Mega Matrix Corp. - Quarter Report: 2020 September (Form 10-Q)

 

UNITED STATES

 

(Mark One)

 

For the quarterly period ended September 30, 2020

 

 

For the transition period from ____________ to ____________

 

Commission File Number: 001-13387

 

Delaware		94-3263974
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

Burlingame, California 94010

 

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	ACY	NYSE American

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐ 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐  Accelerated filer ☐

Non-accelerated filer ☒  Smaller reporting company ☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

 

The number of shares of the registrant’s common stock outstanding as of November 12, 2020 was 1,545,884. 

 

As used in this report, unless the context indicates otherwise, “AeroCentury” refers to AeroCentury Corp. and the “Company” refers to AeroCentury together with its consolidated subsidiaries.

  

 Forward-Looking Statements

 

This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements in this report other than statements of historical fact are forward-looking statements for purposes of these provisions, including any statements of the Company’s plans and objectives for future operations, the Company’s future financial or economic performance (including known or anticipated trends), and the assumptions underlying or related to the foregoing. Statements that include the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential," or "continue," or the negative thereof, or other comparable terminology, are forward-looking statements.

 

Forward-looking statements in this report include statements about the following matters, although this list is not exhaustive:

 

 

All of the Company’s forward-looking statements involve risks and uncertainties that could cause the Company's actual results to differ materially from those projected or assumed by such forward-looking statements. Among the factors that could cause such differences are: the Company’s ability to comply with its debt obligations to Drake; the Company’s ability to reach agreeement with Drake and regarding repayment terms on the debt purchased by Drake from the MUFG Lenders; the potential impact on the Company’s debt obligations of developments regarding LIBOR, including the potential phasing out of this metric; the Company's ability to raise capital on acceptable terms when needed and in desired amounts, or at all; the Company's ability to locate and acquire appropriate and revenue-producing assets; deterioration of the market for or appraised values of aircraft owned by the Company; the Company’s ability to retain its existing customers, or attract replacement customers or prospective purchasers for off-lease aircraft if and when existing customers are lost or become unable to maintain lease compliance;a surge in interest rates; any noncompliance by the Company's lessees with obligations under their respective leases, including payment obligations; any economic downturn or other financial crisis; the timing, rate and amount of maintenance expenses for the Company’s asset portfolio, as well as the distribution of these expenses among the assets in the portfolio; limited trading volume in AeroCentury’s common stock; the duration and continuing impact of the COVID-19 pandemic, including a potential resurgence in COVID-19 cases; and the other factors detailed under "Factors That May Affect Future Results and Liquidity" in Item 2 of this report. In addition, the Company operates in a competitive and evolving industry in which new risks emerge from time to time, and it is not possible for the Company to predict all of the risks it may face, nor can it assess the impact of all factors on its business or the extent to which any factor or combination of factors could cause actual results to differ from expectations. As a result of these and other potential risks and uncertainties, the Company’s forward-looking statements should not be relied on or viewed as predictions of future events.

 

This cautionary statement should be read as qualifying all forward-looking statements included in this report, wherever they appear. All forward-looking statements and descriptions of risks included in this report are made as of the date hereof based on information available to the Company as of the date hereof, and except as required by applicable law, the Company assumes no obligation to update any such forward-looking statement or risk for any reason. You should, however, consult the risks and other disclosures described in the reports the Company files from time to time with the United States Securities and Exchange Commission (“SEC”) after the date of this report for updated information.

 

 

Table of Contents

PART I – FINANCIAL INFORMATION 4

Item 1.  Financial Statements. 4

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations. 15

Item 3.  Quantitative and Qualitative Disclosures About Market Risk. 18

Item 4.  Controls and Procedures. 18

PART II – OTHER INFORMATION 18

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds. 18

Item 6.  Exhibits. 18

 

 

 

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

AeroCentury Corp.

Condensed Consolidated Balance Sheets

(Unaudited)

 

ASSETS
	September 30,	December 31,
	2020	2019
Assets:
Cash and cash equivalents	$4,863,800	$2,350,200
Restricted cash	50,000	1,076,900
Accounts receivable, including deferred rent of $0 and $828,000 at      September 30, 2020 and December 31, 2019, respectively	123,100	1,139,700
Finance leases receivable, net of allowance for doubtful accounts of $1,170,000 and $2,908,600 at September 30, 2020 and December 31, 2019, respectively	2,880,000	8,802,100
Aircraft and aircraft engines held for lease, net of accumulated depreciation of $36,848,500 and $31,338,700 at September 30, 2020 and December 31, 2019, respectively	96,052,100	108,368,600
Assets held for sale	15,331,500	26,036,600
Property, equipment and furnishings, net of accumulated depreciation of $14,700 and $9,600 at September 30, 2020 and December 31, 2019, respectively	14,600	62,900
Office lease right of use, net of accumulated amortization of $11,000 and $524,500 at September 30, 2020 and December 31, 2019, respectively	158,900	948,300
Deferred tax asset	1,185,300	517,700
Prepaid expenses and other assets	361,400	292,800
Total assets	$121,020,700	$149,595,800
LIABILITIES AND STOCKHOLDERS’ (DEFICIT)/EQUITY
Liabilities:
Accounts payable and accrued expenses	$1,081,900	$736,000
Accrued payroll	172,300	164,200
Notes payable and accrued interest, net of unamortized debt issuance costs of $1,906,500 and $3,825,700 at September 30, 2020 and December 31, 2019, respectively	111,575,400	111,638,400
Derivative liability	874,700	1,824,500
Derivative termination liability	3,075,300	-
Lease liability	170,700	336,400
Maintenance reserves	1,804,700	4,413,100
Accrued maintenance costs	121,800	446,300
Security deposits	4,159,900	1,034,300
Unearned revenues	1,578,300	3,039,200
Deferred income taxes	-	2,529,800
Income taxes payable	36,300	175,000
Total liabilities	124,651,300	126,337,200
Commitments and contingencies (Note 8)
Stockholders’ equity:
Preferred stock, $0.001 par value, 2,000,000 shares authorized,    no shares issued and outstanding	-	-
Common stock, $0.001 par value, 10,000,000 shares authorized, 1,545,884 shares outstanding at September 30, 2020 and December 31, 2019	1,800	1,800
Paid-in capital	16,782,800	16,782,800
(Accumulated deficit)/retained earnings	(16,895,100)	10,882,100
Accumulated other comprehensive loss	(482,800)	(1,370,800)
	(593,300)	26,295,900
Treasury stock at cost, 213,332 shares at September 30, 2020 and      December 31, 2019, respectively	(3,037,300)	(3,037,300)
Total stockholders’ (deficit)/equity	(3,630,600)	23,258,600
Total liabilities and stockholders’ (deficit)/equity	$121,020,700	$149,595,800

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

AeroCentury Corp.

