Fleet Summary
(a)
Assets Held for Lease
Key portfolio metrics of the Company’s aircraft held for lease as of
March 31
, 2019 and December 31, 2018 were as follows:
|
|
March 31
,
2019
|
|
|
December 31, 2018
|
|
Number of aircraft and engines held for lease
|
|
|
16
|
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
Weighted average fleet age
|
|
11.1 years
|
|
|
11.1 years
|
|
Weighted average remaining lease term
|
|
57 months
|
|
|
58 months
|
|
Aggregate fleet net book value
|
|
$
|
174,310,900
|
|
|
$
|
184,019,900
|
|
|
For the Three Months Ended
March 31
,
|
|
2019
|
2018
|
Average portfolio utilization
|
98%
|
90%
|
The year-to-year increase was primarily due to sales during 2018 of assets that were off lease in the 2018 period.
The following table sets forth the net book value and percentage of the net book value, by type, of the Company’s assets that were held for
lease at
March 31
, 2019 and December 31, 2018:
|
|
March 31
, 2019
|
|
|
December 31, 2018
|
|
Type
|
|
Number
owned
|
|
|
% of net book value
|
|
|
Number
owned
|
|
|
% of net book value
|
|
Turboprop aircraft:
|
|
|
|
|
|
|
|
|
|
|
|
|
Bombardier Dash-8-400
|
|
|
2
|
|
|
|
14
|
%
|
|
|
2
|
|
|
|
13
|
%
|
Bombardier Dash-8-300
|
|
|
1
|
|
|
|
2
|
%
|
|
|
2
|
|
|
|
5
|
%
|
Saab 340B Plus
|
|
|
-
|
|
|
|
-
|
%
|
|
|
-
|
|
|
|
-
|
%
|
Saab 340B
|
|
|
-
|
|
|
|
-
|
%
|
|
|
-
|
|
|
|
-
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regional jet aircraft:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Canadair 900
|
|
|
5
|
|
|
|
40
|
%
|
|
|
5
|
|
|
|
39
|
%
|
Embraer 175
|
|
|
3
|
|
|
|
17
|
%
|
|
|
3
|
|
|
|
16
|
%
|
Canadair 1000
|
|
|
2
|
|
|
|
14
|
%
|
|
|
2
|
|
|
|
14
|
%
|
Canadair 700
|
|
|
3
|
|
|
|
13
|
%
|
|
|
3
|
|
|
|
12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Engines:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pratt & Whitney 150A
|
|
|
-
|
|
|
|
-
|
%
|
|
|
1
|
|
|
|
1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the first quarter of 2019, the Company purchased no aircraft, and sold one aircraft and certain aircraft parts. During the first
quarter of 2018, the Company purchased no aircraft and sold two aircraft that were held for lease and parts from assets that were held for sale.
The following table sets forth the net book value and percentage of the net book value of the Company’s assets that were held for lease at
March 31
, 2019 and December 31, 2018 in the indicated regions (based on the domicile of the lessee):
|
|
March 31
, 2019
|
|
|
December 31, 2018
|
|
Region
|
|
Net book value
|
|
|
% of
net book value
|
|
|
Net book value
|
|
|
% of
net book value
|
|
Europe
|
|
$
|
107,953,500
|
|
|
|
62
|
%
|
|
$
|
110,069,000
|
|
|
|
60
|
%
|
North America
|
|
|
66,357,400
|
|
|
|
38
|
%
|
|
|
68,485,400
|
|
|
|
37
|
%
|
Asia
|
|
|
-
|
|
|
|
-
|
%
|
|
|
5,465,500
|
|
|
|
3
|
%
|
|
|
$
|
174,310,900
|
|
|
|
100
|
%
|
|
$
|
184,019,900
|
|
|
|
100
|
%
|
For the three months ended
March
31, 2019,
approximately 29%, 27% and 20% of the Company’s operating lease revenue was derived from customers in Slovenia, the United States and Spain, respectively. Operating lease revenue does not include interest income from the Company’s finance leases.
The following table sets forth geographic information about the Company’s operating lease revenue for leased aircraft and aircraft equipment, grouped by domicile of the lessee:
|
|
For the Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Region
|
|
Number
of lessees
|
|
|
% of
operating
lease revenue
|
|
|
Number
of lessees
|
|
|
% of
operating
lease revenue
|
|
Europe
|
|
|
4
|
|
|
|
60
|
%
|
|
|
3
|
|
|
|
56
|
%
|
North America
|
|
|
4
|
|
|
|
36
|
%
|
|
|
4
|
|
|
|
39
|
%
|
Asia
|
|
|
1
|
|
|
|
4
|
%
|
|
|
1
|
|
|
|
5
|
%
|
At
March 31
, 2019 and December 31, 2018, the Company
also had six aircraft subject to finance leases. For the quarter ended
March 31
, 2019, approximately 62% and 38% of the Company’s finance lease revenue was
derived from customers in Africa and Europe, respectively.
(b)
Assets Held for Sale
Assets held for sale at
March
31, 2019 consisted of two
Saab 340B Plus turboprop aircraft, one Bombardier Dash-8-300 aircraft, one Pratt & Whitney 150A engine and airframe parts from two turboprop aircraft.
Results of Operations
(a)
Revenues and Other Income
Revenues and other income decreased by 4% to $7.6 million in the first quarter of 2019 from $7.9 million in the first quarter of 2018. The
decrease was primarily a result of decreased maintenance reserves and finance lease revenues, the effects of which were partially offset by increases in operating lease revenues and gains on the sale of older assets.
Operating lease revenue increased by 11% to $7.1 million in the first quarter of 2019 from $6.5 million in the first quarter of 2018,
primarily due to revenue from assets purchased in the second quarter of 2018.
Finance lease revenue decreased by 38% to $0.2 million in the first quarter of 2019 from $0.4 million in the first quarter of 2018, primarily
due to a lower finance lease receivables balance in the 2019 period and the purchase by the lessee of three aircraft subject to finance leases during the third quarter of 2018.
Maintenance reserves that are retained by the Company at lease end are recorded as revenue at that time. The Company recorded no such
revenue during the first quarter of 2019. During the first quarter of 2018, the Company recorded $1.1 million of such revenue, arising from cash received from the former lessee of three aircraft after such aircraft were returned to the Company by
the lessee during 2017. Such amounts were not accrued at lease termination based on management’s evaluation of the creditworthiness of the lessee.
During the first quarter of 2019, the Company recorded gains totaling approximately $0.2 million on the sale of an aircraft and aircraft
parts.
During the first quarter of 2018, the Company sold two aircraft and recorded a net loss of $8,200.
(b)
Expenses
Total expenses increased by 25% to $9.2 million in the first quarter of 2019 from $7.4 million in the first quarter of 2018. The increase
was primarily a result of increases in interest expense, salaries and employee benefits and professional fees, general and administrative and other expenses and asset impairment provisions. These increases were partially offset by a decrease in
management fees.
