maintenance of a restricted account
held with an MUFG Lender to hold aircraft sales proceeds pending
application toward the Drake Indebtedness;
●
Replacement of
references to “MUFG Union Bank, N.A.,” with “UMB,
Bank, N.A.”, the new Administrative Agent under the Loan
Agreement;
●
Requirement
of approval by Drake for any “Material
Amendments” to leases for the collateral, defined as any
amendment of, or waiver or consent under, any lease involving a
modification of lease payments, any reduction in, or waiver or
deferral of, Rent, a modification to any residual value guaranty,
any modification that adversely affects the collateral or the
rights and interests of the lender and/or administrative agent in
the collateral, any reduction of any amounts payable to any lender
or Agent under any indemnity, or any change to the state of
registration of aircraft collateral; and
●
Deletion of certain
financial reporting requirements and changes to required frequency
of certain other surviving reporting requirements.
The
Drake Indebtedness is secured by a first priority lien held by
Drake, which lien is documented in an amended and restated mortgage
and security agreement assigned to Drake, on all of the
Company's assets, including the Company’s entire aircraft
portfolio, except for two aircraft on lease to Kenyan lessees and
five aircraft, two of which were sold in October 2020 and three of
which were sold in March 2021, that were subject to special purpose
financing held by subsidiaries of the Company.
The
Company and Drake are currently engaged in discussions regarding
the satisfaction and discharge of the Drake
Indebtedness.
During
2019, the Company engaged B. Riley Securities, Inc. 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 the Company’s lenders,
potential new 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 Drake
Indebtedness or raise sufficient capital to repay all amounts owed
under the Drake Indebtedness, the Company’s financial
condition and liquidity would be materially adversely affected and
its ability to continue operations could be materially
jeopardized.
(c) 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 were owned by the Company’s two UK
special-purpose entities and were sold in October 2020 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 Pandemic, 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 lease arrearage was repaid by the
lessee in late September, which permitted the special-purpose
subsidiaries to come back into compliance with their Nord Loan
indebtedness. In October 2020, the Company sold the two aircraft to
the lessee, and fully repaid the indebtedness on such aircraft with
the proceeds of the sale. The excess proceeds from the sale were
held as restricted cash by ACY E-175. The restricted cash, the
three aircraft held by ACY E-175 and ACY E-175’s Nord Loans
and derivative liability were classified as held for sale at
December 31, 2020. As discussed in Note 12, in March 2021,
the Company sold its interest in the special-purpose subsidiary and
was released from any remaining guarantee obligations under the
Nord Loan and interest swap obligations of the special-purpose
subsidiary.
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 de-designated
the two related derivative instruments from hedge accounting 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 de-designated those swaps from hedge
accounting in March 2020 as well. In December 2020, the Company
determined that the payments after February 2021 for the three
remaining swaps were probable not to occur as a result of the
Company’s agreement to sell its interest in ACY E-175 during
the first quarter of 2021, and recognized the accumulated other
comprehensive income related to such payments as interest
expense.
(d) 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 October 19, 2021. 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 has applied for forgiveness and
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. As discussed in Note 12, the Company was granted
a second PPP Loan in February 2021.
7. 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 6, 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, as
a result of lease payment defaults for the aircraft owned by ACY
19002 and ACY 19003 and conversations with the lessee for the three
aircraft owned by ACY E-175 regarding likely rent concessions, and
consequently de-designated all five swaps as hedges because the
lease payments are used to service the Nord Loans associated with
the swaps. As a result of de-designation, 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 $321,800 related to
the Nord Swaps was recognized as an expense in 2020. In December
2020, the Company determined that the payments after February 2021
for the three remaining swaps were probable not to occur as a
result of the Company’s agreement to sell its interest in ACY
E-175 during the first quarter of 2021, and recognized $600,400 of
accumulated other comprehensive income related to such payments as
interest expense.
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 $1,421,800 related to the MUFG Swaps was
recognized as interest expense in 2020. The two swaps related to
the MUFG Credit Facility were terminated in March 2020 and the
Company incurred a $3.1 million obligation, recorded as interest
expense and derivative termination liability, in connection with
such termination, payment of which was due no later than the March
31, 2021 maturity of the Drake Indebtedness.
