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ACY > SEC Filings for ACY > Form 10-Q on 15-May-2014All Recent SEC Filings

Show all filings for AEROCENTURY CORP

Form 10-Q for AEROCENTURY CORP


15-May-2014

Quarterly Report


Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the Company's Form 10-K for the year ended December 31, 2013 and the unaudited financial statements and related notes that appear elsewhere in this report.

Critical Accounting Policies, Judgments and Estimates

The Company's discussion and analysis of its financial condition and results of operations are based upon the financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities at the date of the financial statements. In the event that actual results differ from these estimates or the Company adjusts these estimates in future periods, the Company's operating results and financial position could be materially affected. For a discussion of Critical Accounting Policies, Judgments and Estimates, refer to Note 1 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q.

For a discussion of the Company's accounting policies regarding maintenance reserves, refer to Note 4 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q. For a discussion of the Company's change in method of accounting for certain maintenance reserves and lessor maintenance obligations and its application to prior periods, refer to Note 2 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q.

Results of Operations

The Company recorded net income of $0.4 million in the quarter ended March 31, 2014 compared to net income of $3.8 million the same period of 2013.

Quarterly operating lease revenue increased 19% from $4.9 million in the quarter ended March 31, 2013 to $5.9 million in the first quarter of 2014, primarily as a result of increases in operating lease revenue from assets purchased during 2013 and 2014. The effect of these increases was partially offset by the effect of assets that were on lease in the 2013 period but off lease in the 2014 period and the effect of asset sales during 2013.

Maintenance reserves revenue decreased 74% from $6.5 million in the quarter ended March 31, 2013 to $1.7 million in the quarter ended March 31, 2014. The amount recorded in the 2013 period was received from the prior lessee of two of the Company's aircraft when the leases were assigned to a new lessee in 2012 and recognized as maintenance reserves revenue upon termination of those leases in the first quarter of 2013. The 2014 amount represents maintenance reserves retained at lease end when an aircraft was returned to the Company.

The average net book value of assets held for lease during the first quarters of 2014 and 2013 was approximately $182.1 million and $143.9 million, respectively, representing an increase of 27%. The average portfolio utilization during the quarters ended March 31, 2014 and 2013 was 81% and 78%, respectively.

During the first quarter of 2014, the Company recorded net gains totaling $0.4 million related to the sale of two aircraft. During the first quarter of 2013, the Company recorded a gain of $0.2 million related to the sale of one aircraft.

The Company's maintenance expense increased 10% to $2.3 million in the first quarter of 2014 from $2.1 million in the same period of 2013, as a result of increases in maintenance performed by the Company on off-lease aircraft. During the first quarters of 2014 and 2013, retained maintenance reserves funded $0.1 million and $0.7 million, respectively, of the Company's maintenance expense in those periods.

During the first quarters of 2014 and 2013, the Company added equipment to the lease portfolio of approximately $31.2 million and $1.8 million, respectively. The Company sold equipment with a book value of approximately $2.6 million and $1.4 million during the first quarters of 2014 and 2013, respectively. Depreciation and management fees in the first quarter of 2014 increased by 6% and 21%, respectively, over the previous year, primarily as a result of acquisitions and changes in residual assumptions from year to year.

The Company's interest expense increased by 23% from $1.1 million in the first quarter of 2013 to $1.3 million in the first quarter of 2014, primarily as a result of a higher average Credit Facility balance, the effect of which was offset by lower amortization of Credit Facility fees in 2014.

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Liquidity and Capital Resources

The Company is currently financing its assets primarily through debt financing and excess cash flows.

(a)Credit Facility

The Company's $130 million Credit Facility (the "Credit Facility"), which is provided by a syndicate of banks, expires on September 30, 2015. The Credit Facility is secured by all of the assets of the Company, including its aircraft and engine portfolio.

In November 2013, the Company obtained a waiver of compliance with a lessee concentration covenant under its Credit Facility agreement at the September 30, 2013 and December 31, 2013 calculation dates. The Company was in compliance with all other covenants under the Credit Facility agreement at December 31, 2013, and was in compliance with all covenants at March 31, 2014.