The Company’s interest expense increased by 29% to $2.9 million in the first quarter of 2019 from $2.3 million in the same period of 2018,
primarily as a result of a higher average debt balance, a higher average interest rate and $0.4 million of valuation charges related to the Company’s interest rate swaps.
Until the acquisition of JHC on October 1, 2018, management fees paid to JMC were based on the net book value of the Company’s aircraft and
engines as well as finance lease receivable balances. After the Merger, JMC’s operating expenses, including salaries and employee benefits, became the responsibility of the Company. The total of management fees, salaries and employee benefits and
professional fees, general and administrative and other expenses was approximately $1.4 million and $2.0 million in the first quarters of 2019 and 2018, respectively. Professional fees, general and administrative and other expenses in the 2018
period included $200,000 incurred in connection with the acquisition of JHC.
During the first quarter of 2019, the Company recorded impairment charges totaling $1.4 million on two aircraft and an engine held for sale,
based on expected sales proceeds. The Company recorded no impairment provisions during the first quarter of 2018.
Liquidity and Capital Resources
The Company is currently financing its assets and operations primarily through debt financing and excess cash flow from operations.
(a)
Credit
Facility
The Company has a Credit Facility, as described in Note 4(a) to the Company’s condensed consolidated financial statements in this report. In
February 2019, the Credit Facility, which had availability of $170 million (with the ability for the Company to request an increase up to $180 million) and was to mature on May 31, 2019, was extended to February 19, 2023, reduced to $145 million
(with the ability for the Company to request an increase up to $160 million) and amended in certain other respects, including with respect to certain of the Company’s financial covenants thereunder.
In addition to payment obligations (including principal and interest payments on outstanding borrowings and commitment fees based on the
amount of any unused portion of the Credit Facility), the Credit Facility contains financial covenants with which the Company must comply, including, but not limited to, positive earnings requirements, minimum net worth standards and certain
ratios, such as debt to equity ratios.
The Company was in compliance with all covenants under the Credit Facility at March 31, 2019. The Company was not in compliance with the
interest coverage, debt service coverage, no-net-loss and revenue concentration covenants under the Credit Facility at
December 31
, 2018. The December 31, 2018
noncompliance was cured by the February 2019 amendment and restatement of the agreement governing the Credit Facility, which also revised certain of these financial covenants requirements through the February 2023 maturity date of the extended
Credit Facility.
If the Company is out of compliance with any of its Credit Facility covenants at future calculation dates, it would need to request waivers
or amendments of applicable covenants from the lenders if such compliance failure is not timely cured. Any such future noncompliance
that is not timely cured or waived
would result in a default under the Credit Facility, which could have material negative consequences, as described further below.
The Company’s ability to maintain compliance with its covenants in the Credit Facility is subject to a variety of factors, including, among
others (i) unanticipated decreases in the market value of the Company’s assets, or in the rental rates deemed achievable for such assets, that cause the Company to record an impairment charge against earnings, (ii) lessee noncompliance with lease
obligations, (iii) inability to locate new lessees for returned aircraft or equipment within a reasonable remarketing period, or at a rent level consistent with projected rates, (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, and (vi) inability to timely dispose of off-lease assets at prices commensurate with their market value.
Any default under the Credit Facility, if not cured in the time permitted or waived by the lenders, could result in the Company’s inability
to borrow any further amounts under the Credit Facility, the acceleration of the Company’s obligation to repay amounts borrowed under the Credit Facility, or foreclosure upon any or all of the assets of the Company.
In order to reduce its exposure to the risk of increased interest rates The Company entered into two Swaps in March 2019, which have an
aggregate total notional amount equal to $50 million and extend through the maturity of the Credit Facility in February of 2023.
(b)
Special
Purpose Financing and Term Loans
In August 2016, the Company acquired, using wholly-owned special purpose entities, two regional jet aircraft, using cash and third-party
financing (referred to as “special purpose financing” or “UK LLC SPE Financing”) separate from the Credit Facility, as described in Note 4(b) to the Company’s condensed consolidated financial statements in this report.
In February 2019, the UK LLC SPE Financing was repaid as part of a refinancing involving the Term Loans, which were made to special purpose
subsidiaries of the Company. Under the Term Loans, four aircraft that previously served as collateral under the Credit Facility were moved into newly formed special purpose subsidiaries and, along with the aircraft owned by the two existing
special purpose subsidiaries, were pledged as collateral under the Term Loans.
All of the Term Loans contain cross-default provisions, so that any default by a lessee of any of the subject aircraft could result in the
Term Loan lender exercising its remedies under the Term Loan agreement, including, but not limited to, possession of the aircraft that is subject to a lessee default. In addition, a default under the Term Loan agreement would be a default under
the Credit Facility agreement.
Collectively, the LLC Borrowers entered into six interest rate derivatives, or Swaps. Each such swap has a notional amount that mirrors the
amortization under the corresponding Term Loan entered into by the LLC Borrowers, effectively converting each of the six Term Loans from variable rate to fixed rate. Each of these six Swaps extend for the length of the corresponding Term Loan,
with maturities from 2020 through 2025.
(c)
Cash
Flow
The Company’s primary sources of cash from operations are payments due under the Company’s operating and finance leases, maintenance
reserves, which are billed monthly to lessees based on asset usage, and proceeds from the sale of aircraft and engines.
The Company’s primary uses of cash are for (i) purchases of assets, (ii) Credit Facility and Term Loans financing interest, principal and
interest swap payments, (iii) before completion of the Merger, management fees and expense reimbursement owed to JMC, (iv) after completion of the Merger, salaries, employee benefits and general and administrative expenses, (v) professional fees,
including legal, accounting and directors’ fees costs and maintenance expense and (vi) reimbursement to lessees from collected maintenance reserves.
The Company’s payments for maintenance consist of reimbursements to lessees for eligible maintenance costs under their leases and maintenance
incurred directly by the Company for preparation of off-lease assets for re-lease to new customers. The timing and amount of such payments may vary widely between quarterly and annual periods, as the required maintenance events can vary greatly in
magnitude and cost, and the performance of the required maintenance events by the lessee or the Company, as applicable, are not regularly scheduled calendar events and do not occur at uniform intervals. 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, if available, or seek alternative sources of financing to provide funding for these payments.
Prior to the Company’s acquisition of JHC on October 1, 2018, the Company’s portfolio of aircraft assets was managed and administered under
the terms of the Management Agreement with JMC. Under the Management Agreement, JMC received a monthly management fee based on the net asset value of the Company’s assets under management. JMC also received an acquisition fee for locating assets
for the Company to acquire. Acquisition fees were included in the cost basis of the asset purchased. JMC also received a remarketing fee in connection with the re-lease or sale of the Company’s assets. Remarketing fees were amortized over the
applicable lease term or included in the gain or loss on sale.
