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| ACY > SEC Filings for ACY > Form 10-Q on 13-Nov-2008 | All Recent SEC Filings |
13-Nov-2008
Quarterly Report
The following discussion should be read in conjunction with the Company's Form 10-KSB for the year ended December 31, 2007 and the unaudited financial statements and the related notes that appear elsewhere in this report.
Results of Operations for the Three Months and Nine Months Ended September 30, 2008 and 2007
(a) Revenues
Operating lease revenue was $1,041,700 and $4,183,800 greater in the three months and nine months ended September 30, 2008, respectively, compared to the same periods in 2007, primarily because of increased operating lease revenue from aircraft purchased during 2007 and 2008 and re-leases of several of the Company's aircraft during 2007 at increased rental rates. The aggregate effect of these increases was partially offset by a decrease in revenue related to aircraft that were off lease for all or part of the 2008 periods.
Maintenance reserves revenue, comprised of non-refundable reserves which are earned based on lessee aircraft usage, was $1,883,900 and $1,152,500 for the three months ended September 30, 2008 and 2007, respectively, and $5,534,000 and $2,826,800 for the nine months ended September 30, 2008 and 2007, respectively. Such income was $731,400 and $2,707,200 greater in the three months and nine months ended September 30, 2008, respectively, compared to the 2007 periods primarily as a result of the increase in maintenance reserves resulting from the acquisition of aircraft in 2007.
Other income was $179,900 greater in the nine months ended September 30, 2008 compared to the same period in 2007, primarily as a result of $150,000 of compensation in 2008 for a potential re-lease transaction that was not consummated.
(b) Expense items
Interest expense was $25,700 greater in the three months ended September 30, 2008 compared to the same period in 2007. The Company incurred $356,700 more in interest expense related to its Subordinated Notes in the 2008 period than in 2007 as a result of a higher principal balance and amortization of fees. During the three months ended September 30, 2008, the Company recorded $80,200 of net settlement interest related to the Swap, which was entered into on December 31, 2007. The aggregate effect of these increases was almost entirely offset by $314,400 less interest related to the Company's Credit Facility debt in the three months ended September 30, 2008 compared to the same period in 2007. This decrease was a result of the net effect of lower average index rates upon which the Credit Facility's interest rates were based, and a higher average Credit Facility balance. The Company also recorded a gain of $50,200 for the change in fair value of the Swap and $46,500 less in commitment fees related to the unused portion of its Credit Facility and Subordinated Notes debt.
Interest expense was $610,000 greater in the nine months ended September 30, 2008, compared to the same period in 2007. The Company incurred $924,300 more in interest expense related to its Subordinated Notes in the 2008 period than in 2007 as a result of a higher principal balance and amortization of fees. During the nine months ended September 30, 2008, the Company recorded $164,900 of net settlement interest related to the Swap and a loss of $64,500 for the change in fair value of the Swap. The aggregate effect of these increases was partially offset by $518,900 less interest related to the Company's Credit Facility debt in the nine months ended September 30, 2008 compared to the same period in 2007. This decrease was a result of the net effect of lower average index rates upon which the Credit Facility's interest rates were based, and a higher average Credit Facility balance. The Company also recorded $24,800 less in commitment fees related to the unused portion of its Credit Facility and Subordinated Notes debt.
Depreciation was $383,700 and $1,340,400 greater in the three months and nine months ended September 30, 2008 compared to the same periods in 2007, primarily because of purchases of aircraft during 2007 and 2008. Management fees, which are calculated on the net book value of the aircraft owned by the Company, were $162,900 and $568,400 greater in the three months and nine months ended September 30, 2008, respectively, compared to the same periods in 2007 because of higher net book values as a result of aircraft acquisitions. The effects of this increase were partially offset by the effect of depreciation on the net book value of the Company's aircraft.
The Company's maintenance expense is dependent on the aggregate amount of the maintenance claims submitted by lessees for reimbursement from non-refundable reserves and expenses incurred in connection with off-lease aircraft. Primarily as a result of higher expense related to off-lease aircraft, the Company incurred $545,500 more in maintenance expense in the three months ended September 30, 2008 than in the same period in 2007. In the nine months ended September 30, 2008, the Company incurred $3,254,300 more in maintenance expense than in the same period of 2007, as a result of an increase in total lessee claims in 2008, as well as an increase in expense related to off-lease aircraft. During the three months and nine months ended September 30, 2008, $454,900 and $1,887,400 respectively, of the Company's maintenance expense was funded by non-refundable maintenance reserves which were recorded as income when accrued. The amounts funded by non-refundable maintenance reserves during the three months and nine months ended September 30, 2007 were $347,100 and $1,127,600, respectively.
