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| ACY > SEC Filings for ACY > Form 10-Q on 13-Aug-2009 | All Recent SEC Filings |
13-Aug-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 and Six Months Ended June 30, 2009 and 2008
(a)Revenues
Operating lease revenue was $681,800 and $1,257,200 greater in the three months and six months ended June 30, 2009, respectively, compared to the same periods in 2008, primarily because of increases of $576,000 and $1,236,000, respectively, in operating lease revenue from aircraft purchased during 2008, as well as increases related to re-leases of aircraft that were off lease for part of the 2008 periods, 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 the three-month and six-month periods in 2009, respectively.
Maintenance reserves revenue is comprised of non-refundable reserves that are earned based on lessee aircraft usage. Such income was $358,100 and $539,200 lower in the three-month and six-month 2009 periods, respectively, compared to the same periods in 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 periods compared to the 2008 periods.
Other income was $232,600 and $59,200 higher in the three months and six months ended June 30, 2009, respectively, compared to the same periods in 2008, principally because the 2009 periods included $245,400 of interest income related to a federal tax refund received in June 2009. The six-month period of 2008 included $150,000 for compensation paid by a lessee for canceling a potential re-lease transaction.
(b)Expense items
Interest expense was $280,400 higher in the three months ended June 30, 2009, compared to the three moths ended June 30, 2008, primarily because of the net effect of the following:
an increase of $264,100 in Subordinated Notes fee amortization as a result of the issuance of additional Subordinated Notes in July 2008;
a gain in fair value of $141,400 related to the Swap in 2009, compared to a $355,900 gain in 2008 (which gains were reflected as reductions in interest expense for the two periods);
an increase of $148,300 related to a higher outstanding principal balance of Subordinated Notes;
an increase of $112,500 in net settlement interest related to the Swap;
an increase of $6,700 in Credit Facility unused commitment fees as a result of higher average unused available borrowings under the Credit Facility;
a decrease of $371,100 in Credit Facility interest as a result of lower average interest rates;
a decrease of $68,200 related to a lower outstanding balance under the Credit Facility;
a decrease of $22,800 in Subordinated Notes unused commitment fees as a result of lower average unused available borrowings under the Subordinated Notes; and
a decrease of $3,600 in special purpose financing loan fee amortization.
Interest expense was $439,100 lower in the six months ended June 30, 2009, compared to the six moths ended June 30, 2008, primarily because of the net effect of the following:
a decrease of $936,500 in Credit Facility interest as a result of lower average interest rates;
a gain in fair value of $279,700 related to the Swap in 2009, compared to a $114,700 loss on the Swap in 2008 (which gain and loss were reflected as a reduction and an increase, respectively, in interest expense for the two periods);
a decrease of $104,300 related to a lower outstanding balance under the Credit Facility;
a decrease of $45,500 in Subordinated Notes unused commitment fees as a result of lower average unused available borrowings under the Subordinated Notes;
a decrease of $10,000 in special purpose financing loan fee amortization;
an increase of $461,700 in Subordinated Notes fee amortization as a result of the issuance of additional Subordinated Notes in July 2008;
an increase of $303,800 related to a higher outstanding principal balance of Subordinated Notes;
an increase of $277,700 in net settlement interest related to the Swap; and
an increase of $8,400 in Credit Facility unused commitment fees as a result of higher average unused available borrowings under the Credit Facility.
Depreciation was $164,900 and $365,800 greater in the three months and six months ended June 30, 2009, respectively, compared to the same periods in 2008, primarily because of purchases of aircraft during 2008.
Management fees, which are calculated on the net book value of the aircraft, were $23,800 and $67,700 greater in the three months and six months ended June 30, 2009, respectively, compared to the same periods in 2008 because of higher net book values as a result of aircraft acquisitions in 2008. The effects of these increases 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 June 30, 2009, the Company recognized $456,800 more in maintenance expense than in the same period of 2008, due to the net effect of the following:
an increase of $985,500 in expense related to off-lease aircraft; and
a decrease of $528,700 in total lessee work incurred.
In the six months ended June 30, 2009, the Company recognized $419,300 less in maintenance expense than in the same period of 2008, due to the net effect of the following:
a decrease of $1,589,600 in total lessee work incurred; and
an increase of $1,170,300 in expense related to off-lease aircraft.
During the three months and six months ended June 30, 2009, $610,600 and $1,393,700 respectively, of the Company's maintenance expense was funded by non-refundable maintenance reserves which were recorded as income when accrued, as compared to $494,000 and $1,432,600 for the same periods in 2008, respectively.
The Company records non-income based sales, use, value-added and franchise taxes as other tax expense.
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 liability insurance.
The Company's effective tax rates for all periods presented were approximately 34%.
Liquidity and Capital Resources
The Company is currently financing its assets primarily through debt borrowings and excess cash flows.