Following the Merger, the risk of increased JMC expenses, including employee salaries and benefits, worldwide travel related to the
management of the Company's aircraft portfolio, office rent, outside technical experts and other overhead expenses, is now the responsibility of the Company. In addition, because the management and administrative services previously performed by
JMC are now internalized, the Company is no longer paying management or acquisition fees to JMC in exchange for the performance of these services. As a result, the Company expects the types, timing and amounts of, and patterns and trends with
respect to, its recorded expenses to change as a result of the Merger, but the manner and extent of these changes remains uncertain until the Company has performed and controlled these functions for some period of time.
The amount of interest paid by the Company depends primarily on the outstanding balance of its Credit Facility. Although the amounts owed
under the Credit Facility accrue interest at a floating rate plus an interest rate margin, and are thus dependent on fluctuations in prevailing interest rates, in March 2019 the Company entered into two interest rate swap transactions for the
variable interest rate payment amounts due for $50 million of the outstanding Credit Facility debt. As a result, although the amount of interest paid by the Company under the Credit Facility will fluctuate depending on prevailing interest rates,
the swap will offset some of this variability such that the Company will be affected by interest rate fluctuations under the Credit Facility only to the extent of any excess of the outstanding balance under the Credit Facility over the amount
covered by the related interest rate swap. Interest related to the Company’s Term Loans also accrues at variable rates, but the Company has entered into interest rate swaps that effectively convert the Term Loans interest payments to fixed rate
payments.
The Credit Facility and the Term Loans, as well as their related interest rate swap transactions, use LIBOR as a benchmark for establishing
the rates at which interest accrues. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform. These reforms and other pressures may cause LIBOR to disappear entirely or to perform differently
than in the past. Although the consequences of these developments cannot be entirely predicted, they could include an increase in the cost to the Company of its LIBOR debt or even an acceleration of maturity of such debt if a suitable replacement
index cannot be agreed upon or is not available.
Management believes that the Company will have adequate cash flow to meet its ongoing operational needs, including any required repayments
under the Credit Facility and Term Loans, for at least the next 12 months from the issuance of this Quarterly Report, based upon its current estimates of future revenues and expenditures. These estimates reflect assumptions about, among other
things, (i) revenues from assets to be re-leased, (ii) the amount, timing and patterns of management and administrative expenses being borne by the Company after the Merger rather than a third -party management company, (iii) cost and anticipated
timing of aircraft maintenance to be performed, (iv) required debt payments, (v) timely use of proceeds of unused debt capacity for additional acquisitions of income-producing assets, and (vi) interest rates.
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. As discussed
above, in
Liquidity and Capital Resources – (a) Credit Facility
, and below in
Outlook
and
Factors that May Affect Future Results and Liquidity
, there are a
number of factors that may cause actual results to deviate from these forecasts. If these assumptions prove to be incorrect and the Company’s cash requirements exceed its cash flow, the Company would need to pursue additional sources of
financing to satisfy these requirements, which may not be available when needed, on acceptable terms or at all. See
Factors that May Affect
Future Results and Liquidity
below for more information about financing risks and limitations.
(i)
Operating activities
The Company’s cash flow from operations decreased by $0.6 million in the first quarter of 2019 compared to the first quarter of 2018. As
discussed below, the increase in cash flow was primarily a result of decreases in payments received for rent and maintenance reserves, as well as increases in payments made for salaries and employee benefits, professional fees and general and
administrative expenses and income taxes. This positive effect was partially offset by a decrease in payments made for maintenance.
(A)
Payments for rent
Receipts from lessees for rent decreased by $1.4 million in the first quarter of 2019 compared to the same period of 2018, primarily due to
delinquencies related to one of the Company’s customers, and a decrease in the rent payable by another lessee, the effects of which were partially offset by rent for two aircraft acquired during the second quarter of 2018.
(B)
Payments for
maintenance reserves
Receipts from lessees for maintenance reserves decreased by $1.8 million in the first quarter of 2019 compared to the same period of 2018,
primarily due to delinquencies related to one of the Company’s customers, as well as cash received in the 2018 period from the former lessee of three aircraft that were returned to the Company during 2017. Such payments were for unpaid maintenance
reserves, as well as amounts due pursuant to the return conditions of the applicable leases. The Company did not accrue unpaid reserves or return condition amounts at the time of lease termination based on management’s evaluation of the
creditworthiness of the lessee. Therefore, the Company has accounted for payments as they are received and recording the amount in maintenance reserves revenue in the period in which a payment is received.
(C)
Payments for management fees, salaries and employee
benefits and JMC expense reimbursement
Payments made for management fees decreased by $0.4 million in the first quarter of 2019 compared to the same period of 2018, primarily as a
result of the Company’s acquisition of JHC on October 1, 2018. Payments made for salaries and employee benefits, which became the responsibility of the Company after the Merger, were $0.7 million in the first quarter of 2019
.
(D)
Payments for maintenance
Payments made for maintenance decreased by $2.6 million in the first quarter of 2019 compared to the first quarter of 2018 as a result of
decreased maintenance performed by the Company on off-lease aircraft to prepare them for sale or re-lease.
(E)
Payments for income taxes
Payments made for income taxes increased by $0.4 million in the first quarter of 2019 compared to the same period of 2018 as a result of foreign
income taxes related to the Company’s UK LLC SPE Financing entities.
(ii)
Investing activities
During the first quarters of 2019 and 2018, the Company received net cash of $2.8 million and $4.9 million, respectively, from the sale of
assets. During the first quarter of 2018, the Company used cash of $1.2 million for deposits on two aircraft that it acquired during the second quarter.
(iii)
Financing activities
During the first quarters of 2019 and 2018, the Company borrowed $5.1 million $0, respectively, under the Credit Facility. In the same
periods of 2019 and 2018, the Company repaid $33.8 million and $11.0 million, respectively, of its total outstanding debt under the Credit Facility. Such repayments were funded by excess cash flow, the sale of assets and, in 2019, proceeds from
the Term Loans. During the first quarters of 2019 and 2018, the Company’s special purpose entities repaid $9.2 million and $1.1 million, respectively, of UK LLC SPE Financing. During the 2019 period, the Company also repaid $1.6 million of Term
Loans principal. During the first quarters of 2019 and 2018, the Company paid $5.1 million and $0, respectively, for debt issuance and amendment fees.
(iv)
Off balance sheet arrangements
The Company has no material off balance sheet arrangements.
Outlook
The Company has identified four principal factors that it believes may materially affect the Company’s growth and operating results in the
near term. These and other factors that could impact the Company’s business, performance and liquidity are described in more detail under
Factors
that May Affect Future Results and Liquidity
below.
•
The Company must source additional capital, though equity financings, additional debt financings or other alternatives, in order to grow. One of the motivations for AeroCentury’s acquisition of JHC was to remove the
outside management structure of the Company, which was believed to be an impediment to attracting capital sources. There can be no assurance that the Company will be able to obtain additional capital when needed, in the amounts desired or on
favorable terms, as a successful capital-raising transaction depends on many factors, some of which are outside the Company’s control.