The Company records non-income based sales, use, value-added and franchise taxes as other tax expense. Such expenses were $339,100 and $406,200 lower in the three months ended September 30, 2008 compared to the three months ended September 30, 2007. Based on the Company's analysis of value-added taxes related to an aircraft leased in Australia, the Company recorded value-added taxes, penalties and interest totaling $283,900 and $290,100 in the three months and nine months ended September 30, 2007, respectively. Upon completion of further analysis and confirmation from the Australian tax authority, the Company reduced the accruals for such amounts in the three months and nine months ended September 30, 2008 by $63,400 and $177,100 respectively.
The Company's insurance expense consists primarily of directors and officers insurance, as well as product liability insurance and insurance for off-lease aircraft and aircraft engines, which varies depending on the type and length of time each off-lease asset is insured. Aircraft insurance expense was $59,000 and $154,700 greater in the three months and nine months ended September 30, 2008, respectively, compared to the same periods in 2007 as a result of differences in the type of and length of time the insured assets were off lease.
The Company's effective tax rates of approximately 37% and 36% for the three months and nine months ended September 30, 2008, respectively, were substantially higher than the 29% and 32% for the three months and nine months ended September 30, 2007, respectively, as a result of (i) the Company's recognition of the tax benefits associated with foreign tax credits in the 2007 periods and (ii) recognition in 2008 of the effect of a difference for GAAP and tax purposes in the valuation of warrants issued in connection with the Company's issuance of the Subordinated Notes.
The Company is currently financing its assets primarily through debt borrowings, special purpose financing and excess cash flows.
(a) Credit Facility
During the nine months ended September 30, 2008, the Company borrowed $12,500,000 and repaid $10,500,000 of the outstanding principal under its revolving credit facility (the "Credit Facility"). The balance of the principal amount owed under the Credit Facility at September 30, 2008 was $61,596,000 and interest of $84,500 was accrued. At September 30, 2008, the Company was in compliance with all covenants of the Credit Facility.
The Company is currently in compliance with all covenants and, based on its current projections, the Company believes it will continue to be in compliance with all covenants of its Credit Facility, but there can be no assurance of such compliance in the future. See "Factors That May Affect Future Results - 'Risks of Debt Financing' and 'Credit Facility Obligations,'" below.
The Company's interest expense in connection with the Credit Facility generally increases and decreases with prevailing interest rates. Because aircraft owners seeking financing generally can obtain financing through either leasing transactions or traditional secured debt financings, prevailing interest rates are a significant factor in determining market lease rates, and market lease rates generally move up or down with prevailing interest rates, assuming supply and demand of the desired equipment remain constant. However, because lease rates for the Company's assets typically are fixed under existing leases, the Company normally does not experience any positive or negative impact in revenue from changes in market lease rates due to interest rate changes until existing leases have terminated and new lease rates are set as aircraft are re-leased. As discussed in (b) below, the Company entered into an interest rate swap in December 2007.
(b) Derivative instrument
In December 2007, the Company entered into a two-year interest rate swap (the "Swap") with a notional amount of $20 million, under which it committed to make or receive a net settlement for the difference in interest receivable computed monthly on the basis of 30-day LIBOR and interest payable monthly on the basis of a fixed rate of 4.04% per annum.
The Company recognized net settlement expense related to the Swap of $80,200 and $164,900 for the three months and nine months ended September 30, 2008, respectively, as a component of interest expense. Short-term interest rates are currently below the fixed rate of the Swap. If short-term interest rates remain below the fixed rate of the Swap, the Company will incur additional interest expense as a result.
At September 30, 2008, the Company also recognized a $214,500 liability for the Swap on its condensed consolidated balance sheet as a component of notes payable and accrued interest. The Company also recognized a gain of $50,200 for the three months ended September 30, 2008 and a loss of $64,500 for the nine months ended September 30, 2008 as a component of interest expense for the change in fair value of the swap contract. Market expectations of increasing interest rates will tend to decrease the fair value of the swap, and expectations of decreasing interest rates will tend to increase the fair value of the swap.
(c) Senior unsecured subordinated debt
As of September 30, 2008, the carrying amount of the Subordinated Notes was $12,666,300 (outstanding principal amount of $14,000,000 less unamortized debt discount of $1,333,700) and accrued interest payable was $0. As of September 30, 2008, the Company was in compliance with all covenants under the Subordinated Notes Agreement and is currently in compliance.