The
Company has reflected the following amounts in its net
loss:
|
For the Years
Ended
December 31,
|
|
|
|
Change in value of
undesignated interest rate swaps
|
$1,979,800
|
$255,200
|
Reclassification
from other comprehensive income to interest expense
|
1,150,900
|
142,200
|
Reclassification
from other comprehensive income to interest expense
–
forecasted
transaction probable not to occur
|
1,167,700
|
-
|
Included in
interest expense
|
$4,298,400
|
$397,400
|
|
|
|
The
following amount was included in other comprehensive income/(loss),
before tax:
|
|
|
|
Gain/(loss) on
derivative instruments deferred into other comprehensive
income/(loss)
|
$(575,000)
|
$(1,887,900)
|
Reclassification
from other comprehensive income to interest expense
|
1,150,900
|
142,200
|
Reclassification
from other comprehensive income to interest expense
–
forecasted
transaction probable not to occur
|
1,167,700
|
-
|
Change in
accumulated other comprehensive income
|
$1,743,600
|
$(1,745,700)
|
Approximately
$2,600 of the current balance of accumulated other comprehensive
loss is expected to be reclassified in the first quarter of
2021.
At
December 31, 2020, the fair
value of the Company’s interest rate swaps was
$767,900.
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 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.
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.
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
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.
The Company recognized an ROU asset and lease liability of
$169,800, both of which were non-cash items and are not reflected
in the consolidated statement of cash flows. No cash was paid at
the inception of the lease, and a discount rate of 3% was used,
based on the interest rates available on secured commercial real
estate loans available at the time. At December 31, 2020, the
weighted average discount rate was 3% and the weighted average
remaining lease term was 25 months.
The
Company estimates that the maturities of operating lease base rent
of its office space were as follows as of December 31, 2020 and December 31, 2019:
|
|
2021
|
$81,300
|
2022
|
88,700
|
2023
|
7,400
|
|
177,400
|
Discount
|
(5,400)
|
Lease
liability
|
$172,000
|
During
the years ended December 31,
2020 and 2019, the Company recognized amortization, finance costs
and other expense related to the office lease as
follows:
|
For the Years
Ended
December
31,
|
|
|
|
|
|
|
Fixed rental
expense during the year
|
$552,200
|
$443,500
|
Variable lease
expense
|
23,100
|
116,000
|
Total lease expense
during the year
|
$575,300
|
$559,500
|
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, 2020, the Company
measured the fair value of its interest rate swaps of $14,091,300
(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 $767,900
as of December 31, 2020. In the
year ended December 31, 2020,
$1,979,800 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 December
31, 2020 and December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
Money
market
funds
|
$-
|
$-
|
$-
|
$-
|
$400
|
$400
|
$-
|
$-
|
Derivatives
|
(767,900)
|
-
|
(767,900)
|
-
|
(1,824,500)
|
-
|
(1,824,500)
|
-
|
Total
|
$(767,900)
|
$-
|
$(767,900)
|
$-
|
$(1,824,100)
|
$400
|
$(1,824,500)
|
$-
|
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. The independent
appraisals utilized the market approach which uses recent sales of
comparable assets, making appropriate adjustments to reflect
differences between them and the subject property being
analyzed. Certain
assumptions are used in the management’s estimate of
the fair value of aircraft including the adjustments made to
comparable assets, identifying
market data of similar assets, and estimating cost to sell. 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 2020, the Company
recorded impairment losses totaling $28,751,800. Of this total,
$14,639,900 was for seven of its aircraft held for lease, comprised
of (i) $7,006,600 for two aircraft that were written down to their
estimated sales prices, less cost of sale and were sold in 2020 and
(ii) $7,633,300 for five aircraft that were written down based on
third-party appraisals. The Company also recorded losses of
$11,337,200 for a turboprop aircraft and three regional jet
aircraft that are held for sale and that were written down based on
third-party appraisals and $2,774,700 for two turboprop aircraft
that are being sold in parts and three regional jet aircraft based
on their estimated sales prices, less cost of sale. The
Company recorded impairment charges totaling $31,007,400 on nine of
its assets held for sale in 2019 (of which $5,351,300 was related
to assets sold 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
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, 2020 and
December 31, 2019:
|
Assets
Written Down to Fair Value
|
|
|
|
|
For the
Years Ended December 31,
|
|
|
|
|
|
|
|
1
|
2
|
3
|
|
1
|
2
|
3
|
2020
|
2019
|
Assets
held for lease
|
$32,650,000
|
$-
|
$-
|
$32,650,000
|
$-
|
$-
|
$-
|
$-
|
$7,633,300
|
$-
|
Assets
held for sale
|
38,041,600
|
-
|
-
|
38,041,600
|
25,880,700
|
-
|
$-
|
25,880,700
|
14,111,900
|
25,656,100
|
Total
|
$70,691,600
|
$-
|
$-
|
$70,691,600
|
$25,880,700
|
$-
|
$-
|
$25,880,700
|
$21,745,200
|
$25,656,100
|
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 and Drake Loan,
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(t). 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 bore floating rates
of interest that reset periodically to a market benchmark rate plus
a credit margin. The same is true of the Drake 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 Drake Loan, approximates current
market rates, and therefore that the outstanding principal and
accrued interest of $89,296,000 and $84,460,300 at December 31, 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 $14,150,300 and $31,003,800 approximate their fair
values at December 31, 2020 and
December 31, 2019, respectively. Such fair value is categorized as
a Level 3 input under the GAAP fair value hierarchy.
