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| ACY > SEC Filings for ACY > Form 10-Q on 14-May-2009 | All Recent SEC Filings |
14-May-2009
Quarterly Report
The following discussion should be read in conjunction with the Company's Form 10-K for the year ended December 31, 2008, and the unaudited financial statements and the related notes that appear elsewhere in this report.
Results of Operations for the Three Months Ended March 31, 2009 and 2008
(a) Revenues
Operating lease revenue was $575,300 greater in the three months ended March 31, 2009, compared to the same period in 2008, primarily because of a $793,000 increase in operating lease revenue from aircraft purchased during 2008, re-leases of two of the Company's aircraft that were off lease for part of the first quarter of 2008, and re-leases of several of the Company's aircraft during 2008 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 2009 in the amount of $221,000.
Maintenance reserves revenue, comprised of non-refundable reserves that are earned based on lessee aircraft usage, was $1,568,400 and $1,749,500 in the three months ended March 31, 2009, and 2008, respectively. Such income was $181,100 lower in the 2009 period compared to 2008 primarily as a result of lower average usage of aircraft by some the Company's lessees and because there were more aircraft off lease in the 2009 period compared to the 2008 period.
Other income was $173,300 lower in the three months ended March 31, 2009, compared to the same period in 2008, principally because the 2008 period included $150,000 of compensation paid by a lessee for canceling a potential re-lease transaction.
(b) Expense items
Interest expense was $719,500 lower in the three months ended March 31, 2009, compared to the three moths ended March 31, 2008, primarily because of the net effect of the following:
• a gain in fair value of $138,300 related to the interest rate swap in the three months ended March 31, 2009, compared to a $470,600 loss in the same period of 2008 (which were reflected as a reduction and an increase, respectively, in interest expense for the two periods);
• a decrease of $563,600 in Credit Facility interest as a result of lower average interest rates;
• a decrease of $28,100 in Credit Facility and Subordinated Notes unused commitment fees as a result of lower average unused balances;
• an increase of $118,500 related to higher Credit Facility and Subordinated Notes balances;
• an increase of $197,500 in Subordinated Notes fee amortization as a result of the issuance of additional Subordinated Notes in July 2008; and
• an increase of $165,100 in net settlement interest related to the interest rate swap.
Depreciation was $200,900 greater in the three months ended March 31, 2009, compared to the same period in 2008, primarily because of purchases of aircraft during 2008.
Management fees, which are calculated on the net book value of the aircraft, were $43,900 greater in the three months ended March 31, 2009, compared to the same period in 2008 because of higher net book values as a result of aircraft acquisitions in 2008. The effects of this increase were partially offset by the effect of depreciation.
The Company's maintenance expense is dependent on the aggregate amount of maintenance incurred by lessees related to non-refundable reserves and expenses incurred in connection with off-lease aircraft, and, therefore, can vary greatly between periods. In the three months ended March 31, 2009, the Company recognized $876,100 less in maintenance expense than in the same period of 2008, due to the net effect of the following:
• a decrease of $1,060,800 in total lessee work incurred; and
• an increase of $184,700 in expense related to off-lease aircraft.
During the first three months of 2009 and 2008, the Company incurred $783,100 and $938,600, respectively, of maintenance expense was funded by non-refundable maintenance reserves, which were recorded as income when accrued.
The Company records non-income based sales, use, value-added and franchise taxes as other tax expense. Such expenses were $136,500 higher in the three months ended March 31, 2009, compared to the same period in 2008. The increase was partially due to an increase in Delaware state franchise taxes of $55,400, the effect of which was partially offset by a $32,600 decrease in value-added taxes related to an aircraft leased in Australia. In 2008, upon completion of further analysis and confirmation from the Australian tax authority, the Company reduced the accruals for such amounts in the three months ended March 31, 2008 by $113,700.
The Company's insurance expense consists primarily of 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, as well as directors and officers insurance. Aircraft insurance expense was $16,500 greater in the first three months of 2009 compared to the same period in 2008 as a result of differences in the type of and length of time the insured assets were off lease. Directors and officers insurance was $1,500 higher in the 2009 period as a result of higher premiums.