In July 2008, the Company and the holders of Subordinated Notes agreed to amend the Subordinated Notes Agreement to reduce the maximum amount of Subordinated Notes to be issued under the Subordinated Notes Agreement from $28 million to $14 million and to reduce the number of shares of the Company's Common Stock issuable upon exercise of the Warrants from 171,473 to 81,224. The Company recorded a reduction to paid-in capital and debt discount of $597,400 related to the reduction in Warrants. The amendment also provided for the refund to the Company of certain fees paid at the initial closing of the Subordinated Notes Agreement, as well as a portion of the unused commitment fees paid through June 30, 2008 and revised certain prepayment provisions of the Subordinated Notes Agreement. The net proceeds from the $4,000,000 of Subordinated Notes that were issued pursuant to the amendment were used to repay a portion of the Company's Credit Facility debt. Future acquisitions may be financed from funds available under the Credit Facility.
(d) Special purpose financings
Until August 2008, the Company had two special purpose financings in connection with AeroCentury V LLC and AeroCentury VI LLC. In April 2008, the Company repaid the outstanding principal of $4,109,900 owed by AeroCentury V LLC under its special purpose financing and paid a prepayment penalty of $8,200. In August 2008, the Company transferred ownership of the two aircraft that served as collateral for the financing from AeroCentury V LLC to AeroCentury Corp., upon which the aircraft became eligible as collateral under the Credit Facility. On August 25, 2008, AeroCentury V LLC dissolved. During the nine months ended September 30, 2008, AeroCentury VI LLC repaid $268,400 of principal. The principal amount owed under that note was $840,800 and interest of $1,300 was accrued at September 30, 2008. As of September 30, 2008, the Company was in compliance with all covenants of the note obligations of AeroCentury Investments VI LLC and is currently in compliance.
(e) Cash flow
The Company's primary source of cash is lease rentals of its aircraft assets. Currently, one of the Company's deHavilland DHC-8-300 aircraft, one of its Fokker 50 aircraft, its two Saab 340A aircraft and one turboprop engine are off lease. The Company is not receiving rent income for its off-lease aircraft and may incur significant maintenance expense in order to prepare the aircraft for re-lease. In October 2008, the Company signed a term sheet for the re-lease of its off-lease DHC-8-300 aircraft and delivery to the new lessee, which also leases two of the Company's DHC-8-100 aircraft, is expected to occur in the fourth quarter of 2008. In addition, two of the Company's other aircraft leases expire in 2008; however, the Company believes that it is likely that the aircraft will be retained by the lessee pursuant to lease extensions.
The Company's primary uses of cash are for aircraft maintenance and interest. The amount and timing of the Company's maintenance expenditures are dependent on the aggregate amount of the maintenance claims submitted by lessees for reimbursement from reserves and expenses incurred in connection with off-lease aircraft and preparation of such aircraft for re-lease. The amount of interest paid by the Company is dependent on the outstanding balance of its Credit Facility, Subordinated Notes and special purpose financing debt. In addition, the amount of interest expenditures related to the Company's Credit Facility and special purpose financing debt are dependent on changes in prevailing interest rates.
Management believes that the Company will have adequate cash flow to meet its ongoing operational needs, including required repayments under its Credit Facility, Subordinated Notes financing and special purpose financings, based upon its estimates of future revenues and expenditures. The Company's expectations concerning such cash flows are based on existing lease terms and rents, as well as numerous estimates, including (i) rents on assets to be re-leased, (ii) timely use of proceeds of unused debt capacity toward additional acquisitions of income producing assets, and (iii) the cost and anticipated timing of maintenance to be performed. While the Company believes that the assumptions it has made in forecasting its cash flow are reasonable in light of experience, actual results could deviate from such assumptions. Among the more significant external factors outside the Company's control that could have an impact on the accuracy of cash flow assumptions are (i) an increase in interest rates that negatively affects the Company's profitability and causes the Company to violate covenants of its Credit Facility or its Subordinated Notes, which may in turn require repayment of some or all of the amounts outstanding under the Credit Facility or the Subordinated Notes, (ii) lessee non-performance or non-compliance with lease obligations (which may affect Credit Facility collateral limitations and Subordinated Notes covenants, as well as revenue and expenses), (iii) inability to locate and acquire a sufficient volume of additional aircraft assets at prices that will produce acceptable net returns and (iv) lessee performance of maintenance earlier than anticipated.