As discussed in Note 2(b), as a result of payment delinquencies by
the Company’s two customers of aircraft subject to sales-type
finance leases, the Company recorded a bad debt allowance of
$1,503,000 during 2020. The finance lease receivables are valued at
their collateral value under the practical expedient
alternative.
There
were no transfers in or out of assets or liabilities measured at
fair value under Level 3 during 2020 or 2019.
10. 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.
11. Income Taxes
The items comprising the income tax provision are as
follows:
|
For the
Years Ended December 31,
|
|
|
|
Current
tax provision:
|
|
|
Federal
|
$(11,400)
|
$(34,100)
|
State
|
4,000
|
3,300
|
Foreign
|
(20,100)
|
418,200
|
Current
tax provision
|
(27,500)
|
387,400
|
Deferred
tax benefit:
|
|
|
Federal
|
(9,589,200)
|
(4,553,700)
|
State
|
(90,700)
|
(78,800)
|
Foreign
|
(1,351,100)
|
(262,700)
|
Valuation
allowance
|
7,493,800
|
-
|
Deferred tax
benefit
|
(3,537,200)
|
(4,895,200)
|
Total
income tax benefit
|
$(3,564,700)
|
$(4,507,800)
|
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
|
$(9,619,800)
|
$(4,444,900)
|
State
tax benefit, net of federal benefit
|
(67,200)
|
(75,900)
|
Foreign
tax expenses
|
(1,375,000)
|
-
|
Non-deductible
management and acquisition fees
|
-
|
7,600
|
Other
non-deductible expenses
|
3,500
|
5,400
|
Valuation
allowance
|
7,493,800
|
-
|
Total
income tax benefit
|
$(3,564,700)
|
$(4,507,800)
|
Temporary differences and carry-forwards that give rise to a
significant portion of deferred tax assets and liabilities as of
December 31, 2020 and 2019 were as follows:
|
|
|
|
|
Deferred tax
assets:
|
|
|
Current and prior
year tax losses
|
$9,616,600
|
$4,980,100
|
Deferred interest
expense
|
3,631,600
|
269,800
|
Foreign tax
credit
|
573,900
|
758,400
|
Maintenance
reserves
|
390,500
|
470,000
|
Deferred derivative
losses
|
81,100
|
452,100
|
Deferred
maintenance, bad debt allowance and other
|
59,900
|
19,800
|
Alternative minimum
tax credit
|
-
|
11,400
|
Total
deferred tax assets
|
14,353,600
|
6,961,600
|
Valuation
allowance
|
(7,493,800)
|
-
|
Deferred
tax assets, net of valuation allowance
|
6,859,800
|
6,961,600
|
Deferred tax
liabilities:
|
|
|
Accumulated
depreciation on aircraft and aircraft engines
|
(5,654,700)
|
(8,666,700)
|
Deferred
income
|
(58,000)
|
(175,600)
|
Leasehold
interest
|
3,800
|
(131,400)
|
Total deferred tax
liabilities
|
(5,708,900)
|
(8,973,700)
|
Net deferred tax
assets/(liabilities), net of valuation allowance and deferred tax
liabilities
|
$1,150,900
|
$(2,012,100)
|
|
|
Reported
as:
|
|
|
Deferred
tax asset
|
$8,644,700
|
$517,700
|
Deferred
income taxes (liability)
|
-
|
(2,529,800)
|
Valuation
allowance
|
(7,493,800)
|
-
|
Net
deferred tax assets/(liabilities)
|
$1,150,900
|
$(2,012,100)
|
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, 2020 and December 31, 2019.