Condensed Consolidated Statements of Operations

(Unaudited)

	For the Nine Months Ended September 30,		For the Three Months Ended September 30,
	2020	2019	2020	2019
Revenues and other income:
Operating lease revenue	$12,395,800	$20,820,100	$3,249,100	$6,705,900
Maintenance reserves revenue, net	221,400	16,968,400	221,400	16,968,400
Finance lease revenue	56,300	764,800	-	268,600
Net gain on disposal of assets	8,700	322,000	19,800	44,000
Net loss on sales-type leases	-	(170,600)	-	-
Other (loss)/income	(23,200)	11,200	-	400
	12,659,000	38,715,900	3,490,300	23,987,300
Expenses:
Interest	13,492,700	7,745,000	3,020,100	2,347,600
Impairment in value of aircraft	16,820,500	24,923,000	439,000	23,354,600
Depreciation	5,514,900	9,140,700	1,342,100	2,970,000
Professional fees, general and    administrative and other	4,368,900	2,627,300	1,370,600	944,900
Bad debt expense	1,170,000	3,918,000	-	3,918,000
Salaries and employee benefits	1,533,500	1,749,000	498,800	529,200
Insurance	602,900	409,600	191,400	130,200
Maintenance	246,400	373,100	78,000	255,900
Other taxes	77,600	88,700	26,500	25,600
	43,827,400	50,974,400	6,966,500	34,476,000
Loss before income tax (benefit)/provision	(31,168,400)	(12,258,500)	(3,476,200)	(10,488,700)
Income tax (benefit)/provision	(3,391,200)	(2,641,400)	604,900	(2,257,300)
Net loss	$(27,777,200)	$(9,617,100)	$(4,081,100)	$(8,231,400)
Loss per share:
Basic	$(17.97)	$(6.22)	$(2.64)	$(5.32)
Diluted	$(17.97)	$(6.22)	$(2.64)	$(5.32)
Weighted average shares used in    loss per share computations:
Basic	1,545,884	1,545,884	1,545,884	1,545,884
Diluted	1,545,884	1,545,884	1,545,884	1,545,884

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

AeroCentury Corp.

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

 

	For the Nine Months Ended September 30,		For the Three Months Ended September 30,
	2020	2019	2020	2019
Net loss	$(27,777,200)	$(9,617,100)	$(4,081,100)	$(8,231,400)
Other comprehensive loss:
Unrealized losses on derivative instruments	(575,000)	(1,985,100)	-	(174,500)
Reclassification of net unrealized losses on derivative      instruments to interest expense	1,706,200	5,900	149,100	28,000
Tax benefit/(expense) related to items of other      comprehensive loss	(243,200)	425,100	(32,400)	31,500
Other comprehensive income/(loss)	888,000	(1,554,100)	116,700	(115,000)
Total comprehensive loss	$(26,889,200)	$(11,171,200)	$(3,964,400)	$(8,346,400)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

AeroCentury Corp.

Condensed Consolidated Statements of Stockholders’ Equity/(Deficit)

For the Three Months and Nine Months Ended September 30, 2019 and September 30, 2020

(Unaudited)

 

	Number of Common Stock Shares Outstanding	Common Stock	Paid-in Capital	Retained Earnings/ (Deficit)	Treasury Stock	Accumulated Other Comprehensive Loss	Total
Balance, December 31, 2018	1,545,884	$1,800	$16,782,800	$27,540,600	$(3,037,300)	$-	$41,287,900
Net loss	-	-	-	(1,308,200)	-	-	(1,308,200)
Accumulated other comprehensive loss	-	-	-	-	-	(427,800)	(427,800)
Balance, March 31, 2019	1,545,884	1,800	16,782,800	26,232,400	(3,037,300)	(427,800)	39,551,900
Net loss	-	-	-	(77,600)	-	-	(77,600)
Accumulated other comprehensive loss	-	-	-	-	-	(1,011,300)	(1,011,300)
Balance, June 30, 2019	1,545,884	1,800	16,782,800	26,154,800	(3,037,300)	(1,439,100)	38,463,000
Net loss	-	-	-	(8,231,400)	-	-	(8,231,400)
Accumulated other comprehensive loss	-	-	-	-	-	(115,000)	(115,000)
Balance, September 30, 2019	1,545,884	$1,800	$16,782,800	$17,923,400	$(3,037,300)	$(1,554,100)	$30,116,600
Balance, December 31, 2019	1,545,884	$1,800	$16,782,800	$10,882,100	$(3,037,300)	$(1,370,800)	$23,258,600
Net loss	-	-	-	(10,178,400)	-	-	(10,178,400)
Accumulated other comprehensive income	-	-	-	-	-	583,700	583,700
Balance, March 31, 2020	1,545,884	1,800	16,782,800	703,700	(3,037,300)	(787,100)	13,663,900
Net loss	-	-	-	(13,517,700)	-	-	(13,517,700)
Accumulated other comprehensive income	-	-	-	-	-	187,600	187,600
Balance, June 30, 2020	1,545,884	1,800	16,782,800	(12,814,000)	(3,037,300)	(599,500)	333,800
Net loss	-	-	-	(4,081,100)	-	-	(4,081,100)
Accumulated other comprehensive income	-	-	-	-	-	116,700	116,700
Balance, September 30, 2020	1,545,884	$1,800	$16,782,800	$(16,895,100)	$(3,037,300)	$(482,800)	$(3,630,600)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