The Company's effective tax rates for the three months ended March 31, 2009 and 2008 were approximately 34% for both periods.
The Company is currently financing its assets primarily through debt borrowings and excess cash flows.
(a) Credit Facility
The current amount available under the Company's revolving credit facility (the "Credit Facility") is $80 million and may be increased to a maximum of $110 million. During the three months ended March 31, 2009, the Company borrowed $0 and repaid $3,596,000 of the outstanding principal under the Credit Facility. The balance of the principal amount owed under the Credit Facility at March 31, 2009, was $54,500,000 and interest of $53,800 was accrued.
The Company was in compliance at March 31, 2009, and currently is in compliance with all covenants of the Credit Facility. 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, although the Company did enter into an interest rate swap in December 2007 that expires at the end of 2009, as discussed in (b) below. 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.
(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 Swap is designed to limit exposure to interest rate increases on $20 million of the Company's Credit Facility debt by fixing the net interest payable over the term of the Swap.
The Company recognized net settlement expense related to the Swap of $179,400 for the three months ended March 31, 2009, 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 March 31, 2009, the Company also recognized a $507,500 liability for the Swap on its condensed consolidated balance sheet as a component of notes payable and accrued interest, which reflects market expectations concerning the "spread" between fixed and variable interest rates over the remaining term of the Swap. The Company also recognized a gain of $138,300 for the three months ended March 31, 2009 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. Over the remaining term of the Swap, so long as there is no default by either counterparty and the Company does not elect to terminate it early, the change in fair value of the Swap will be recognized as a reduction in interest expense.
(c) Senior unsecured subordinated debt
As of March 31, 2009, the carrying amount of the Subordinated Notes was $13,008,400 (outstanding principal amount of $14,000,000 less unamortized debt discount of $991,600) and accrued interest payable was $0. The Company is currently, and at March 31, 2009, was, in compliance with all covenants under the Subordinated Notes Agreement. Based on its current projections, the Company believes it will continue to be in compliance with all covenants of its Subordinated Notes Agreement, 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.
(d) Special purpose financings
In March 2009, the Company repaid the outstanding principal of $646,800 owed by AeroCentury VI LLC under its special purpose financing and paid a prepayment penalty of $1,300. At the same time, the Company transferred ownership of the aircraft that served as collateral for the financing from AeroCentury VI LLC to AeroCentury Corp., whereupon the aircraft became eligible as collateral under the Credit Facility.
(e) Cash flow
The Company's primary sources of cash are aircraft lease rentals and maintenance reserves billed to lessees based on aircraft usage. Maintenance reserves collected by the Company are not required by the leases to be segregated and are included in cash and cash equivalents on the Company's condensed consolidated balance sheet.
The Company is currently not receiving lease revenue for its off-lease assets, comprised of one of the Company's Fokker 50 aircraft, its two Saab 340A aircraft, a Saab 340B aircraft and one turboprop engine. The Company has and will continue to incur significant maintenance expense in order to prepare these aircraft for re-lease. Eight of the Company's leases expire in 2009. The Company believes that it will be successful in extending the leases for a majority of the aircraft, given preliminary indications from current lessees.
The Company's primary uses of cash are for financing interest payments, maintenance expense, management fees, professional fees, insurance and, beginning in April 2009, principal payments on the Subordinated Notes pursuant to an amortization schedule. 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 and Subordinated Notes debt. In addition, the amount of interest expenditures related to the Company's Credit Facility is 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 and Subordinated Notes financing, 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,
(iii) required debt payments, (iv) interest rate increases and decreases, and
(v) 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, (iv) lessee performance of maintenance earlier than anticipated and (v) failure of the Credit Facility participants to fully fund their respective commitments.
(i) Operating activities
Although the Company's net income was $942,600 higher in the three months ended March 31, 2009 compared to the same period in 2008, the Company's cash flow from operations decreased by $422,400 in the 2009 period compared to 2008. This was primarily due to maintenance expense accrued in the first quarter of 2008, but not paid until the second quarter. The change in cash flow from period to period is a result of changes in several cash flow items during the period, including principally the following:
Payments received from lessees for rent were $223,200 greater in the three months ended March 31, 2009, compared to the same period in 2008, due primarily to rent payments for aircraft acquired during 2008, and re-leases during 2008 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 2009 period.