(a)Credit Facility
The current amount available under the Credit Facility is $80 million and may be increased to a maximum of $110 million either with additional commitments from current Credit Facility participants or with new lenders approved by the Credit Facility agent bank. During the six months ended June 30, 2009, the Company borrowed $0 and repaid $7,096,000 of the outstanding principal under the Credit Facility. The balance of the principal amount owed under the Credit Facility at June 30, 2009, was $51,000,000 and interest of $43,100 was accrued.
The Company was in compliance at June 30, 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 the Swap in December 2007 that expires in December 2009, as discussed in Note 4 above and paragraph (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 the Swap, a two-year interest rate 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 $183,100 and $362,500 for the three months and six months ended June 30, 2009, 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 June 30, 2009, the Company also recognized a $366,100 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 gains on the Swap of $141,400 and $279,700 for the three months and six months ended June 30, 2009, respectively, 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 June 30, 2009, the carrying amount of the Subordinated Notes was $11,931,300 (outstanding principal amount of $12,740,000 less unamortized debt discount of $808,700) and accrued interest payable was $0. The Company is currently, and at June 30, 2009, was, in compliance with all covenants under the securities purchase agreement pursuant to which the Company issued the Subordinated Notes. Based on its current projections, the Company believes it will continue to be in compliance with all covenants of the securities purchase agreement pursuant to which the Company issued the Subordinated Notes, 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 monthly 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 Fokker 50 aircraft, two Saab 340A aircraft, one 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. Six of the Company's leases expire during the second half of 2009. The Company believes that it will be successful in extending the leases for a majority of these aircraft, given preliminary indications from current lessees.
The Company's primary uses of cash are for financing principal and interest payments due under the Company's debt obligations, maintenance expense, management fees, professional fees, and insurance. The debt repayment obligations increased in April 2009, when the Subordinated Notes debt repayment schedule began to require principal amortization in addition to interest. The amount of interest paid by the Company is dependent on the outstanding balance of its Credit Facility and Subordinated Notes debt. Although the Subordinated Notes debt bears a fixed interest rate, the amount of interest owed under the Credit Facility is dependent on changes in prevailing interest rates, since the Credit Facility debt carries a floating interest rate. The amount and timing of the Company's maintenance payments 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.
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, 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.
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 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
The Company's cash flow from operations increased by $2,626,500 in the six months ended June 30, 2009 compared to the same period in 2008. This was primarily due to the net effect of the following in the 2009 period:
an increase of $697,500 in rent collected;
a decrease of $809,700 in maintenance reserves income;
an increase of $358,000 in security deposits;
a decrease of $551,000 in interest paid;
a decrease of $583,700 in maintenance payments; and
receipt of a $1,870,500 federal tax refund, including interest income of $245,400.
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:
Lease rents, maintenance reserves and security deposits
Payments received from lessees for rent were $697,500 greater in the six months ended June 30, 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 $809,700 less in the six months ended June 30, 2009 than in the six months ended June 30, 2008 as a result of lower average usage of aircraft by some the Company's lessees.
The Company received security deposits in the amount of $100,000 during the first six months of 2009. During the first six months of 2008, the Company returned a $308,000 security deposit to a lessee upon return of an aircraft at lease end and received security deposits totaling $50,000.
Payments for interest
Payments for interest decreased by $551,000 in the first six months of 2009 compared to the same period of 2008. The Company paid $1,105,500 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 outstanding balances and lower average index rates upon which the Credit Facility and special purpose financing interest rates were based. The Company also paid $8,200 more in commitment fees related to the unused portion of its Credit Facility in the 2009 period. The Company paid $45,500 less in commitment fees related to its Subordinated Notes debt in the 2009 period because no such fees were payable after the Company's issuance of Subordinated Notes in July 2008. The aggregate effect of these decreases was partially offset by an increase of $303,900 in interest expense related to the Company's Subordinated Notes in the six months ended June 30, 2009, compared to the same period in 2008 as a result of a higher principal balance. During the first six months of 2009, the Company also recorded $287,900 more of net settlement interest related to the Swap than during the 2008 period.
Payments for maintenance
Payments for maintenance were $583,700 lower in the first six months of 2009 compared to the 2008 period, as a result of payments for lessee maintenance claims which were $852,900 lower in 2009, offset partially by $269,200 of higher payments for off-lease aircraft in 2009. 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, which are dependent upon utilization and required maintenance intervals, and maintenance paid for off-lease aircraft.
Income taxes
During the six months ended June 30, 2009 the Company received $1,625,100 of Federal tax refunds and paid taxes of $900. The Company received $210,500 of Federal tax refunds and paid taxes of $500 in the six months ended June 30, 2008.
(ii)Investing activities
During the first six months of 2009 and 2008, the Company used cash of $0 and $14,081,800 respectively, for aircraft purchases and capital equipment installed on aircraft.