AeroCentury Corp.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	For the Nine Months Ended September 30,
	2020	2019
Net cash provided by operating activities	$5,983,900	$8,146,400
Investing activities:
Proceeds from sale of aircraft and aircraft engines held for lease,    net of re-sale fees	-	1,702,500
Proceeds from sale of assets held for sale, net of re-sale fees	3,229,900	5,505,400
Investment in aircraft parts and acquisition costs	-	(150,000)
Net cash provided by investing activities	3,229,900	7,057,900
Financing activities:
Issuance of notes payable – MUFG Credit Facility and MUFG Loan	-	5,100,000
Repayment of notes payable – MUFG Credit Facility and MUFG Loan	(1,165,000)	(44,300,000)
Issuance of notes payable – Nord Loans	-	44,310,000
Repayment of notes payable – UK LLC SPE Financing	-	(9,211,100)
Repayment of notes payable – Nord Loans	(5,131,500)	(5,513,000)
Issuance of notes payable – PPP Loan	276,400	-
Debt issuance costs	(1,707,000)	(5,074,200)
Net cash used in financing activities	(7,727,100)	(14,688,300)
Net increase in cash, cash equivalents and restricted cash	1,486,700	516,000
Cash, cash equivalents and restricted cash, beginning of period	3,427,100	1,542,500
Cash, cash equivalents and restricted cash, end of period	$4,913,800	$2,058,500

 

Non-cash financing activities:
Non-cash issuance of notes payable – Credit Facility $ 2,150,000	$-

 

The components of cash and cash equivalents and restricted cash at the end of each of the periods presented consisted of:

 

	September 30,
	2020	2019
Cash and cash equivalents	$4,863,800	$2,058,500
Restricted cash	50,000	-
Total cash, cash equivalents and restricted cash shown in the statement of cash flows	$4,913,800	$2,058,500

 

During the nine months ended September 30, 2020 and 2019, the Company paid interest totaling $3,250,300 and $6,141,300, respectively. The Company paid income taxes of $222,900 and $536,000 during the nine months ended September 30, 2020 and 2019, respectively.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

AeroCentury Corp.

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2020

 

1. Organization and Summary of Significant Accounting Policies

 

(a) The Company and Basis of Presentation

 

AeroCentury Corp. (“AeroCentury”) is a Delaware corporation incorporated in 1997. AeroCentury together with its consolidated subsidiaries is referred to as the “Company.”

 

In August 2016, AeroCentury formed two wholly-owned subsidiaries, ACY 19002 Limited (“ACY 19002”) and ACY 19003 Limited (“ACY 19003”) for the purpose of acquiring aircraft using a combination of cash and third-party financing (“UK LLC SPE Financing” or “special-purpose financing”) separate from AeroCentury’s credit facility (the “MUFG Credit Facility”). The UK LLC SPE Financing was repaid in full in February 2019 as part of a refinancing involving new non-recourse term loans totaling approximately $44.3 million (“Nord Loans”) made to ACY 19002, ACY 19003, and two other newly formed special-purpose subsidiaries of AeroCentury, ACY SN 15129 LLC (“ACY 15129”) and ACY E-175 LLC (“ACY E-175”), which were formed for the purpose of refinancing four of the Company’s aircraft using the Nord Loans. See Note 4(b) for more information about the Nord Loans.

 

Financial information for AeroCentury and its consolidated subsidiaries is presented on a consolidated basis in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020 or for any other period. All intercompany balances and transactions have been eliminated in consolidation.

 

(b) Going Concern

 

As discussed in Note 4, the Company was in default under its MUFG Credit Facility as of December 31, 2019. On May 1, 2020, the Company and the MUFG Credit Facility Lenders (“MUFG Lenders”) executed an amendment to the MUFG Credit Facility (as amended, the “MUFG Loan Agreement”) to convert the MUFG Credit Facility into a term loan facility (as converted, the “MUFG Loan”). The amendment included certain requirements and establishment of deadlines for achievement of milestones toward execution of Company strategic alternatives for the Company and/or its assets acceptable to the MUFG Lenders. The amendment cured the December default, but the Company was in default under the MUFG Loan Agreement due to non-payment of interest due on July 1, 2020, August 3, 2020, September 1, 2020 and October 1, 2020. As discussed in Note 5, the Company was also obligated to pay $3.1 million related to the termination of the MUFG Swaps in March 2020. On October 30, 2020, the MUFG Lenders sold the MUFG Loan and the obligation of the Company from termination of the MUFG Swaps to Drake Asset Management Jersey Limited (“Drake”), and the Company and Drake entered into an amendment of the loan (as amended, the “Drake Loan Agreement”) under which, among other things, the cash component of interest due for March 2020 and thereafter for the term of the loan will be capitalized and the requirement for execution of a Strategic Alternative and related milestones was deleted (see Note 11 regarding Subsequent Events).

 

Drake has the right to exercise any and all remedies for default under the Drake Loan Agreement. Such remedies include, but are not limited to, declaring the entire indebtedness immediately due and payable and, if the Company were unable to repay such accelerated indebtedness, foreclosing upon the assets of the Company that secure the indebtedness under the Drake Loan Agreement (the “Drake Loan”) and the indebtedness for the terminated swaps (together, the “Drake Indebtedness”), which consist of substantially all of the Company’s assets except for certain assets held in the Company’s single asset special-purpose financing subsidiaries. As discussed in Note 4, the Company also defaulted on payment under the Nord Loans.

 

The COVID-19 pandemic has led to significant cash flow issues for airlines, and some airlines, including some of the Company’s customers, have been unable to timely meet their obligations under their lease obligations with the Company unless government financial support is received, of which there can be no assurance. Any additional significant nonpayment or late payment of lease payments by a significant lessee or combination of lessees could in turn impose limits on the Company’s ability to fund its ongoing operations as well as cause the Company to be unable to meet its debt obligations, which in turn could lead to an immediate acceleration of debt and foreclosure upon the Company’s assets.

 

As a result of these factors, there is substantial doubt regarding the Company’s ability to continue as a going concern. The condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q have been prepared on a going concern basis and do not include any adjustments that might arise as a result of uncertainties about the Company’s ability to continue as a going concern.