•
On October 1, 2018, the Company acquired JHC, the parent of JMC, which has acted as the management company for the Company since the Company’s inception. The Company believes that the combination of the management
function performed by JMC and the portfolio held by the Company could be accretive to the Company and could create value for the stockholders of the combined post-Merger company, but such accretion may not be realized until after transaction and
integration costs in connection with the Merger have been incurred, or at all. Most of the one-time costs associated with the Merger, including a settlement loss of $2.5 million, were recognized by the Company in 2018, though there may be some
additional costs recognized in future periods.
•
Increased production of aircraft types in the Company’s market niche of worldwide regional aircraft has resulted in some manufacturers offering more competitive pricing for new aircraft to regional aircraft
customers. In addition, notwithstanding recent interest rate increases in the United States, competition for assets in this market niche has continued to increase. Some of the Company’s newer competitors are funded by investment banks and
private equity firms seeking higher yields on investment assets than are currently available from traditional income investment types. The increased competition has resulted in higher acquisition prices for many of the aircraft types that the
Company has targeted to buy and, at the same time, downward pressure on lease rates for these aircraft, resulting in lower revenues and margins and, therefore, fewer acceptable acquisition opportunities for the Company. The Company anticipates
this trend will continue for the short- to medium-term, but could change if and when yields on alternative investments return to a more normal historical range.
•
The Company has not identified sale customers for three turboprop aircraft that are currently off lease and classified as held for sale. These aircraft are older types that are no longer in production, and as a
result, the Company does not view it as unusual that market demand for these aircraft is weak and expects that they may remain unsold for a significant period of time.
Critical Accounting Policies, Judgments and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are based upon the condensed consolidated
financial statements included in this report, 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 or during the applicable reporting period. 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 further discussion of Critical
Accounting Policies, Judgments and Estimates, refer to Note 1 to the Company’s financial statements in this report.
Factors that May Affect Future Results and Liquidity
The Company’s business, financial condition, results of operations, liquidity, prospects and reputation could be affected by a number of
factors. In addition to matters discussed elsewhere in this discussion, the Company believes the following are the most significant factors that may impact the Company; however, additional or other factors not presently known to the Company or
that management presently deems immaterial could also impact the Company and its performance and liquidity.
Availability of Financing.
As
described above, the Company must source additional capital, through equity financings, additional debt financings or other alternatives, in order to grow. One of the current primary limitations on the Company’s ability to draw under its Credit
Facility or incur any other additional debt financing is the covenant limitation on the Company’s maximum debt to equity ratio. As a result, unless this ratio changes due to equity financing or otherwise, the Company’s ability to rely upon the
Credit Facility as a capital resource will remain limited. Additionally, although one of the motivations for AeroCentury’s acquisition of JHC was to remove the outside management structure of the Company, which was believed to be an impediment to
attracting capital sources, there could be other material factors, some of which are outside of the Company’s control, that prevent or limit the Company’s ability to access additional capital. As a result, there can be no assurance that the
Company will be able to obtain additional capital when needed, in the amounts desired or on favorable terms in the future.
Noncompliance with Debt Financial
Covenants.
The Company’s use of debt as its primary form of acquisition financing subjects the Company to increased risks associated with leverage. In addition to payment obligations, the Company’s debt agreements include financial
covenants, including some requiring the Company to have positive earnings, meet minimum net worth standards and comply with certain other financial ratios. The Company was not in compliance with certain of these standards and ratios under the
Credit Facility as of December 31, 2018. Although this noncompliance was cured with the February 2019 amendments to the Credit Facility agreement, which revised certain of these financial covenants to better accommodate the Company’s financial
circumstances as a post-Merger entity with unified asset and portfolio management and to position the Company for future growth, the Company may be subject to additional compliance failures of these or other debt covenants at future calculation
dates, and the lenders are under no obligation to forbear or waive any such future noncompliance. Any default under the Credit Facility or any other debt agreement, if not cured in the time permitted or waived by the respective lender, could
result in the Company’s inability to borrow under the debt instrument, the acceleration of the Company’s debt obligations, or the foreclosure upon any or all of the assets of the Company.
Credit Facility Debt Limitations.
The
amount available to be borrowed under the Credit Facility is limited by asset-specific advance rates. Lease arrearages or off-lease periods for a particular asset that serves as collateral under the Credit Facility may reduce the loan advance rate
permitted with respect to that asset and, therefore, reduce the permitted borrowing under the facility or require repayments. Amounts subject to payment deferral agreements also reduce the amount of permitted borrowing. The Company believes it
will have sufficient borrowing availability under the Credit Facility to meet its anticipated capital needs in the near term in spite of these limitations and it will have sufficient cash funds to make any required principal repayment that arises
due to any such borrowing limitations, but actual cash levels could deviate from these assumptions.
Term Loan Debt Limitations
. The
special purpose subsidiaries, ACY 19002 Limited, ACY 19003 Limited,
ACY SN 15129 LLC, and ACY E-175 LLC,
that own the six aircraft serving as collateral for the
Term Loans are the named borrowers (“Borrower LLCs”) under the Term Loans, and each Term Loan is secured by the corresponding aircraft owned by the applicable Borrower LLC. AeroCentury, as the parent corporation of each Borrower LLC, is not a
party to the Term Loan agreements, but has entered into agreements with lessees of the Borrower LLCs to guarantee certain obligations to such lessees under each lessee’s lease agreement with a Borrower LLC and with the Term Loan Lender to guarantee
certain representations, warranties and covenants delivered by the Borrower LLCs to the Term Loan Lender in connection with the refinancing transaction. As a result, although the Term Loans are non-recourse to AeroCentury, AeroCentury could become
directly responsible for the Borrower LLCs’ obligations under the Term Loans and the related lease agreements pursuant to these guaranty arrangements. Moreover, any noncompliance under the Term Loans by a Borrower LLC could negatively affect the
liquidity, aircraft portfolio and reputation of the Company as a whole.
The required payments under each Term Loan are expected to be funded by the operating lease rental revenue received from the lessee of the
corresponding aircraft, and each Borrower LLC’s continued compliance with its Term Loan will depend upon the lessee’s compliance with its lease payment obligations. Failure by a lessee to make timely payments could result in a default under the
applicable Term Loan and could result in an acceleration of all Term Loan indebtedness of the applicable Borrower LLC or foreclosure by the Term Loan lender on the applicable aircraft. Furthermore, a default by any Borrower LLC under its Term Loan
would also constitute a default under the Credit Facility, and therefore any failure by a Borrower LLC’s lessee to comply with its lease payment obligations or any other compliance failure by a Borrower LLC under its Term Loan could result in the
Company’s noncompliance under several of its debt agreements, which could have a material negative adverse effect on the Company’s liquidity and capital resources.
Consummation of Merger May Subject the
Company to Additional Risks.
On October 1, 2018 the Company acquired JHC, the parent of the Company’s management company, JMC. The acquisition of JHC subjects the Company to certain risks, including the following:
•
Assumption of Expenses Covered under Management Agreement.