(iii)Financing activities
The Company made borrowings of $0 and $12,500,000 during the first six months of 2009 and 2008, respectively. The Company repaid $9,104,000 and $6,131,600 of its outstanding debt in the six months ended June 30, 2009 and 2008, respectively. Such payments were funded by excess cash flow.
Outlook
(a) General
The current global downturn has resulted in a significant reduction in airline passenger volume and in reaction to that, a reduction in the number of aircraft needed for operation by large and small carriers in nearly all geographic areas. This reduction in aircraft demand may have a significant impact on both the acquisition and remarketing areas of the Company's business, and if it continues without improvement for a significant period of time, may have a material impact on the Company's profitability.
With respect to acquisitions, in contrast with previous years, demand for leased aircraft for start-up regional operations or fleet expansion by established carriers has significantly declined. The Company therefore anticipates that there will be few acquisition opportunities for the Company for the remainder of 2009. Furthermore, while this period of industry contraction continues, it is likely that the Company's asset portfolio will grow at a slower rate than in previously years.
The continued reduction in the demand for aircraft by air carriers may also increase the possibility that lessees will choose to return leased aircraft at lease expiration rather than renew the leases for such aircraft. It also increases the risk of a lease default by lessees of the Company, particularly less-established carriers. If the Company experiences an unanticipated increase in the number of its aircraft being returned at lease end or upon a lessee default, this combined with the lack of other carriers seeking aircraft in this environment of contraction may make finding replacement lessees more challenging for the Company, and require a larger proportion of the Company's focus than in years past. A significant increase in the number of aircraft off-lease, or a significant increase in the time that returned aircraft are off lease, will have an adverse impact on the Company's results.
In the short term, however, except for the lease termination and payment deferrals discussed in more detail below, the Company has not yet 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 the majority of its customers. The Company is closely monitoring the performance of all of its lessees
To date in 2009, the Company has agreed to rent payment deferrals for three of its lessees, to assist them through a difficult financial situation related to each carrier's specific situation but in some cases exacerbated by the global economic situation.
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 all four payments.
In April 2009, the Company received a request from a Mexican lessee of three of the Company's Fokker 100 aircraft to defer certain future payments, primarily as a result of a decrease in passenger volume due to the H1N1 virus outbreak. In June, the Company and the lessee entered into an agreement which deferred payment of three months of rent for each aircraft and allowed for the application of a portion of the security deposits held by the Company to maintenance reserves owed to the Company. The deferred rent is to be paid in monthly installments from January 2010 through the expiration date of each lease.
In June 2009, the Company also agreed to defer payment of rent and reserves due from the lessee of two of the Company's DHC-8-100 and one DHC-8-300 aircraft. The agreement allows for the deferred amount to be paid in monthly installments beginning in August 2009.
(b)Pending Transactions and Remarketing Efforts
The Company has a signed term sheet and received a deposit for the re-lease of its two off-lease Saab 340A aircraft and one spare engine. Delivery of both aircraft to the lessee is expected to occur in the second half of 2009. The Company is currently seeking to re-lease a Fokker 50 aircraft and a Saab 340B aircraft that were returned by their previous lessees in August 2008 and February 2009, respectively. The amount of maintenance expense that will be incurred in future periods for work necessary to prepare the four currently off lease aircraft and one off-lease engine for re-lease is estimated to total approximately $1,700,000.
To date in 2009, the Company has extended the leases for five of its aircraft. The Company is currently negotiating the extension of four of the six other aircraft leases that expire in the remainder of 2009, and the Company believes that it will be successful in extending the leases for a majority of these aircraft, given preliminary indications from the 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.
Factors that May Affect Future Results
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 in a period of financial difficulty and contraction due to the global economic downturn. Passenger volume has fallen significantly for carriers in all parts of the globe, and the loss of revenue has affected many carriers' financial condition. This loss of revenue, combined with the continuing unavailability of additional debt financing relied on by many regional carriers caused by the current credit crisis, may increase the likelihood of failures. Events such as the spread of the H1N1 flu epidemic to other parts of the globe or a terrorist attack against aviation which could exacerbate an already weakened condition and lead to widespread failures in the air carrier industries. If lessees experience financial difficulties and are unable to meet lease obligations, this will, in turn, affect the Company's financial performance.
Ownership Risks. The Company's portfolio is leased under operating leases, where the terms of the leases are less than the entire anticipated useful life of an asset. The Company's ability to recover its purchase investment in an asset subject to an operating lease is dependent upon the Company's ability to profitably re-lease or sell the asset after the expiration of the initial lease term. Some of the factors that have an impact on the Company's ability to re-lease or sell include worldwide economic conditions, general aircraft market conditions, regulatory changes that may make an asset's use more expensive or preclude use unless the asset is modified, changes in the supply or cost of aircraft equipment and technological developments which cause the asset to . . .
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