There can be no assurance that the Company will be in compliance with any of the covenants under the Credit Facility through its term, and in the event of any failure to be in compliance, the Company will need to seek additional waivers or amendment of applicable covenants from its lenders if such compliance failure is not timely cured. Any default under the Credit Facility, if not cured within the time permitted under the facility or waived by the lenders, could result in foreclosure upon any or all of the assets of the Company.

The Company's interest expense generally increases and decreases with prevailing interest rates. The Company has the ability to enter into interest rate swaps to economically hedge against interest rate increases in its floating rate debt under the Credit Facility and has done so in the past.

For additional information regarding the Company's credit facility, refer to Note 5 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q.

(b)Cash flow

The Company's primary sources of cash are (i) rent payments due under the Company's operating and finance leases and (ii) maintenance reserves billed monthly to lessees based on asset usage.

The Company's primary uses of cash are for purchase of aircraft and engines, maintenance expense and reimbursement to lessees from collected maintenance reserves, management fees, professional fees, insurance, and Credit Facility interest and principal payments. The amount of interest paid by the Company depends on the outstanding balance of its Credit Facility, which carries a floating interest rate as well as an interest rate margin, and is therefore also dependent on changes in prevailing interest rates.

The timing and amount of the Company's payments for maintenance vary, depending on the timing of lessee-performed maintenance that is eligible for reimbursement, the aggregate amount of such claims and the timing and amount of maintenance incurred in connection with preparation of off-lease assets for re-lease to new customers. The Company's maintenance payments typically constitute a large portion of its cash needs, and the Company may from time to time borrow additional funds under the Credit Facility to provide funding for such payments.

Management believes that the Company will have adequate cash flow to meet its ongoing operational needs, including any required repayments under the Credit Facility due to borrowing base limitations, based upon its estimates of future revenues and expenditures, which include assumptions regarding (i) revenues for assets to be re-leased, (ii) required debt payments, (iii) interest rates, (iv) the cost and anticipated timing of maintenance to be performed and (v) timely use of proceeds of unused debt capacity toward additional acquisitions of income producing assets.

Although the Company believes that the assumptions it has made in forecasting its cash flow are reasonable in light of experience, actual results could deviate from such assumptions. Among the more significant factors that could have an impact on the accuracy of cash flow assumptions are (i) lessee non-compliance with lease obligations, (ii) inability to locate new lessees for returned equipment within a reasonable remarketing period, or at a rent level consistent with projected rates for the asset, (iii) lessee performance of maintenance, and payment of related maintenance claims, earlier than anticipated, (iv) inability to locate and acquire a sufficient volume of additional assets at prices that will produce acceptable net returns, (v) increases in interest rates, (vi) inability to timely dispose of off-lease assets at prices commensurate with their market value, and (vii) any one or a combination of the above factors that causes the Company to violate covenants under the Credit Facility agreement, which may in turn require repayment of some or all of the amounts outstanding.

(i)Operating activities

The Company's cash flow from operations increased by $1.5 million in the first quarter of 2014 compared to the same period in 2013. As discussed below, the change in cash flow was primarily a result of increases in payments received for operating lease revenue and security deposits as well as a decrease in payments for aircraft insurance, the effects of which were partially offset by increases in payments for maintenance, interest and management fees.

Payments for operating lease revenue and maintenance reserves

Payments received from lessees for rent increased by $2.5 million in the first quarter of 2014 compared to the first quarter of 2013, primarily due to rent from assets purchased during late 2013 and early 2014. Payments received for maintenance reserves decreased by $0.3 million in the first quarter of 2014 compared to the same period in 2013, primarily as a result of payment delinquencies and lower utilization of some assets for which the Company collects maintenance reserves.

The Company is receiving no lease revenue for its assets that are currently off lease, which assets are comprised of three Fokker 50 aircraft, one Saab 340B aircraft, six Fokker 100 aircraft, two General Electric CF34-8E engines, and one Tay 650-15 engine. The Tay 650-15 engine, which was acquired during the first quarter of 2013, is being held as a spare and used in connection with required maintenance on the Company's Fokker 100 aircraft.