Payments received for refundable and non-refundable maintenance reserves are based on usage of the Company's aircraft. Such payments were $363,800 less in the three months ended March 31, 2009, than in the three months ended March 31, 2008 as a result of lower average usage of aircraft by some the Company's lessees.
The Company did not receive or return any security deposits during the first three months of 2009. During the first three months of 2008, the Company returned a $308,000 security deposit to a lessee upon return of an aircraft at lease end.
Payments for interest
Payments for interest decreased by $369,600 in the first three months of 2009 compared to the same period of 2008. The Company paid $669,600 less interest related to the Company's Credit Facility and special purpose financing debt in the 2009 period compared to the same period in 2008 as a result of lower average index rates upon which the Credit Facility and special purpose financing interest rates were based. The Company also paid $2,000 more in commitment fees related to the unused portion of its Credit Facility in the 2009 period. The Company paid $23,000 less in commitment fees related to its Subordinated Notes debt in the 2009 period because no such fees are payable after the Company's second Subordinated Notes draw in July 2008. The aggregate effect of these decreases was partially offset by an increase of $155,600 in interest expense related to the Company's Subordinated Notes in the three months ended March 31, 2009, compared to the same period in 2008 as a result of a higher principal balance. During the first three months of 2009, the Company also recorded $165,400 more of net settlement interest related to the Swap than during the first three months of 2008.
Payments for maintenance
Payments for maintenance were $897,400 greater in the first three months of 2009 compared to the first three months of 2008, as a result of higher maintenance expenditures for off-lease aircraft of $1,087,400 offset partially by $191,000 of lower payments for lessee maintenance claims. The amount of payments for maintenance in future periods will be dependent on the amount and timing of maintenance paid as reimbursement to lessees from maintenance reserves and maintenance paid for off-lease aircraft, both of which will largely be influenced by utilization of and maintenance cycles on aircraft.
Income taxes
The Company paid taxes of $400 and $1,300 in the three months ended March 31, 2009, and 2008, respectively. During the three months ended March 31, 2008, the Company received $210,500 of federal tax refunds.
(ii) Investing activities
During the first three months of 2009 and 2008, the Company used cash of $0 and $25,300 respectively, for capital equipment installed on aircraft.
(iii) Financing activities
The Company made no borrowings during the first three months of 2009 or 2008. The Company repaid $4,344,000 and $1,841,900 of its outstanding debt in the three months ended 2009 and 2008, respectively. Such payments were funded by excess cash flow.
Because the global economy is in a significant downturn, the Company anticipates that many air carriers will be forced to reduce capacity, which may negatively impact their needs for additional aircraft, which in turn may mean fewer leasing or sales opportunities for the Company. To date, except for the lease termination and payment deferrals discussed below, the Company has not experienced significant changes in any of its customers' payment timeliness but has seen indications of a weakening in the financial condition and operating results of some customers.
The current tightening of the credit markets may create increased demand for sale-leasebacks from carriers as a way to monetize owned assets, or from carriers that are proceeding with fleet expansions but are unable to obtain asset-based acquisition loans. The Company therefore anticipates that there will be opportunities for acquisitions during 2009 albeit fewer than in previous years, and that the available borrowing capacity under the Credit Facility will be sufficient to fund targeted acquisitions projected through 2009.
The Company is currently seeking to re-lease its two Saab 340A aircraft, one Saab 340B aircraft, and one Fokker 50 aircraft that are off lease.
One of the Saab 340A aircraft has already had significant maintenance performed on it to ready it for remarketing. Maintenance on the second Saab 340A aircraft, estimated to cost approximately $367,000, will not commence until a new lessee is identified.