 

(c) Impact of COVID-19

 

In March 2020, the World Health Organization (“WHO”) declared the novel strain of coronavirus (“COVID-19”) a pandemic, and COVID-19 has continued to have wide-ranging impacts as the virus spreads globally (the “COVID-19 Outbreak”). In March 2020, the WHO classified the COVID-19 Outbreak as a pandemic, based on the rapid increase in exposure globally. The ongoing COVID-19 Outbreak has had an overwhelming effect on all forms of transportation globally, but most acutely for the airline industry. The combined effect of fear of infection during air travel and international and domestic travel restrictions has caused a dramatic decrease in passenger loads in all areas of the world, not just in those countries with active clusters of COVID-19, but in airline ticket net bookings (i.e. bookings made less bookings canceled) of flights as well. This has led to significant cash flow issues for airlines, including some of the Company’s customers. Two of the Company’s eight customers did not make operating lease rent payments that were due in March, April, May and June 2020, totaling approximately $3.5 million. As discussed in Notes 4(b) and 11, one of the customers paid the deferred rent in September 2020 and purchased the aircraft in October 2020. The Company permitted the second customer, which leases two regional turboprop aircraft, to make reduced payments totaling approximately $0.3 million in April, May and June 2020 and the customer paid the reduced amounts. In addition, two other customers, each of which leases an aircraft subject to a sales-type lease, did not make lease payments totaling approximately $0.9 million, and the Company and the customers are discussing remedies regarding non-payment of a portion of the lease payments due during the first quarter of 2020 as well as the lease payments due during the second and third quarters. As discussed in Note 3, the Company recorded impairments of $439,000 and $16,820,500 during the three months and nine months ended September 30, 2020. The impact of the COVID-19 Outbreak has also lead the Company to determine that there is uncertainty related to rent, interest and debt payments such that, as disclosed in Notes 4 and 5, the Company dedesignated its interest rate swaps as hedges in March 2020 since the payments related to the swaps were deemed not probable to occur.

 

Furthermore, for the duration of the pandemic and a period of financial recovery thereafter, sale and acquisition transactions are likely to be curtailed entirely or delayed while the industry returns to financial stability, which could impact the Company’s ability to implement a recapitalization plan (“Recapitalization Plan”). The Company has made estimates of the impact of the pandemic within its financial statements and there may be changes to those estimates in future periods. While the Company’s results of operations, cash flows and financial condition would be negatively impacted, the extent of the impact for the remainder of 2020 cannot be reasonably estimated at this time.

 

(d) Use of Estimates

 

The Company’s condensed consolidated financial statements have been prepared in accordance with GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable for making judgments that are not readily apparent from other sources.

 

The most significant estimates with regard to these condensed consolidated financial statements are the residual values and useful lives of the Company’s long-lived assets, the current value of the Company’s assets held for sale, the amount and timing of future cash flows associated with each asset that are used to evaluate whether assets are impaired, accrued maintenance costs, accounting for income taxes, the assumptions used to value the Company’s derivative instruments, the valuation of the right of use asset and related lease liability associated with the Company’s office, and the amounts recorded as allowances for doubtful accounts.

 

(e) Comprehensive Income/(Loss)

 

The Company accounts for former interest rate cash flow hedges by reclassifying accumulated other comprehensive income into earnings in the periods in which the expected transactions occur or when it is probable that the hedged transactions will no longer occur, and are included in interest expense.

 

(f) Finance Leases

 

As of December 31, 2019, the Company had three aircraft subject to sales-type leases and three aircraft subject to direct financing leases. All six leases contain lessee bargain purchase options at prices substantially below the subject asset’s estimated residual value at the exercise date for the option. Consequently, the Company classified each of these six leases as finance leases for financial accounting purposes. For such finance leases, the Company reports the discounted present value of (i) future minimum lease payments (including the bargain purchase option) and (ii) any residual value not subject to a bargain purchase option, as a finance lease receivable on its balance sheet, and accrues interest on the balance of the finance lease receivable based on the interest rate inherent in the applicable lease over the term of the lease. For each of the three sales-type leases, the Company recognized as a gain or loss the amount equal to (i) the net investment in the sales-type lease plus any initial direct costs and lease incentives less (ii) the net book value of the subject aircraft at inception of the applicable lease.

 

In the first nine months of 2020, the Company sold the underlying aircraft in one of its sales-type leases and all three of its direct finance leases to the lessees, resulting in net losses totaling $47,900. The remaining two sales-type leases were substantially modified and, as a result of payment delinquencies by the two customers, the Company recorded a bad debt allowance of $1,170,000 during the first quarter of 2020. The two leases remain treated as sales-type leases.

 

(g) Taxes

 

As part of the process of preparing the Company’s condensed consolidated financial statements, management estimates income taxes in each of the jurisdictions in which the Company operates.  This process involves estimating the Company’s current tax exposure under the most recent tax laws and assessing temporary differences resulting from differing treatment of items for tax and GAAP purposes.  These differences result in deferred tax assets and liabilities, which are included in the balance sheet.  In assessing the valuation of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income or availability to carryback the losses to taxable income during periods in which those temporary differences become deductible. The Company considered several factors when analyzing the need for a valuation allowance including the Company's current five-year cumulative loss through September 30, 2020, the impacts of COVID-19 pandemic on the worldwide airline industry and the need to rapidly refinance its debt or sell its assets in accordance with the provisions of its Drake Indebtedness.  Significant management judgment is required in determining the Company’s future taxable income for purposes of assessing the Company’s ability to realize any benefit from its deferred taxes.  Based on its analysis, the Company has concluded that a valuation allowance is necessary for its U.S. deferred tax assets not supported by either future taxable income or availability of future reversals of existing taxable temporary differences and has recorded a valuation allowance of $1,409,400 and $4,585,300 for the three months and nine months ended September 30, 2020, respectively.  Additionally, the Company has concluded that, based on its analysis, some of its foreign deferred tax assets are not expected to be realized based on limitations on the utilization of its foreign net operating losses, and has therefore recorded a valuation allowance of $778,000 for the three months and the nine months ended September 30, 2020.

 

The Company accrues non-income based sales, use, value added and franchise taxes as other tax expense in the condensed consolidated statement of operations.

 

(h) Interest Rate Hedging

 

During the first quarter of 2019, the Company entered into certain derivative instruments to mitigate its exposure to variable interest rates under the Nord Loan debt and a portion of the MUFG Indebtedness. Hedge accounting is applied to such a transaction only if specific criteria have been met, the transaction is deemed to be “highly effective” and the transaction has been designated as a hedge at its inception. Under hedge accounting treatment, generally, the effects of derivative transactions are recorded in earnings for the period in which the hedge transaction affects earnings. A change in value of a hedging instrument is reported as a component of other comprehensive income/(loss) and is reclassified into earnings in the period in which the transaction being hedged affects earnings.