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 March of 2020, the
Coronavirus Aid, Relief, and Economic Security Act (the
“CARES Act”) became law. The CARES Act included tax
provisions that accelerated the ability to receive refunds of AMT
credits from prior year, which allowed the Company to accelerate
$11,400 of the refund of such credit into its 2019 tax
return.
The
CARES Act included provisions under which the amount of deductible
interest increased from 30% to 50% of adjusted taxable income for
the 2019 and 2020 years. 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, 2020 and 2019, of $16.8 million and $0, respectively.
The cumulative deferred interest expense of $16.8 million may be
carried forward indefinitely until the Company has excess positive
adjusted taxable income against which it can deduct the deferred
interest balance.
The
CARES Act also included 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.
The current year federal operating loss carryovers of approximately
$36.7 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 $20.7 million federal net operating loss
carryovers may be carried forward indefinitely. The current year
state operating loss carryovers of approximately $392,400 will be
available to offset taxable income in the two preceding years and
in future years through 2040. As discussed below, the Company
does not expect to utilize the net operating loss carryovers
remaining at December 31, 2020 in future years.
During
the year ended December 31, 2020, the Company had pre-tax loss from
domestic sources of approximately $6.8 million and pre-tax loss
from foreign sources of approximately $39 million. 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
for the year ended December 31, 2019. The Company’s foreign
tax credit carryover will be available to offset federal tax
expense in future years through 2029.
As of
December 31, 2020, the Company has a valuation allowance of
approximately $7.5 million against its net domestic deferred tax
assets not supported by either future taxable income or
availability of future reversals of existing taxable temporary
differences, for which realization cannot be considered more likely
than not at this time. In assessing the need for a valuation
allowance, the Company considered all positive and negative
evidence, including scheduled reversals of deferred tax
liabilities, projected future taxable income, tax planning
strategies, and past financial performance. The worldwide pandemic
and its impact on the travel industry has created uncertainty on
the Company’s future profitability. Recent negative operating
results and default on its credit facility has caused the Company
to be in a cumulative loss position as of December 31, 2020. The
uncertain impact of the coronavirus on the travel industry recovery
and recent declines in aircraft values has contributed to near-term
industry uncertainty. The net deferred
tax asset of $1.15 million at December 31, 2020, represents
expected future refunds for taxes previously paid and recoverable
from net operating loss carrybacks of foreign subsidiaries that are
not parties to the U.S. bankruptcy proceedings.
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 2016. At December 31, 2020, the
Company had a balance of accrued tax, penalties and interest
totaling $74,000 related to unrecognized tax benefits on its
non-U.S. operations included in the Company’s accounts and
taxes payable. The Company anticipates decreases of approximately
$4,000 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:
December
31,
|
|
|
|
Balance at January
1
|
$94,400
|
$85,400
|
Additions for prior
years’ tax positions
|
5,100
|
9,000
|
Reductions from
expiration of statute of limitations
|
(25,500)
|
-
|
Balance at December
31
|
$74,000
|
$94,400
|
The
Company accounts for interest related to uncertain tax positions as
interest expense, and for income tax penalties as tax
expense.
12. Subsequent Events
(a) Sale of Special-purpose Subsidiary
On
March 16, 2021, the Company sold its 100% percent membership
interest (the “LLC Interest”) in ACY E-175 LLC, which
owned three Embraer E-175 aircraft (the “Leased
Aircraft”) on lease to a U.S. regional airline. ACY E-175 LLC
was the sole obligor under refinancing debt for the Leased Aircraft
owed to Nord. The Nord debt was non-recourse to the Company, but
was secured by a pledge of the LLC Interest, as well as a lien on
the assets of ACY E-175 LLC, including the Leased Aircraft.