The Fokker 50 aircraft was returned early by its lessee, which ceased operations due to insolvency in late 2008. Maintenance reserves of approximately $1.1 million previously collected from the lessee and previously recorded as income are being used to partially fund the work necessary to prepare the aircraft for re-lease. The repair work commenced in late 2008, and the Company recorded approximately $1.2 million of expense through December 31, 2008 and approximately $200,000 during the first quarter of 2009. Expense for remaining work will be recognized when performed, which the Company expects to occur before September 30, 2009. Total maintenance expense to prepare this aircraft for re-lease is estimated to be $1.8 million. The Company is currently negotiating a term sheet for the off-lease Fokker 50 aircraft with a current lessee of two other of the Company's Fokker 50 aircraft.
Additionally, one of the Company's Saab 340B aircraft is undergoing maintenance in preparation for re-leasing to another lessee. In January 2009, the Company terminated its lease for the aircraft with an Australian lessee due to payment and other defaults under the lease. The expiration date of the lease for this aircraft had been in March 2009. The lessee has ceased operations and its business is being wound up under local insolvency laws. The Company does not anticipate a significant monetary recovery on any claims against the lessee given the number of secured claims on the lessee's few remaining assets. The Company estimates that the aircraft will require approximately $1.3 million of maintenance to prepare it for re-lease. Through March 31, 2009, the Company recorded approximately $200,000 of expense to prepare the aircraft for re-lease. The Company believes that it will be able to complete the remaining required maintenance and find a new customer for the aircraft during 2009.
To date in 2009, the Company has extended the leases for three of its aircraft and is negotiating the extension of a fourth lease. Seven of the Company's other aircraft leases expire in 2009, and the Company believes that it will be successful in extending the leases for a majority of these aircraft, given preliminary indications from current lessees. If the aircraft that are currently off lease remain off lease for an extended period of time and the Company is not successful in extending the leases for a majority of the eight aircraft with leases expiring in 2009, the Company may not be able to meet its operational needs or 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 works where necessary with lessees to ensure continued compliance with obligations under their respective leases. Currently, the Company is closely monitoring the performance of three lessees with a total of seven aircraft under lease. The Company continues to work closely with these lessees to ensure compliance with their current obligations. In February 2009, the Company and the lessee of two of the Company's aircraft agreed to defer a portion of the rent and maintenance reserves due from the lessee. The deferral required payment in four, equal monthly installments beginning in March 2009; the Company has received the first two payments. Another lessee has indicated to the Company that due to a significant drop in revenue as a result of the H1N1 virus crisis, the lessee may seek a three-month rent deferral from the Company.
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.
The Company accrues non-refundable maintenance reserves billed to lessees as income based on aircraft usage and records maintenance expenses as incurred. The Company accrues estimated maintenance costs based on information provided by its lessees and, accordingly, estimates of such expenses depend on timely and accurate reporting by such parties. Because revenue accrues based upon utilization of aircraft, but expense depends upon costs accrued for actual maintenance events, which may be somewhat sporadic, the Company expects that its reported net income will be subject to significant fluctuations between different reporting periods. Due to the acquisition of Fokker 100 jet engine powered aircraft during 2007 and 2008, the magnitude of these fluctuations may be greater due to 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 honor their commitment to provide loans as committed in the Credit Facility agreements and that the unused capacity under the Credit Facility will remain available and provide 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. The current term of the Credit Facility expires in March 2010. While the Company anticipates that, at that time, the current lenders participating in the facility will remain as participants in the amount for which they are currently committed, there is no assurance that such will occur. If one or more participants does not continue, then the Company will either need to pay off such participant by obtaining additional commitment amounts from the remaining lenders, finding new replacement lenders, or selling assets, or doing a combination of any of the foregoing.
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 any or all of 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, the second tranche of which closed in July 2008, while providing additional resources for acquisitions of revenue generating assets, also had the effect of increasing the Company's overall cost of capital, as they bear an effective overall interest rate that is currently higher than the rate payable under the Credit Facility. The two tranches of Subordinated Notes financing started bearing interest immediately upon their issuance and, therefore, timely acquisition of income producing assets has become more critical to the Company's financial results. The agreement under which the Subordinated Notes were issued also contains financial and other covenants which, if violated, could cause a default.
General Economic Conditions and Lowered Demand for Travel. The Company's business is dependent upon general economic conditions and the strength of the . . .
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