 

If at any time after designation of a cash flow hedge, such as those entered into by the Company, it is no longer probable that the forecasted cash flows will occur, hedge accounting is no longer permitted and a hedge is “dedesignated.” After dedesignation, if it is still considered reasonably possible that the forecasted cash flows will occur, the amount previously recognized in other comprehensive income/(loss) will continue to be reversed as the forecasted transactions affect earnings. However, if after dedesignation it is probable that the forecasted transactions will not occur, amounts deferred in accumulated other comprehensive income/(loss) will be recognized in earnings immediately.

 

As noted in Note 5, in October 2019 the Company became aware that, as a result of certain defaults under its MUFG Credit Facility, certain of the forecasted transactions related to its MUFG Credit Facility interest rate swaps were no longer probable of occurring and, hence, those swaps were dedesignated from hedge accounting at that time. The two swaps related to the MUFG Credit Facility were terminated in March 2020 and the Company incurred a $3.1 million obligation in connection with such termination, payment of which is due no later than the March 31, 2021 maturity of the Drake Loan. As a result of the forecasted transaction being not probable to occur, accumulated other comprehensive loss of $34,500 and $1,421,800 related to the MUFG Swaps was recognized as interest expense in the quarter and nine months ended September 30, 2020, respectively.

 

In March 2020, the Company determined that the future hedged interest payments related to its five remaining Nord Loan interest rate hedges were no longer probable of occurring, and consequently dedesignated all five swaps from hedge accounting.

 

 

 

(i) Recent Accounting Pronouncements

 

ASU 2016-13

 

The FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), in June 2016 (“ASU 2016-13”). ASU 2016-13 provides that financial assets measured at amortized cost are to be presented as a net amount, reflecting a reduction for a valuation allowance to present the amount expected to be collected (the “current expected credit loss” model of reporting). As such, expected credit losses will be reflected in the carrying value of assets and losses will be recognized before they become probable, as is required under the Company’s present accounting practice. In the case of assets held as available for sale, the amount of the valuation allowance will be limited to an amount that reflects the marketable value of the debt instrument. This amendment to GAAP is effective in the first quarter of 2023 for calendar-year SEC filers that are smaller reporting companies as of the one-time determination date. Early adoption is permitted beginning in 2019. The Company plans to adopt the new guidance on January 1, 2023, and has not determined the impact of this adoption on its consolidated financial statements.

 

ASU 2019-12

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), to simplify the accounting for income taxes. The new guidance removes certain exceptions for recognizing deferred taxes for investments, performing intra-period allocation and calculating income taxes in interim periods. It also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. This guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements and related disclosures.

 

FASB Staff Guidance on Effects of COVID-19

 

In April 2020, the FASB staff provided some relief from the unprecedented effect of the COVID-19 pandemic. Under this guidance, lessors may elect to treat lease concessions due to COVID-19 as if they arose from enforceable rights and obligations that existed in the lease contract, with the consequent effect that the concessions would not be treated as a lease modification which could require reclassification and remeasurement of the lease and to either recognize income during the deferral period or to treat deferred rent as variable rent during the period. Other guidance released in April 2020 provides that when hedge accounting is discontinued and it is probable that the forecasted transaction that had been hedged will occur beyond two months after its originally expected date as a result of the effects of COVID-19, the reporting entity may still defer recognizing related AOCI immediately and should defer recognition of such amounts until the forecasted transactions actually occur. The Company has elected to treat certain lease concessions to lessees as if they arose from rights initially in the lease contracts and so did not give rise to modifications of the leases, and to treat deferrals as variable rent during the period of the deferral, reducing income during such period.

 

(j) Reclassifications

 

Certain prior period amounts have been reclassified to conform with the current period presentation.

 

2. Aircraft Lease Assets

 

The Company’s leases are normally “triple net leases” under which the lessee is obligated to bear all costs, including tax, maintenance and insurance, on the leased assets during the term of the lease. In most cases, the lessee is obligated to provide a security deposit or letter of credit to secure its performance obligations under the lease, and in some cases, is required to pay maintenance reserves based on utilization of the aircraft, which reserves are available for qualified maintenance costs during the lease term and may or may not be refundable at the end of the lease. Typically, the leases also contain minimum return conditions, as well as an economic adjustment payable by the lessee (and in some instances by the lessor) for amounts by which the various aircraft or engine components are worse or better than a targeted condition set forth in the lease. Some leases contain renewal or purchase options, although the Company’s sales-type leases contain a bargain purchase option at lease end which the Company expects the lessees to exercise or require that the lessee purchase the aircraft at lease-end for a specified price.

 

Because all of the Company’s leases transfer use and possession of the asset to the lessee and contain no other substantial undertakings by the Company, the Company has concluded that all of its lease contracts qualify for lease accounting. Certain lessee payments of what would otherwise be lessor costs (such as insurance and property taxes) are excluded from both revenue and expense.

 

The Company evaluates the expected return on its leased assets by considering both the rents receivable over the lease term, any expected additional consideration at lease end, and the residual value of the asset at the end of the lease. In some cases, the Company depreciates the asset to the expected residual value because it expects to sell the asset at lease end; in other cases, it may expect to re-lease the asset to the same or another lessee and the depreciation term and related residual value will differ from the initial lease term and initial residual value. Residual value is estimated by considering future estimates provided by independent appraisers, although it may be adjusted by the Company based on expected return conditions or location, specific lessee considerations, or other market information.

 

Three of the Company’s operating lease assets are subject to manufacturer residual value guarantees totaling approximately $16 million at the end of their lease terms in the second quarter of 2025. The Company considers the best market for re-leasing and/or selling its assets at the end of its leases, although it does not expect to retain ownership of the assets under sales-type leases given the lessees’ bargain purchase options or required purchase.

 

During the third quarter of 2020, the Company recorded impairment losses totaling $300,000 for two of its aircraft held for lease, which were written down based on estimated future cash flow. The Company also recorded an impairment loss of $139,000 on an aircraft that is held for sale, which was written down based on its estimated sales price, less cost of sale.