The Company's cash flow from operations for the nine months ended September 30, 2008 compared to 2007 increased by $369,700. The change in cash flow is a result of changes in several cash flow items during the year, including principally the following:
Lease rents, maintenance reserves and security deposits
Payments received from lessees for rent were $3,977,900 greater in the nine months ended September 30, 2008 compared to 2007, due primarily to the effect of increased rent payments for aircraft acquired during 2007 and 2008, and re-leases during 2007 at increased rental rates for several of the Company's aircraft. The aggregate effect of these increases was partially offset by a decrease in revenue related to aircraft that were off lease for all or part of the 2008 period.
Although increased demand generally in the turboprop market has caused lease rates to stabilize and, in some cases, rise, there can be no assurance that rental rates on aircraft to be re-leased will not decline, so that, absent additional acquisitions by the Company beyond those made in 2007 and in 2008, aggregate lease revenues for the current portfolio could decline in the future.
Payments received for refundable and non-refundable maintenance reserves are based on usage of the Company's aircraft. Such payments were $2,989,400 greater in the first nine months of 2008 than in the first nine months of 2007 as a result of usage of the five aircraft acquired in 2007, the effect of which was partially offset by a net decrease in average lessee usage of other aircraft owned by the Company.
During the nine months ended September 30, 2008, the Company returned a $307,980 security deposit to a lessee upon return of an aircraft at lease end and received $210,000 of deposits in connection with the proposed re-lease of three of the Company's off-lease aircraft. During the same period in 2007, the Company received $1,705,000 of security deposits in connection with four aircraft purchased in 2007 and re-leases of two aircraft.
Payments for maintenance
Payments for maintenance were $3,758,100 greater in the first nine months of 2008 compared to the same period in 2007 as a result of increases in the amount of maintenance claims submitted by lessees in 2008 and the amount of maintenance for off-lease aircraft. The amount of payments for maintenance in future periods will be dependent on the amount and timing of maintenance paid from lessee maintenance reserves held by the Company and maintenance paid for off-lease aircraft.
Payments for management fees
Payments for management fees increased by $603,500 in the nine months ended September 30, 2008 compared to the same period in 2007 because of an overall higher net book value as a result of aircraft acquisitions.
Payments for professional fees and general and administrative expenses
Payments for professional fees and general and administrative expenses increased by $254,200 in the first nine months of 2008 compared to the same period in 2007 primarily because of higher accounting and legal fees.
Payments for aircraft insurance
Payments for aircraft insurance were $184,500 greater in the nine months ended September 30, 2008 compared to the same period in 2007 because the Company had more aircraft off lease in the 2008 period.
Income taxes
During the nine months ended September 30, 2008, the Company received $210,500 of federal tax refunds and paid taxes of $1,500. The Company received a federal tax refund of $64,600 and paid taxes of $1,200 in the nine months ended September 30, 2007.
(ii) Investing activities
During the nine months ended September 30, 2008 and 2007, the Company used cash of $14,502,980 and $25,873,200 respectively, for aircraft acquisitions and capital equipment installed on aircraft.
(iii) Financing activities
The Company borrowed $12,500,000 and $21,500,000 for aircraft financing and repaid $15,223,700 and $16,249,300 of its outstanding debt in the first nine months of 2008 and 2007, respectively. The Company also issued $4,000,000 and $10,000,000 of principal amount of Subordinated Notes, the net proceeds of which were used to repay a portion of the Company's Credit Facility debt in the first nine months of 2008 and 2007, respectively.
As discussed above in "Liquidity and Capital Resources - (c) Senior unsecured subordinated debt," the Company received $4,000,000 through the issuance of Subordinated Notes in July 2008. The proceeds were used to pay down Credit Facility debt. The Company anticipates that the available debt capacity under the Credit Facility will be sufficient to fund planned acquisitions for the remainder of 2008 and 2009.
In the second quarter of 2008, the Company and a regional carrier signed a term sheet for a four-year re-lease of two aircraft and the carrier tendered a refundable security deposit. As a result, the Company began performing maintenance on one of the aircraft and such work was substantially complete at September 30, 2008. In early October, based on the financial condition of the potential lessee, the Company and the regional carrier terminated negotiations for the lease of both aircraft, and the Company returned the security deposit. The Company is currently seeking other re-lease opportunities for both aircraft, and maintenance on the second aircraft will not commence until a new lessee is identified.