Payments for maintenance

Payments for maintenance increased by $1.3 million in the first quarter of 2014 compared to the first quarter of 2013, primarily as a result of an increase in maintenance costs for off-lease aircraft. The amount of payments for maintenance in future periods will depend on the amount and timing of maintenance paid as reimbursement to lessees for maintenance reserves claims, which are dependent upon utilization and required maintenance intervals, and maintenance paid for off-lease assets.

Payment for interest and management fees

Payments for interest and management fees increased by $0.4 million and $0.6 million, respectively, in the first quarter of 2014 compared to the same period of 2013 as a result of a higher Credit Facility balance and asset purchases.

(ii)Investing activities

During the three months ended March 31, 2014 and 2013, the Company received cash of $3.0 million and $1.7 million, respectively, from the sale of assets. During the same time periods, the Company used cash of $32.2 million and $1.8 million, respectively, for purchases and capital improvement of aircraft.

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(iii)Financing activities

The Company borrowed $30.6 million and $0 under the Credit Facility during the first quarters of 2014 and 2013, respectively. In these same time periods, the Company repaid $3.2 million and $0.3 million, respectively, of its total outstanding debt under the Credit Facility. Such repayments were funded by excess cash flow. During the first quarters of 2014 and 2013, the Company paid $0.1 million and $2.1 million of fees related to the extension and administration of the Company's Credit Facility. Such fees are amortized over the term of the Credit Facility.

Outlook

(a)General

The slow recovery from the global downturn has resulted in a significant reduction in airline passenger volume and, in reaction to that, a reduction in the number of aircraft and aircraft engines needed for operation by carriers in nearly all geographic areas, especially Europe. This presents a challenging environment for the Company in three respects:

There remains heightened risk of an unanticipated lessee default, as evidenced by the bankruptcies of two of the Company's customers in each of 2012 and 2013. A lessee's default and the unscheduled return of an asset to the Company for remarketing could result not only in reduced operating lease revenue but also in unanticipated, unrecoverable expenses arising from the lessee's default on its maintenance and return condition obligations. The Company monitors the performance of all of its customers and has noted that several of the Company's customers have experienced weakened operating results and have not yet achieved financial stability.

There is also a greater possibility that the Company's current lessees will choose to return leased assets at lease expiration rather than renew the existing leases, notwithstanding that any such lessee may incur significant expenses to satisfy return conditions. Due to decreased demand for aircraft capacity, it is likely that the Company will experience lower on-lease utilization rates and longer lead times for remarketing of returned assets, as well as lower rental rates for remarketed assets, as was the case with several lease extensions and re-leases since 2011. This trend is expected to continue to affect the Company's operating revenue through 2014.

Finally, due to the slow growth in demand for air travel and capacity by carriers, there is likely to be a lack of significant growth in the pool of customers requiring aircraft. A slow-growing pool of customers requiring aircraft could increase the Company's reliance on a small number of lessees, which increases the Company's risk of financial covenant compliance (see "Factors That May Affect Future Results - Concentration of Lessees and Aircraft Type," below).

(b)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.

At April 30, 2014, the dominant types of aircraft in the Company's portfolio were as follows:

                         Number        % of net
Model                     owned       book value
Bombardier Dash-8-300          9               20 %
Bombardier CRJ-700             3               17 %
Fokker 100                     7               16 %
Bombardier Dash-8-Q400         3               14 %
Bombardier CRJ-705             1               10 %

For the month ended April 30, 2014, the Company's sources of operating lease revenue were from the following regions:

                             % of
                Number     operating
Region        of lessees lease revenue
North America          2           31%
Africa                 2           25%
Asia                   4           18%
Caribbean              1           13%
Europe                 3           12%
South America          1            1%

(c)Remarketing Efforts

In April 2014, the Company sold a Saab 340B aircraft. The Company has a 100% deposit for the sale of a second Saab 340B aircraft. The Company has a signed purchase agreement and deposit for the sale of an off-lease Fokker 50 aircraft. The Company is seeking remarketing opportunities for a Dash-8-300 aircraft, two Fokker 50 aircraft and two General Electric CF34-8E5 engines.

Six of the Company's Fokker 100 aircraft are off lease. The Company has signed letters of intent for the lease of three of the aircraft, has received initial deposits and expects to deliver the aircraft during the second quarter of 2014. The Company is seeking remarketing opportunities for its other off-lease Fokker 100 aircraft.