 

(a) Assets Held for Lease

 

At September 30, 2020 and December 31, 2019, the Company’s aircraft held for lease consisted of the following:

	September 30, 2020		December 31, 2019
Type	Number Owned	% of net book value	Number owned	% of net book value
Regional jet aircraft	9	79%	9	80%
Turboprop aircraft	2	21%	2	20%

 

The Company did not purchase or sell any aircraft held for lease during the first nine months of 2020. None of the Company’s aircraft held for lease were off lease at September 30, 2020.

 

As of September 30, 2020, minimum future lease revenue payments receivable under non-cancelable operating leases were as follows:

 

Years ending December 31
Remainder of 2020	$3,234,500
2021	10,512,500
2022	8,760,100
2023	8,760,100
2024	6,931,400
Thereafter	1,683,300
	$39,881,900

 

The remaining weighted average lease term of the Company’s assets under operating leases was 35 months and 41 months at September 30, 2020 and December 31, 2019, respectively.

 

(b) Sales-Type and Finance Leases

 

In January 2020, the Company amended the leases for three of its assets that were subject to sales-type leases. The amendments provided for (i) the sale of one aircraft to the customer in January 2020, which resulted in a gain of $12,700, (ii) application of collected maintenance reserves and a security deposit held by the Company to past due amounts for the other two aircraft, (iii) payments totaling $585,000 in January for two of the leases and (iv) the reduction of future payments due under the two leases. As a result of payment delinquencies by the two customers of these aircraft, the Company recorded a bad debt allowance of $1,170,000 during the first quarter.

 

In January 2020, the lessee for an aircraft leased pursuant to a direct financing lease notified the Company of its intention to exercise the lease-end purchase option for the aircraft in March 2020. In February 2020, the Company and the same lessee agreed to the early exercise of lease-end purchase options for direct financing leases that were to expire in March 2021 and March 2022. All three aircraft were sold to the lessee in March 2020, resulting in a loss of $52,000. During the second and third quarters of 2020, the Company recorded additional legal expenses totaling $8,600 related to the sale.

 

 

 

At September 30, 2020 and December 31, 2019, the net investment included in sales-type leases and direct financing leases receivable were as follows:

	September 30, 2020	December 31, 2019
Gross minimum lease payments receivable	$4,138,000	$12,772,300
Less unearned interest	(88,000)	(1,053,900)
Allowance for doubtful accounts	(1,170,000)	(2,908,600)
Difference between minimum lease payments receivable and collateral value of leases	-	(7,700)
Finance leases receivable	$2,880,000	$8,802,100

 

As of September 30, 2020, minimum future payments receivable under finance leases were as follows:

Years ending December 31
Remainder of 2020	$1,013,000
2021	1,284,000
2022	1,284,000
2023	557,000
	$4,138,000

 

 

The remaining weighted average lease term of the Company’s assets under sales-type and finance leases was 28 months and 20 months at September 30, 2020 and December 31, 2019, respectively.

 

The following is a roll forward of the Company’s finance lease receivable allowance for doubtful accounts from December 31, 2019 to September 30, 2020:

Balance, December 31, 2019	$2,908,600
Deductions upon sale of assets	(735,200)
Deductions upon lease amendments	(2,173,400)
Additions charged to expense	1,170,000
Balance, September 30, 2020	$1,170,000

 

3. Assets Held for Sale

 

Assets held for sale at September 30, 2020 included three regional jet aircraft, one turboprop aircraft, which is subject to a short-term operating lease, and airframe parts from two turboprop aircraft.

 

During the third quarter of 2020, the Company recorded a loss of $139,000 on an aircraft that is held for sale, which was written down to its estimated sales price, less cost of sale.

 

During the third quarter of 2020, the Company received $69,400 in cash and accrued $25,500 in receivables for parts sales. These amounts were accounted for as follows: $30,100 reduced accounts receivable for parts sales accrued in the second quarter of 2020; $43,600 reduced the carrying value of the parts; and $21,200 was recorded as gains in excess of the carrying value of the parts. During the third quarter of 2019, the Company received $220,500 in cash and accrued $77,000 in receivables for parts sales. These amounts were accounted for as follows: $142,100 reduced accounts receivable for parts sales accrued in the second quarter of 2019; $131,900 reduced the carrying value of the parts; and $23,500 was recorded as gains in excess of the carrying value of the parts.

 

 

 

4. Notes Payable and Accrued Interest

 

At September 30, 2020 and December 31, 2019, the Company’s notes payable and accrued interest consisted of the following:

 

	September 30, 2020	December 31, 2019
MUFG Credit Facility and MUFG Loan:
Principal	$85,069,100	$84,084,100
Unamortized debt issuance costs	(1,558,000)	(3,084,200)
Accrued interest	2,280,000	376,200
Nord Loans:
Principal	25,783,000	30,914,500
Unamortized debt issuance costs	(348,500)	(741,500)
Accrued interest	72,400	89,300
Paycheck Protection Program Loan:
Principal	276,400	-
Accrued interest	1,000	-
	$111,575,400	$111,638,400

 

(a) MUFG Credit Facility

 

In February 2019, the MUFG Credit Facility, which was to expire on May 31, 2019, was extended to February 19, 2023, and was amended in certain other respects. Also, four aircraft that previously served as collateral under the MUFG Credit Facility and two aircraft that previously served as collateral under special-purpose subsidiary financings were refinanced in February 2019 using non-recourse term loans (the “Nord Loans”) with an aggregate principal of $44.3 million.

 

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 MUFG Credit Facility), the MUFG Credit Facility agreement contained 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 not in compliance with various covenants contained in the MUFG Credit Facility agreement, including those related to interest coverage and debt service coverage ratios and a no-net-loss requirement under the MUFG Credit Facility, beginning in the third quarter of 2019.

 

On October 15, 2019, the agent bank for the MUFG Lenders delivered a Reservation of Rights Letter to the Company which contained notice of the Borrowing Base Default and a demand for repayment of the amount of the Borrowing Base Deficit by January 13, 2020, and also contained formal notices of default under the MUFG Credit Facility relating to the alleged material adverse effects on the Company’s business as a result of the early termination of leases for three aircraft and potential financial covenant noncompliance based on the Company’s financial projections provided to the MUFG Lenders (the Borrowing Base Default and such other defaults referred to as the “Specified Defaults”). The Reservation of Rights Letter also informed the Company that further advances under the MUFG Credit Facility agreement would no longer be permitted due to the existence of such defaults.