Under the Management Agreement with JMC, the
Company paid management fees to JMC based upon the book value of the Company’s aircraft assets, an acquisition fee for each asset purchased by the Company, and a remarketing/re-lease fee for each sale or re-lease transaction entered into with
respect to the Company’s aircraft. In return, JMC provided the Company with comprehensive management services, under which JMC had full responsibility for payment of all employee salaries and benefits, outside technical services, worldwide travel
needed to promote the Company's business, office space, utilities, IT and communications, furniture and fixtures, and other general administrative and overhead costs. Under the Management Agreement, if the fees collected were not adequate to cover
JMC’s expenses in managing the Company’s portfolio, such losses were borne entirely by JMC.
Upon completion of the Merger on October 1, 2018, the Company became responsible for all expenses that were previously
incurred by JMC in managing the Company. The risk of increased costs for these expenses is now the responsibility of the Company, and such costs are no longer limited to the amount of the management fee, as was the case under the third -party
management structure with JMC. Consequently, the risk of any cost overruns or unanticipated expenses in asset management are borne solely by the Company and are no longer shifted to an unconsolidated third party. As a result, the Company’s
expense categories, amounts, timing and patterns could change significantly in post-Merger periods and could be subject to increased period-to-period fluctuations.
•
Internalization of Management.
JHC is now a wholly-owned subsidiary of the Company, and sole responsibility for
management of the combined company now falls upon the Company’s management. If the Company is dissatisfied with management services, the Company will have to address the shortcomings internally, and if they cannot be resolved with existing
management and personnel, the Company may be required to reorganize its management structure and/or replace personnel or seek new third -party management services, either of which could result in the Company incurring significant expense and use of
resources.
•
Assumption of JHC Liabilities.
By acquiring JHC in the Merger, JHC has become a wholly-owned subsidiary of the
Company. To the extent that JHC or any of its subsidiaries have liabilities, these have become liabilities of the Company on a consolidated basis. While the Merger Agreement provides for limited indemnification by JHC shareholders for certain
liabilities of JHC or its subsidiaries that arise from pre-Merger occurrences and the Company performed due diligence reviews of the liabilities of JHC and its subsidiaries before completion of the Merger, the indemnification is limited to the
consideration paid by the Company to JHC’s shareholders and such due diligence reviews are inherently non-exhaustive and may not have uncovered all known or contingent liabilities or presently unknown liabilities that may emerge after the Merger’s
completion.
Ownership Risks.
The Company’s
leases typically are for a period shorter than the entire, anticipated, remaining useful life of the leased assets. As a result, the Company’s recovery of its investment and realization of its expected yield in such a leased asset is dependent
upon the Company’s ability to profitably re-lease or sell the asset following the expiration of the lease. This ability is affected by worldwide economic conditions, general aircraft market conditions, regulatory changes, changes in the supply or
cost of aircraft equipment, and technological developments that may 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 typically 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, airline
consolidations, the number of new aircraft on order, an excess supply of newly manufactured aircraft or used 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 or decrease for certain aircraft types that become more or less desirable based on market conditions and changing airline capacity. Declines in the value of the
Company’s aircraft and any resulting decline in market demand for these aircraft could materially adversely affect the Company’s revenues, performance and liquidity. Also, because the Company’s ability to borrow under the current terms of its
Credit Facility is subject to a covenant setting forth a maximum ratio of (i) the outstanding debt under the facility to (ii) the appraised value of the collateral base of aircraft assets securing the Credit Facility, a significant drop in the
appraised market value of the portfolio could require the Company to make a substantial prepayment of outstanding principal under the Credit Facility in order to avoid a default under the Credit Facility and limit the utility of the Credit Facility
as a source of future funding.
In addition, a successful investment in an asset subject to an operating lease depends in part upon having the asset returned by the lessee
in the condition as required under the lease. Each operating lease obligates a customer to return an asset to the Company in a specified condition, generally in a condition that will allow the aircraft to be readily re-leased to a new lessee,
and/or pay an economic settlement for redelivery that is not in compliance with such specified conditions. The Company strives to ensure this result through onsite management during the return process. However, if a lessee becomes insolvent
during the term of its lease and the Company has to repossess the asset, it is unlikely that the lessee would have the financial ability to meet these return obligations. In addition, if a lessee files for bankruptcy and rejects the aircraft
lease, the lessee would be required to return the aircraft but would be relieved from further lease obligations, including return conditions specified in the lease. In either case, 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.
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 occurred under such a lease, the Company would need to pay the costs of unperformed repair and maintenance under the applicable lease and would likely
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 flow from an asset could
result in an asset impairment charge against the Company’s earnings. The Company periodically reviews long-term assets for impairment, particularly when events or changes in circumstances indicate the carrying value of an asset may not be
recoverable. An impairment charge is recorded when the carrying amount of an asset is estimated to be not recoverable and exceeds its fair value. The Company recorded impairment charges for some of its aircraft in 2018 and 2019, and may be required
to record asset impairment charges in the future as a result of a prolonged weak economic environment, challenging market conditions in the airline industry, events related to particular lessees, assets or asset types or other factors affecting the
value of aircraft or engines.
Interest Rate Risk.
Although the
debt under the Term Loans is fully covered by interest rate swaps that effectively convert the variable interest rate Term Loan payments to fixed rate payments, only approximately half of the Credit Facility debt currently outstanding is subject to
such an interest rate swap. As a result, the amount of interest paid by the Company under the Credit Facility will fluctuate depending on prevailing interest rates to the extent of any excess of the outstanding balance under the Credit Facility
over the amount covered by the related interest rate swap. Consequently, interest rate increases could materially increase the Company’s interest payment obligations under the Credit Facility and thus could have a material adverse effect on the
Company’s liquidity and financial condition. Further, because the interest rates under the Credit Facility and the Term Loans are based on LIBOR, which is
the subject of
recent national, international and other regulatory guidance and proposals for reform, the amount of the Company’s interest payments under these arrangements could increase if LIBOR is phased out or performs differently than in the past.
Lease rates typically, but not always, move over time with interest rates, but market demand and numerous other asset-specific factors also
affect lease rates. Because the Company’s typical lease rates are fixed at lease origination, interest rate changes during the lease term have no effect on existing lease rental payments. Therefore, if interest rates rise significantly and there
is relatively little lease origination by the Company following such rate increases, the Company could experience decreased net income as additional interest expense outpaces revenue growth. Further, even if significant lease origination occurs
following such rate increases, other contemporaneous aircraft market forces may result in lower or flat rental rates, thereby decreasing net income.
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, they will fully protect the Company from losses resulting from a lessee default or bankruptcy.
If a U.S. lessee defaults under a lease and seeks 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 would be further
adversely affected in the event of a bankruptcy filing by a defaulting lessee.