Leases for nine of the Company's assets will expire during the remainder of 2014. The Company has received indications that the lessees for three of the assets will extend the applicable leases. In addition, the Company believes a fourth lease expiring in 2014 will be extended. The lessee for one asset is considering the purchase option contained in the lease. The Company believes that is likely that the remaining four assets will be returned at lease end.

The Company is considering selling some or all of its off-lease aircraft. The Company is analyzing the amount and timing of maintenance required to remarket the aircraft, the amount of which may differ significantly if the aircraft are sold rather than re-leased.

(d)Credit Facility

The Company believes that available borrowings under the Credit Facility, considering possible lessee arrearages or off-lease periods, will be sufficient to meet its continuing obligations and to fund anticipated acquisitions. However, there can be no assurance the Company's beliefs will prove to be correct and that the Company will have sufficient cash to make any required Credit Facility repayments. Although the Company believes it will continue to be in compliance with all of the Credit Facility covenants through the term of the Credit Facility, there can be no assurance of such compliance, and in the event of any non-compliance, the Company will need to seek waivers or amendment of applicable covenants from its lenders if such compliance failure is not timely cured. Any default under the Credit Facility, if not cured in the time permitted under the facility or waived by the lenders, could result in foreclosure upon any or all of the assets of the Company.

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Factors that May Affect Future Results

Ownership Risks. The Company's leases are typically less than the entire anticipated remaining useful life of the leased assets. The Company's ability to recover its investment in an asset subject to such a lease is dependent upon the Company's ability to profitably re-lease or sell the asset after the expiration of the lease term. Some of the factors that have an impact on the Company's ability to re-lease or sell the asset include worldwide economic conditions, general aircraft market conditions, regulatory changes that may make an asset's use more expensive or preclude use due to the age of the aircraft or unless the asset is modified, changes in the supply or cost of aircraft equipment and technological developments that cause the asset to become obsolete. If the Company is unable to remarket its assets on favorable terms when the leases for such assets expire, the Company's financial condition, cash flow, ability to service debt and results of operations could be adversely affected.

The Company acquires used aircraft equipment. The market for used aircraft equipment has been cyclical, and generally reflects economic conditions and the strength of the travel and transportation industry. The demand for and value of many types of used aircraft in the recent past has been depressed by such factors as airline financial difficulties, the number of new aircraft on order and the number of aircraft coming off lease, as well as introduction of new aircraft models and types that may be more technologically advanced, more fuel efficient and/or less costly to maintain and operate. Values may also increase for certain aircraft types that become desirable based on market conditions and changing airline capacity.

In addition, a successful investment in an asset subject to a lease depends in part upon having the asset returned by the lessee in the condition as required under the lease. Each lease typically obligates a customer to return an asset to the Company in a specified condition, which generally requires it be returned in equal or better condition than at delivery to the lessee. If the lessee becomes insolvent during the term of its lease and the Company has to repossess the asset, it is unlikely that the lessee will have the financial ability to meet these return obligations and it is likely that the Company would be required to expend funds in excess of any maintenance reserves collected to return the asset to a remarketable condition. If the lessee files for bankruptcy and rejects the aircraft lease, although the lessee is required to return the aircraft, the lessee is relieved from all further obligations under the lease, including the obligation to return the aircraft in the condition required under the lease. In that case, it is also likely that the Company would be required to expend funds in excess of any maintenance reserves collected to return the asset to a remarketable condition.

Several of the Company's leases do not require payment of monthly maintenance reserves, which serve as the lessee's advance payment for its future repair and maintenance obligations. If repossession due to lessee default or bankruptcy occurs under such a lease, the Company will be left with the costs of unperformed repair and maintenance under the applicable lease and the Company may incur an unanticipated expense in order to re-lease or sell the asset.

Furthermore, the occurrence of unexpected adverse changes that impact the Company's estimates of expected cash flows generated from an asset may result in an asset impairment charge against the Company's earnings. The Company periodically reviews long-term assets for impairment, in particular, when events or changes in circumstances indicate the carrying value of an asset may not be recoverable. An impairment loss is recognized when the carrying amount of an asset is estimated to be not recoverable and exceeds its fair value. The Company may be required to recognize asset impairment charges in the future as a result of a prolonged weak economic environment, challenging market conditions in the airline industry or events related to particular lessees, assets or asset types.