 

In October, November and December 2019, the Company, agent bank and the MUFG Lenders entered into a Forbearance Agreement and amendments extending the Forbearance Agreement with respect to the Specified Defaults under the MUFG Credit Facility. The Forbearance Agreement (i) provided that the MUFG Lenders temporarily forbear from exercising default remedies under the MUFG Credit Facility agreement for the Specified Defaults, (ii) reduced the maximum availability under the MUFG Credit Facility to $85 million and (iii) extended the cure period for the Borrowing Base Deficit from January 13, 2020 to February 12, 2020. The Forbearance Agreement also allowed the Company to continue to use LIBOR as its benchmark interest rate, but increased the margin on the Company’s LIBOR-based loans under the MUFG Credit Facility from a maximum of 3.75% to 6.00% and set the margin on the Company’s prime rate-based loans at 2.75%, as well as added a provision for paid-in-kind interest (“PIK Interest) of 2.5% to be added to the outstanding balance of the MUFG Credit Facility debt in lieu of a cash payment. The Company paid cash fees of $406,250 in connection with the Forbearance Agreement and amendments, as well as a fee of $832,100, which was added to the outstanding balance of the MUFG Credit Facility debt in lieu of a cash payment. The Forbearance Agreement was in effect until December 30, 2019, after which the Company and the MUFG Lenders agreed not to further amend the Forbearance Agreement. On February 12, 2020, the agent bank for the MUFG Lenders delivered a Reservation of Rights Letter to the Company which contained notice of the failure to cure the Borrowing Base Default by February 12, 2020.

 

The unused amount of the MUFG Credit Facility was $915,900 as of December 31, 2019. The weighted average interest rate on the MUFG Credit Facility was 10.23% at December 31, 2019.

 

On May 1, 2020, the Company and the MUFG Lenders entered into a Fourth Amended and Restated Loan and Security Agreement, which amended and restated the existing agreement regarding the Company's indebtedness to the MUFG Lenders and effected the following changes to the terms and provisions of such indebtedness:

 

 

 

 

 

 

 

 

 

 

 

 

On July 8, 2020, the agent bank for the MUFG Lenders delivered a Reservation of Rights Letter to the Company which contained notice of defaults with respect to failure to deliver a lessee acknowledgment of the MUFG Lender’s mortgage from one of the Company’s lessees (which was delayed due to extended negotiations between MUFG and the lessee relating to form of such acknowledgment) and (ii) the failure to make a deferred interest payment as required under the Loan Agreement that was due and payable on the earlier of July 1, 2020 or the date of the sale of a certain aircraft scheduled to be sold upon its return from its lessee (the closing of which sale was delayed beyond July 1, 2020).

 

The Company has engaged B. Riley FBR as an investment banking advisor to help (i) formulate a Recapitalization Plan and analyze various strategic financial alternatives to address the Company’s capital structure, strategic and financing needs, as well as corporate level transactions aimed at achieving maximum value for the Company’s stockholders; and (ii) locate and negotiate with the Company’s lenders, potential new lenders, investors or transaction partners who would play a role in the Company’s Recapitalization Plan. The Company’s ability to develop, obtain approval for and achieve its Recapitalization Plan is subject to a variety of factors. If the Company is not able to satisfy the requirements under the Recapitalization Plan, maintain compliance with its MUFG Indebtedness or raise sufficient capital to repay all amounts owed under the MUFG Indebtedness, the Company’s financial condition and liquidity would be materially adversely affected and its ability to continue operations could be materially jeopardized.

 

As discussed in Note 11, in October 2020, all indebtedness under the MUFG loan was sold to Drake and the Loan Agreement was amended to modify certain provisions.

 

(b) Nord Loans 

 

On February 8, 2019, the Company, through four wholly-owned subsidiary limited liability companies (“LLC Borrowers”), entered into a term loan agreement NordDeutsche Landesbank Girozentrale, New York Branch (“Nord”) that provides for six separate term loans (“Nord Loans”) with an aggregate principal amount of $44.3 million. Each of the Nord Loans is secured by a first priority security interest in a specific aircraft (“Nord Loan Collateral Aircraft”) owned by an LLC Borrower, the lease for such aircraft, and a pledge by the Company of its membership interest in each of the LLC Borrowers, pursuant to a Security Agreement among the LLC Borrowers and a security trustee, and certain pledge agreements. Two of the Nord Loan Collateral Aircraft that are owned by the Company’s two UK special-purpose entities were previously financed using special-purpose financing. The interest rates payable under the Nord Loans vary by aircraft, and are based on a fixed margin above either 30-day or 3-month LIBOR. The proceeds of the Nord Loans were used to pay down the MUFG Credit Facility and pay off the UK LLC SPE Financing. The maturity of each Nord Loan varies by aircraft, with the first Nord Loan maturing in October 2020 and the last Nord Loan maturing in May 2025. The debt under the Nord Loans is expected to be fully amortized by rental payments received by the LLC Borrowers from the lessees of the Nord Loan Collateral Aircraft during the terms of their respective leases and remarketing proceeds.

 

The Nord Loans include covenants that impose various restrictions and obligations on the LLC Borrowers, including covenants that require the LLC Borrowers to obtain Nord consent before they can take certain specified actions, and certain events of default. If an event of default occurs, subject to certain cure periods for certain events of default, Nord would have the right to terminate its obligations under the Nord Loans, declare all or any portion of the amounts then outstanding under the Nord Loans to be accelerated and due and payable, and/or exercise any other rights or remedies it may have under applicable law, including foreclosing on the assets that serve as security for the Nord Loans. The Company was in compliance with all covenants under the Nord Loans at December 31, 2019 but, as discussed below, was in default of its obligation to make its quarterly payments due on March 24, 2020 and June 24, 2020.