Lessees located in low-growth or no-growth areas of the world carry heightened risk of lessee default. The Company has had customers that
have experienced significant financial difficulties, become insolvent, or have entered bankruptcy proceedings. A customer’s insolvency or bankruptcy usually results in the Company’s total loss of the receivables from that customer, as well as
additional costs in order to repossess and, in some cases, repair the aircraft leased by the customer. 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 in an attempt to mitigate losses in the event the lessee is unable to meet or rejects its lease obligations. There can be no assurance, however, that additional customers will not become
insolvent, file for bankruptcy or otherwise fail to perform their lease obligations, or that the Company will be able to mitigate any of the resultant losses.
It is possible that the Company may enter into deferral agreements for overdue lessee obligations. When a customer requests a deferral of
lease obligations, the Company evaluates the lessee’s financial plan, the likelihood that the lessee can remain a viable carrier, and whether the deferral is likely to be repaid according to the agreed schedule. The Company may elect to record the
deferred rent and reserves payments from the lessee on a cash basis, which could have a material effect on the Company’s financial results in the applicable periods. Deferral agreements with lessees also reduce the Company’s borrowing capacity
under its Credit Facility.
Concentration of Lessees and Aircraft Type.
For the quarter ended
March
31, 2019, the Company’s four largest customers accounted for a total of approximately 76% of the Company’s monthly operating lease
revenue. A lease default by or collection problem with one or a combination of any of these significant customers could have a disproportionately negative impact on the Company’s financial results and borrowing base under the Credit Facility, and,
therefore, the Company’s operating results are especially sensitive to any negative developments with respect to these customers in terms of lease compliance or collection. In addition, if the Company’s revenues become overly concentrated in a
small number of lessees, the Company could fail to comply with certain financial covenants in its Credit Facility related to customer concentration, which could result in the negative effects of such a default as described under
Noncompliance with Debt Financial Covenants
, above.
The Company’s aircraft portfolio is currently focused on a small number of aircraft types and models relative to the variety of aircraft used
in the commercial air carrier market. A change in the desirability and availability of any of the particular types and models of aircraft owned by the Company could affect valuations and future rental revenues of such aircraft, and would have a
disproportionately significant impact on the Company’s portfolio value. In addition, the Company is dependent on the third-party companies that manufacture and provide service for the aircraft types in the Company’s portfolio. The Company has no
control over these companies, and they could decide to curtail or discontinue production of or service for these aircraft types at any time or significantly increase their costs, which could negatively impact the Company’s prospects and
performance. These effects would diminish if the Company acquires assets of other types. Conversely, acquisition of additional aircraft of the types currently owned by the Company will increase the Company’s risks related to its concentration of
those aircraft types.
Competition.
The aircraft leasing
industry is highly competitive. The Company competes with other leasing companies, banks, financial institutions, private equity firms, aircraft leasing syndicates, aircraft manufacturers, distributors, airlines and aircraft operators, equipment
managers, equipment leasing programs and other parties engaged in leasing, managing or remarketing aircraft. Many of these competitors have longer operating histories, more experience, larger customer bases, more expansive brand recognition,
deeper market penetration and significantly greater financial resources. Further, competition in the Company's market niche of regional aircraft has increased significantly recently as a result of increased focus on regional air carriers by
competitors who have traditionally neglected this market, new entrants to the acquisition and leasing market and consolidation of certain competitors. If and as competition continues to increase, it has and will likely continue to create upward
pressure on acquisition prices for many of the aircraft types that the Company has targeted to buy and, at the same time, create downward pressure on lease rates, resulting in lower revenues and margins for the Company and, therefore, fewer
acceptable acquisition opportunities for the Company.
Risks Related to Regional Air Carriers.
The Company’s continued focus on its customer base of regional air carriers subjects the Company to certain risks. Many regional airlines rely heavily or even exclusively on a code-share or other contractual relationship with a major carrier for
revenue, and can face financial difficulty or failure if the major carrier terminates or fails to perform under the relationship or files for bankruptcy or becomes insolvent. Some regional carriers may depend on contractual arrangements with
industrial customers such as mining or oil companies, or franchises from governmental agencies that provide subsidies for operating essential air routes, which may be subject to termination or cancellation on short notice. Furthermore, many
lessees in the regional air carrier market are start-up, low-capital, and/or low-margin operators. A current concern for regional air carriers is the supply of qualified pilots. Due to recently imposed regulations of the U.S. Federal Aviation
Administration requiring a higher minimum number of hours to qualify as a commercial passenger pilot, many regional airlines have had difficulty meeting their business plans for expansion. This could in turn affect demand for the aircraft types in
the Company’s portfolio and the Company’s business, performance and liquidity.
General Economic Conditions and Lowered
Demand for Travel.
While the global economy has seen substantial improvement since the 2008 financial crisis and global recession, not all global regions are experiencing growth, and some have not fully recovered. There are indications
that after recent periods of economic growth, major world economies may be headed into a period of slower growth or even recession. The Company does not anticipate any worsening of the financial condition of its overall customer base in the near
term, but believes that there may be further shakeouts of weaker carriers in economically troubled regions, particularly if the world economy experiences a slowdown. Any such shakeouts or any continued or new economic recession or downturn in the
regions in which the Company’s lessees operate could negatively impact the financial condition and viability of certain of the Company’s customers and, in turn, the Company’s business and performance.
A growing concern arises from the fact that much of the recent growth in demand for regional aircraft in developing countries has been driven
by mining or other resource extraction operations by Chinese enterprises in these countries. A downturn in the Chinese domestic economy that reduces demand for imported raw materials could have a significant negative impact on the demand for
business and regional aircraft in these developing countries, including in some of the markets in which the Company does, or seeks to do, business.
Furthermore, instability in Europe due to newly imposed U.S. sanctions against Russia and Iran, and the Russian, Iranian and European
reaction to such sanctions, or due to other factors, could have a negative impact on intra-European carriers with which the Company does business. Also, Brexit and any further departures from the European Union (“EU”) could threaten “open-sky”
policies under which EU -based carriers operate freely within the EU. Losing open-sky flight rights could have a significant negative impact on the health of the Company’s European lessees and, as a result, the financial performance and condition
of the Company.
If international conflicts erupt into military hostilities, heightened visa requirements make international travel more difficult, terrorist
attacks involving aircraft or airports occur, or a major flu outbreak occurs, passengers may avoid air travel altogether, and global air travel worldwide could be significantly affected. Any such occurrence would have an adverse impact on many of
the Company’s customers.
Airline reductions in capacity in response to lower passenger loads can result in reduced demand for aircraft and aircraft engines and a
corresponding decrease in market lease rental rates and aircraft values. This reduced market value could affect the Company’s results if the market value of an asset or assets in the Company’s portfolio falls below carrying value, and the Company
determines that a write-down of the value is appropriate. Furthermore, if older, expiring leases are replaced with leases at decreased lease rates, the lease revenue from the Company’s existing portfolio is likely to decline, with the magnitude of
the decline dependent on the length of the downturn and the depth of the decline in market rents.