Lessee Credit Risk. The Company carefully evaluates the credit risk of each customer and attempts to obtain a third party guaranty, letters of credit or other credit enhancements, if it deems them necessary in addition to customary security deposits. There can be no assurance, however, that such enhancements will be available, or that, if obtained, will fully protect the Company from losses resulting from a lessee default or bankruptcy.

If a lessee that is a certified U.S. airline were in default under a lease and sought protection under Chapter 11 of the United States Bankruptcy Code, Section 1110 of the Bankruptcy Code would automatically prevent the Company from exercising any remedies against such lessee for a period of 60 days. After the 60-day period had passed, the lessee would have to agree to perform the lease obligations and cure any defaults, or the Company would have the right to repossess the equipment. However, this procedure under the Bankruptcy Code has been subject to significant litigation, and it is possible that the Company's enforcement rights may be further adversely affected by a bankruptcy filing by a defaulting lessee.

Several of the Company's customers have experienced significant financial difficulties, become insolvent, or have been declared or have filed for bankruptcy. Such an insolvency or bankruptcy usually discharges all unpaid obligations of the customer existing at the time of the filing, resulting in a total loss of those receivables. The Company closely monitors the performance of all of its lessees and its risk exposure to any lessee that may be facing financial difficulties, in order to guide decisions with respect to such lessee that would mitigate losses in the event the lessee is unable to meet or rejects its lease obligations. There can be no assurance that additional customers will not become insolvent or file for bankruptcy or that the Company will be able to mitigate any of the resultant losses.

Risks of Debt Financing; Credit Facility Financial Covenants. The Company's use of debt as the primary form of acquisition financing subjects the Company to increased risks associated with leveraging. In addition to payment obligations, the Credit Facility agreement includes financial covenants, including some requiring the company to have positive earnings, meet minimum net worth standards and be in compliance with certain financial ratios. There can be no assurance that the Company will be in compliance with these covenants under the Credit Facility through its term, and in the event of any non-compliance, the Company would need to seek waivers or amendment of applicable covenants from its lenders if such compliance failure is not timely cured. The Company's assets secure its debt financing, and any default in payment obligations or other covenants under the Credit Facility, if not cured in the time permitted under the facility or waived by the lenders, could result in foreclosure upon any or all of the assets of the Company.

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Credit Facility Debt Limitations. Under the Credit Facility, the amount available to be borrowed is limited to the total amount of asset-specific advance rates (expressed as a percentage of each asset's net book or appraised value). Lessee arrearages or asset off-lease periods may reduce the advance rate for the related assets and, therefore, the permitted borrowing under the facility. Amounts subject to deferral agreements also reduce the borrowing base. The Company believes it will have sufficient cash funds to make any required principal repayment that arises due to any such borrowing base limitations.

Availability of Financing. The Company's continued growth will depend on its ability to continue to obtain capital, either through debt or equity financings. The financial markets have experienced significant setbacks that have continued to make access to capital and asset-based debt financing more costly and difficult to obtain. There can be no assurance that the Company's belief regarding the availability of financing under the current Credit Facility will prove to be correct, or that the Company will succeed in finding additional funding, and if such financing is found, it may be on terms less favorable than the Company's current debt financings.

General Economic Conditions and Lowered Demand for Travel. The Company's business is dependent upon general economic conditions and the strength of the travel and transportation industry. The industry is continuing to experience financial difficulty due to the slow recovery in the global economy. Passenger volume has fallen significantly for many carriers, and the loss of revenue has affected their financial condition. The current lending environment has made it difficult or impossible for many regional carriers to find the additional debt financing on which they have traditionally relied. The confluence of these economic factors increases the likelihood of failures among the Company's customers. The spread of a disease epidemic, the threat or execution of a terrorist attack against aviation, a worsening financial/bank crisis in Europe, a natural event that interrupts air traffic, political crises or other events that cause a prolonged spike in fuel prices, or other like events could exacerbate an already weakened condition and lead to widespread failures in the air carrier industry. If lessees experience financial difficulties and are unable to meet lease obligations, this will, in turn, negatively affect the . . .

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