In August 2008, due to its cessation of operations, the lessee of one aircraft signed a return agreement with the Company that provided for an early return of the aircraft and the termination of the lessee's obligation to pay rent after the execution date. The Company is taking possession of the aircraft and assuming responsibility for its repair. Maintenance reserves of approximately $1.1 million previously collected from the lessee and recorded as income will be used to prepare the aircraft for re-lease. Approximately $157,000 of such work was recorded as expense in the third quarter of 2008. The balance of such work will be recognized as expense when the work is performed in the fourth quarter of 2008.
In October 2008, the Company and a lessee signed a term sheet for a three-year re-lease of the Company's off lease DHC-8-300 aircraft and delivery is expected to occur in the fourth quarter of 2008. The Company and the lessee, which also leases two of the Company's DHC-8-100 aircraft, also agreed to a three-year extension of the lease for one of those aircraft.
Two of the Company's other aircraft leases expire in the fourth quarter of 2008. The Company believes that it will be successful in extending the leases for these aircraft. If the aircraft are returned at lease end, it is likely the Company will incur significant maintenance expense in the fourth quarter of 2008 and the first quarter of 2009, as a result of the use of previously collected reserves for maintenance that the lessee will be required to perform to meet the return obligations under the leases.
Even if the aircraft that are currently off lease and may come off lease in the remainder of 2008 remain off lease for an extended period of time, the Company believes it will be able to meet its operational needs and remain in compliance with the terms of its Credit Facility and Subordinated Notes.
The Company continually monitors the financial condition of its lessees to avoid unanticipated creditworthiness issues, and where necessary, works with lessees to ensure continued compliance with obligations under their respective leases. Currently, the Company is closely monitoring the performance of two lessees with a total of three aircraft under lease. The Company continues to work closely with these lessees to ensure compliance with their current obligations. If any of the Company's current lessees are unable to meet their lease payment obligations, the Company's future operating results could be materially impacted. Any weakening in the aircraft industry may also affect the performance of lessees that currently appear to the Company to be creditworthy. See "Factors that May Affect Future Results - General Economic Conditions," below.
Beginning on January 1, 2007, due to the adoption of FSP AUG AIR-1, the Company began to accrue non-refundable maintenance reserves received from lessees as income based on aircraft usage and record maintenance expenses as incurred. The Company accrues estimated maintenance costs based on information provided by its third party lessees and, accordingly, estimates of such expenses depend on timely and accurate reporting by such parties. The Company believes that its reported net income may be subject to significant fluctuations from quarter-to-quarter as a result of the adoption of FSP AUG AIR-1. Due to the recent acquisition of Fokker 100 jet engine powered aircraft, the magnitude of these fluctuations may be greater as a result of the higher maintenance reserve rates and related maintenance expense for jet engines as compared to turboprop engines.
Availability of Financing. The Company's continued growth will depend on its ability to obtain capital, either through debt or equity financings. The financial markets have experienced certain setbacks related in many cases to certain financial institutions' investments in mortgage-backed securities. As a result, commercial lending origination has dramatically decreased, and asset based debt financing is now more difficult to obtain. The Company believes that the current banking crisis will not have an immediate effect on the Company. The Company believes the lenders in its Credit Facility will continue to be able to honor their commitment to provide loans as committed in the Credit Facility agreements and that the unused capacity under the Credit Facility provides sufficient capital to fund acquisitions through the end of 2009. The Company, however, will eventually need to seek additional capital once its Credit Facility is fully drawn. The Company is currently seeking additional lenders for participation in its Credit Facility, and investigating other sources of debt financing. There is no assurance that the Company will succeed in finding such additional capital, and if such financing is found, it may not be on terms as favorable as its current debt financings.
Risks of Debt Financing. The Company's use of debt as the primary form of acquisition financing subjects the Company to increased risks of leveraging. Indebtedness owed under the Credit Facility is secured by the Company's existing assets as well as the specific assets acquired with each financing. In addition to payment obligations, the Credit Facility also requires the Company to comply with certain financial covenants, including a requirement of positive earnings, interest coverage and net worth ratios. Any default under the Credit Facility, if not waived by the lenders, could result in foreclosure upon not only the asset acquired using such financing, but also the existing assets of the Company securing the loan. Any such default could also result in a cross default under the Subordinated Notes.
The addition of the Subordinated Notes, while providing additional resources for acquisition by the Company of revenue generating assets, also has the effect of increasing the Company's overall cost of capital, as the Subordinated Notes bear an effective overall interest rate that is currently higher than the rate payable under the Credit Facility. Since the Subordinated Notes bear interest immediately upon issuance, the Company's success in utilizing the proceeds to purchase income-generating assets will be critical to the financial results of . . .
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