Economic downturns can affect certain regions of the world more than others. As the Company’s portfolio is not entirely globally
diversified, a localized downturn in one of the key regions in which the Company leases assets could have a disproportionately significant adverse impact on the Company. The Company’s significant sources of operating lease revenue by region are
summarized in
Fleet Summary – Assets Held for Lease,
above.
International Risks.
The Company
leases assets in overseas markets. Leases with foreign lessees, however, may present different risks than those with domestic lessees. Most of the Company’s expected growth is outside of North America.
A lease with a foreign lessee is subject to risks related to the economy of the country or region in which such lessee is located, which may
be weaker or less stable than the U.S. economy. An economic downturn in a particular country or region may impact a foreign lessee’s ability to make lease payments, even if the U.S. and other foreign economies remain strong and stable.
The Company is subject to certain risks related to currency conversion fluctuations. The Company currently has one customer with rent
obligations payable in Euros, and the Company may, from time to time, agree to additional leases that permit payment in foreign currency, which would subject such lease revenue to monetary risk due to currency exchange rate fluctuations. During
the periods covered by this report, the Company considers the estimated effect on its revenues of foreign currency exchange rate fluctuations to be immaterial; however, the impact of these fluctuations may increase in future periods if additional
rent obligations become payable in foreign currencies.
Even with U.S. dollar-denominated lease payment provisions, the Company could still be negatively affected by a devaluation of a foreign
lessee’s local currency relative to the U.S. dollar, which would make it more difficult for the lessee to meet its U.S. dollar-denominated payments and increase the risk of default of that lessee, particularly if its revenue is primarily derived in
its local currency.
Foreign lessees that operate internationally may also face restrictions on repatriating foreign revenue to their home country. This could
create a cash flow crisis for an otherwise profitable carrier, affecting its ability to meet its lease obligations. Foreign lessees may also face restrictions on payment obligations to foreign vendors, including the Company, which may affect their
ability to timely meet lease obligations to the Company.
Foreign lessees are not subject to U.S. bankruptcy laws, although there may be debtor protection similar to U.S. bankruptcy laws available in
some jurisdictions. Certain countries do not have a central registration or recording system which can be used to locally record the Company’s interest in equipment and related leases. This could make it more difficult for the Company to recover
an aircraft in the event of a default by a foreign lessee. In any event, collection and enforcement may be more difficult and complicated in foreign countries.
Ownership of a leased asset operating in a foreign country and/or by a foreign carrier may subject the Company to additional tax liabilities
that are not present with aircraft operated in the United States. Depending on the jurisdiction, laws governing such tax liabilities may be complex, not well formed or not uniformly enforced. In such jurisdictions, the Company may decide to take
an uncertain tax position based on the best advice of the local tax experts it engages, which position may be challenged by the taxing authority. Any such challenge could result in increased tax obligations in these jurisdictions going forward or
assessments of liability by the taxing authority, in which case the Company may be required to pay penalties and interest on the assessed amount that would not give rise to a corresponding foreign tax credit on the Company’s U.S. tax returns.
The Trump administration and members of the U.S. Congress have made public statements about significant changes in U.S. trade policy and have
taken certain actions that materially impact U.S. trade, including terminating, renegotiating or otherwise modifying U.S. trade agreements with countries in various regions and imposing tariffs on certain goods imported into the United States.
These changes in U.S. trade policy have triggered and could continue to trigger retaliatory actions by affected countries, including China, resulting in “trade wars” with these countries. These trade wars could generally increase the cost of
aircraft, aircraft and engine components and other goods regularly imported by the Company’s customers, thereby increasing costs of operations for its air carrier customers that are located in the affected countries. The increased costs could
materially and adversely impact the financial health of affected air carriers, which in turn could have a negative impact on the Company’s business opportunities, and if the Company’s lessees are significantly affected, could have a direct impact
on the Company’s financial results. Furthermore, the Company often incurs maintenance or repair expenses not covered by lessees in foreign countries, which expenses could increase if such countries are affected by such a trade war.
Level of Portfolio Diversification.
The Company intends to continue to focus solely on regional aircraft. Although the Company invested in a limited number of turboprop aircraft types in the past, including two in the second quarter of 2018, the Company has also acquired several
regional jet aircraft types, which now comprise a larger percentage of the Company’s portfolio based on number of aircraft and net book value. The Company may continue to seek acquisition opportunities for new types and models of aircraft used by
the Company’s targeted customer base of regional air carriers. Acquisition of aircraft types not previously owned by the Company entails greater ownership risk due to the Company’s lack of experience managing those assets and the potentially
different types of customers that may lease them. Conversely, the Company’s focus on a more limited set of aircraft types and solely on regional aircraft subjects the Company to risks that disproportionately impact these aircraft markets, which
are described elsewhere in this discussion. As a result, the level of asset and market diversification the Company chooses to pursue could have a significant impact on its performance and results.
Transition to LIBOR alternative reference
rate.
The London Inter-bank Offered Rate (“LIBOR”) represents the interest rate at which banks offer to lend funds
to one another in the international interbank market for short-term loans, and is the index rate of the Company’s Credit Facility debt and the Term Loan Indebtedness of the LLC Borrower subsidiaries. Beginning in 2008, concerns were expressed that
some of the member banks surveyed by the British Bankers’ Association (the “BBA”) in connection with the calculation of LIBOR rates may have been under-reporting or otherwise manipulating the interbank lending rates applicable to them. Regulators
and law enforcement agencies from a number of governments have conducted investigations relating to the calculation of LIBOR across a range of maturities and currencies. If manipulation of LIBOR or another inter-bank lending rate occurred, it may
have resulted in that rate being artificially lower (or higher) than it otherwise would have been. Responsibility for the calculation of LIBOR was transferred to ICE Benchmark Administration Limited, as independent LIBOR administrator, effective
February 1, 2014.
On July 27, 2017, the U.K. Financial Conduct Authority announced that it will no longer persuade or compel banks to submit rates for the
calculation of LIBOR rates after 2021 (the “July 27th Announcement”). The July 27th Announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently,
at
this time, it is not possible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms
to LIBOR may be enacted in the United Kingdom or elsewhere. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable benchmark, what rate or rates may become accepted alternatives to LIBOR or the effect of
any such changes in views or alternatives on the value of LIBOR-linked securities.
Although the Financial Stability Oversight Council has recommended a transition to an alternative reference rate in the event LIBOR is no
longer available after 2021, which would affect the Company’s Credit Facility and some of its Term Loans, such plans are still in development and, if enacted, could present challenges. Moreover, contracts linked to LIBOR are vast in number and
value, are intertwined with numerous financial products and services, and have diverse parties. The downstream effect of unwinding or transitioning such contracts could cause instability and negatively impact the financial markets and individual
institutions. The uncertainty surrounding the sustainability of LIBOR more generally could undermine market integrity and threaten individual financial institutions and the U.S. financial system more broadly.