The sale was consummated pursuant to a Membership Interest Purchase
Agreement (the “Sale Agreement”), between the Company
and an affiliate of Drake, Drake Jet Leasing 10 LLC, a Delaware
limited liability company (“Buyer”), and the purchase
price for the LLC Interest was $26,500,000, paid in the form of the
Buyer’s assumption of the entire debt of approximately $13.3
million owed to Nord by ACY E-175 LLC, and a cash payment by the
Buyer to the Company of approximately $13.1 million. The
purchase price was determined by negotiations between the Company
and the Buyer following a Request for Proposal bid solicitation for
the assets. The transfer of the LLC Interest was
consented to by Nord, as secured lender, and Nord released the
Company from any remaining guaranty obligations under Nord’s
refinancing debt and interest swap obligations owed by ACY E-175
LLC, pursuant to a Borrower Parent Transfer Agreement between the
Company, LLC, Buyer, Nord, Norddeutsche Landesbank Girozentrale, as
swap counterparty, and Wilmington Trust Company, as security
trustee.
Pursuant
to a Side Letter No. 1 among the Company, Buyer and UMB Bank, N.A.,
the security agent, the Company applied approximately $11.0 million
of the LLC Interest cash sales proceeds toward repayment of the
Company’s indebtedness to Drake under the Drake Loan
Agreement, and the Company retained the remaining $2.1 million of
cash sales proceeds.
(b) Second Paycheck Protection Program Loan
In February 2021,
the Company was granted a second PPP Loan (“Second PPP
Loan”) (collectively, with the initial PPP Loan, the
“PPP Loans”) in the aggregate amount of $170,002. The
Second PPP Loan, in the form of a Note dated February 11, 2021,
matures on February 11, 2026 and bears interest at a rate of 1.00%
per annum, payable in monthly payments commencing 30 days after the
Small Business Administration has made its final determination that
any part of the loan will not be forgiven.
The PPP Loans may
be prepaid by the PPP Borrower at any time prior to maturity with
no prepayment penalties. Funds from the PPP Loans 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 Loans for qualifying expenses. Under the terms of the PPP,
certain amounts of the PPP Loans 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 Loans
will be forgiven, no assurance can be provided that the Company
will obtain such forgiveness.
(c) Chapter 11 Bankruptcy Filing
In
connection with the impending maturity of the Drake Indebtedness
and the continuing economic impact from COVID-19, on March 29, 2021
(the "Petition Date"), the Company and certain of its subsidiaries
in the U.S. (collectively the "Debtors" and the "Debtors-
in-Possession") filed voluntary petitions for relief (collectively,
the "Petitions") under Chapter 11 of Title 11 ("Chapter 11") of the
U.S. Bankruptcy Code (the "Bankruptcy Code") in the U.S. Bankruptcy
Court for the District of Delaware (the "Bankruptcy Court"). The
Chapter 11 cases (the "Chapter 11 Case") are being jointly
administered under the caption In re: AeroCentury Corp., et al., Case No.
21-10636.
The
Bankruptcy Court has approved motions filed by the Debtors that
were designed primarily to mitigate the impact of the Chapter 11
Case on the Company’s operations, customers and employees.
The Debtors are authorized to conduct their business activities in
the ordinary course, and pursuant to orders entered by the
Bankruptcy Court, the Debtors are authorized to, among other things
and subject to the terms and conditions of such orders: (i) pay
employees’ wages and related obligations; (ii) pay certain
taxes; (iii) continue to maintain certain customer programs; (iv)
maintain their insurance program; (v) use cash collateral on an
interim basis; and (vi) continue their cash management
system.
The Debtors are currently operating as debtors-in-possession under
the jurisdiction of the Bankruptcy Court and in accordance with the
applicable provisions of the Bankruptcy Code and orders of the
Bankruptcy Court. In general, as debtors-in-possession under the
Bankruptcy Code, the Debtors are authorized to continue to operate
as an ongoing business but may not engage in transactions outside
the ordinary course of business without the prior approval of the
Bankruptcy Court.
Subject to certain specific exceptions under the Bankruptcy Code,
the Petitions automatically stayed most judicial or administrative
actions against the Debtors and efforts by creditors to collect on
or otherwise exercise rights or remedies with respect to
obligations of the Debtors incurred prior to the Petition Date
("Pre-petition"). Absent an order from the Bankruptcy Court,
substantially all of the Debtors’ Pre-petition liabilities
are subject to settlement under the Bankruptcy
Code.