With respect to the Company’s indebtedness, the inability of the Company and its lenders to agree on a mutually acceptable LIBOR index for
any debt outstanding if LIBOR is no longer published after 2021 could cause the debt to be terminated and repayment of the indebtedness being accelerated and immediately due and payable to the Lender. This could also lead to substantial breakage
fees being payable by the Company in addition to the outstanding principal of such debt.
Swap Counterparty Credit Risks.
The Company and its LLC Borrowers have entered into certain interest rate swaps to hedge the interest
rate risk associated with a portion of the Credit Facility and all of Borrower LLC’s Term Loan indebtedness. These interest rate swap agreements effectively convert the variable rate interest payments to a fixed rate. If an interest rate swap
counterparty cannot perform under the terms of the interest rate swap due to insolvency, bankruptcy or other reasons, the Company would not receive payments due from the counterparty under that swap, and, depending on interest rate conditions at
the time of such default, that could render the Company unable to meet its variable interest rate debt obligations, leading to a default under one or more loan agreements. In such a case, the collateral securing the loan indebtedness could be
foreclosed upon, and/or the Company might incur a loss on the fair market value of the interest rate swap agreement.
Swap Breakage Fees.
To reduce the amount of interest that accrues under the Company’s Credit Facility and/or Term Loans, the Company
could choose to prepay certain amounts borrowed under such loans. Because the Company has hedged its variable rate indebtedness, in addition to prepayment fees that might be payable to the lender under the underlying indebtedness, the Company may
also be obligated to pay certain swap breakage fees to the swap counterparty in order to unwind the interest rate swap on the indebtedness that is being prepaid. Thus interest rate swaps could reduce the economic benefit that the Company might
otherwise achieve through prepayment or could render an otherwise advantageous debt prepayment uneconomical.
Government Regulation.
There are a
number of areas in which government regulation may result in costs to the Company. These include aircraft registration safety requirements, required equipment modifications, maximum aircraft age, and aircraft noise requirements. Although it is
contemplated that the burden and cost of complying with such requirements will fall primarily upon lessees, there can be no assurance that the cost will not fall on the Company. Additionally, even if lessees are responsible for the costs of
complying with these requirements, changes to the requirements to make them more stringent or otherwise increase these costs could negatively impact the Company’s customers’ businesses, which could result in nonperformance under their lease
agreements or decreased demand for the Company’s aircraft. Furthermore, future government regulations could cause the value of any noncomplying equipment owned by the Company to decline substantially. Moreover, any failure by the Company to
comply with the government regulations applicable to it could result in sanctions, fines or other penalties, which could harm the Company’s reputation and performance.
Casualties and Insurance Coverage.
The Company, as an owner of transportation equipment, may be named in a suit claiming damages for injuries or damage to property caused by its assets. As a triple-net lessor, the Company is generally protected against such claims, because the
lessee would be responsible for, insure against and indemnify the Company for such claims. A “triple net lease” is a lease under which, in addition to monthly rental payments, the lessee is generally responsible for the taxes, insurance and
maintenance and repair of the aircraft arising from the use and operation of the aircraft during the term of the lease. Although the United States Aviation Act may provide some additional protection with respect to the Company’s aircraft assets,
it is unclear to what extent such statutory protection would be available to the Company with respect to its assets that are operated in foreign countries where the provisions of this law may not apply.
The Company’s leases generally require a lessee to insure against likely risks of loss or damage to the leased asset and liability to
passengers and third parties pursuant to industry standard insurance policies, and require lessees to provide insurance certificates documenting the policy periods and coverage amounts. The Company has adopted measures designed to ensure these
insurance policies continue to be maintained, including tracking receipt of the insurance certificates, calendaring their expiration dates, and reminding lessees of their obligations to maintain such insurance and provide current insurance
certificates to the Company if a replacement certificate is not timely received prior to the expiration of an existing certificate.
Despite these requirements and procedures, there may be certain cases where losses or liabilities are not entirely covered by the lessee or
its insurance. Although the Company believes the possibility of such an event is remote, any such uninsured loss or liability, or insured loss or liability for which insurance proceeds are inadequate, might result in a loss of invested capital in
and any profits anticipated from the applicable aircraft, as well as potential claims directly against the Company.
Compliance with Environmental Regulations.
Compliance with environmental regulations may harm the Company’s business. Many aspects of aircraft operations are subject to increasingly stringent environmental regulations, and growing concerns about climate change may result in the imposition
by the U.S. and foreign governments of additional regulation of carbon emissions, including requirements to adopt technology to reduce the amount of carbon emissions or imposing a fee or tax system on carbon emitters. Any such regulation could be
directed at the Company’s customers, as operators of aircraft, at the Company, as an owner of aircraft, and/or on the manufacturers of aircraft. Under the Company’s triple-net lease arrangements, the Company would likely try to shift
responsibility for compliance to its lessees; however, it may not be able to do so due to competitive or other market factors, and there might be some compliance costs that the Company could not pass through to its customers and would itself have
to bear. Although it is not expected that the costs of complying with current environmental regulations will have a material adverse effect on the Company’s financial position, results of operations, or liquidity, there is no assurance that the
costs of complying with environmental regulations as amended or adopted in the future will not have such an effect.
Cybersecurity Risks.
The Company
believes that its main vulnerabilities to a cyber-attack would be interruption of the Company’s email communications internally and with third parties, loss of customer and lease archives, and loss of document sharing between the Company’s offices
and remote workers. Such an attack could temporarily impede the efficiency of the Company’s operations; however, the Company believes that sufficient replacement and backup mechanisms exist in the event of such an interruption such that there
would not be a material adverse financial impact on the Company’s business. A cyber-hacker could also gain access to and release proprietary information of the Company, its customers, suppliers and employees stored on the Company’s data network.
Such a breach could harm the Company’s reputation and result in competitive disadvantages, litigation, lost revenues, additional costs, or liability to third parties. While the Company believes that it has sufficient cybersecurity measures in
place commensurate with the risks to the Company of a successful cyber-attack or breach of its data security, its resources and technical sophistication may not be adequate to prevent or adequately respond to and mitigate all types of
cyber-attacks.
Possible Volatility of Stock Price.
The market price of the Company’s common stock is subject to fluctuations following developments relating to the Company’s operating results, changes in general conditions in the economy, the financial markets or the airline industry, changes in
accounting principles or tax laws applicable to the Company or its lessees, or other developments affecting the Company, its customers or its competitors, or arising from other investor sentiment unknown to the Company. Because the Company has a
relatively small capitalization of approximately 1.5 million shares outstanding, there is a correspondingly limited amount of trading and float of the Company’s shares. Consequently, the Company’s stock price is more sensitive to a single large
trade or a small number of simultaneous trades along the same trend than a company with larger capitalization and higher trading volume and float. This stock price and trading volume volatility could limit the Company’s ability to use its capital
stock to raise capital, if and when needed or desired, or as consideration for other types of transactions, including strategic collaborations, investments or acquisitions. Any such limitation could negatively affect the Company’s performance,
growth prospects and liquidity.