 

As a result of the COVID-19 Outbreak, in March and June 2020, one of the Company’s customers, which leases two regional jet aircraft subject to Nord Loan financing, did not make its quarterly rent payments totaling approximately $2.8 million. The nonpayment led to corresponding Nord Loan financing payment events of default under the Nord Loans for each of the LLC Borrowers. In May 2020, with Nord’s consent, the Company collected on the customer’s security letters of credit and paid a portion of the March and June financing payments due under the Nord Loans, and entered into an agreement with the customer to defer payment of the remaining balance of the March rent to June 2020. In June 2020, the Company agreed with the customer to defer payment of the March and June rent to September 2020, and entered into an agreement with Nord to defer until September 24, 2020 (i) payment of the principal amount due under the respective Nord Loans for the two aircraft due in March and June 2020 and (ii) payment of past due interest at the default interest rate on the March and June 2020 overdue payments. The lease arrearage was repaid by the lessee in late September, which permitted the special-purpose subsidiaries to come back into compliance with their Nord Loan indebtedness. The lessee also paid deposits totaling approximately $3,444,000 for purchase of the aircraft. As discussed in Note 11, in October 2020, the Company sold the two aircraft to the lessee, and fully repaid the term loan indebtedness on such aircraft with the proceeds of the sale. The excess proceeds from the purchase were applied to the remaining Nord Term Loan indebtedness owed by a special-purpose subsidiary of the Company secured by three regional jets on lease to a U.S. regional airline. The lessee of those aircraft is in compliance and current in its lease obligations, and the special-purpose subsidiary is in full compliance with its loan repayment obligations.

 

As a result of the customer’s non-payments in March and June 2020 and potential consequent uncertainty concerning future interest payments under the related Nord Loans, the Company dedesignated the two related derivative instruments from hedge accounting during the first quarter of 2020 since the swapped interest was not deemed as probable to occur.

 

After discussions with the lessee for the remaining three swaps related to the Nord Loans, the Company determined that there was sufficient uncertainty related to rent payments and related debt payments, and that the Company could not conclude that the payments related to the swaps were probable of occurring, so that the Company dedesignated those swaps from hedge accounting in March 2020 as well.

 

(c) Paycheck Protection Program Loan

 

On May 20, 2020, JetFleet Management Corp. (the “PPP Borrower”), a subsidiary of AeroCentury Corp., was granted a loan (the “PPP Loan”) from American Express National Bank in the aggregate amount of $276,353, pursuant to the Paycheck Protection Program (the “PPP”) under Division A, Title I of the CARES Act, which was enacted March 27, 2020. The application for these funds required the Company to, in good faith, certify that the current economic uncertainty made the loan request necessary to support the ongoing operations of the Company. This certification further required the Company to take into account its current business activity and its ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. The receipt of these funds, and the forgiveness of the loan attendant to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on its future adherence to the forgiveness criteria.

 

The PPP Loan, which was in the form of a Note dated May 18, 2020 issued by the PPP Borrower and is included in the Company's notes payable and accrued interest, matures on April 22, 2022 and bears interest at a rate of 1.00% per annum, payable in 18 monthly payments commencing on November 20, 2020. The Note may be prepaid by the PPP Borrower at any time prior to maturity with no prepayment penalties. Funds from the PPP Loan may only be used for payroll costs and any payments of certain covered interest, lease and utility payments. The Company intends to use the entire PPP Loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the Loan may be forgiven if they are used for qualifying expenses as described in the CARES Act. Although the Company expects that all or a significant portion of the PPP loan will be forgiven, no assurance can be provided that the Company will obtain such forgiveness.

 

5. Derivative Instruments

 

In the first quarter of 2019, the Company entered into eight fixed pay/receive variable interest rate swaps. The Company entered into the interest rate swaps in order to reduce its exposure to the risk of increased interest rates. With respect to the six interest rate swaps entered into by the LLC Borrowers, the swaps were deemed necessary so that the anticipated cash flows of such entities, which arise entirely from the lease rents for the aircraft owned by such entities, would be sufficient to make the required Nord Loan principal and interest payments, thereby preventing default so long as the lessees met their lease rent payment obligations. The two interest rate swaps entered into by AeroCentury were intended to protect against the exposure to interest rate increases on $50 million of the Company’s MUFG Credit Facility debt.

 

The Company estimates the fair value of derivative instruments using a discounted cash flow technique and uses creditworthiness inputs that corroborate observable market data evaluating the Company’s and counterparties’ risk of non-performance. Valuation of the derivative instruments requires certain assumptions for underlying variables and the use of different assumptions would result in a different valuation. Management believes it has applied assumptions consistently during the period.

 

The Company designated seven of its interest rate swaps as cash flow hedges. Changes in the fair value of the hedged swaps are included in other comprehensive income/(loss), which amounts are reclassified into earnings in the period in which the transaction being hedged affects earnings (i.e., with future settlements of the interest rate swaps). One of the interest rate swaps was not eligible under its terms for hedge treatment and was terminated in 2019 when the associated asset was sold and the related debt was paid off. Changes in fair value of non-hedge derivatives are reflected in earnings in the periods in which they occur.

 

Six of the interest rate swaps were entered into by the LLC Borrowers and provided for reduced notional amounts that mirror the amortization under the Nord Loans entered into by the LLC Borrowers, effectively converting each of the six Nord Loans from a variable to a fixed interest rate, ranging from 5.38% to 6.30%. Each of these six interest rate swaps extended for the duration of the corresponding Nord Loan. Two of the swaps have maturities in 2020 and three have maturities in 2025. The sixth swap was terminated in the fourth quarter of 2019 in connection with the sale of the related aircraft,

 

As discussed in Note 4, in March, the Company determined that the future hedged interest payments related to its five remaining Nord Loan interest rate hedges were no longer probable of occurring, and consequently dedesignated all five swaps as hedges. As a result of dedesignation, future changes in market value will be recognized in ordinary income and AOCI will be reclassified to ordinary income as the forecasted transactions occur. Accumulated other comprehensive loss of $114,600 and $284,500 related to the Nord Swaps was recognized as an expense in the third quarter and first nine months of 2020, respectively.

 

The other two interest rate swaps (the “MUFG Swaps”), related to the Company’s MUFG Credit Facility, were entered into by AeroCentury and had notional amounts totaling $50 million and were to extend through the maturity of the MUFG Credit Facility in February 2023. Under the ISDA agreement for these interest rate swaps, defaults under the MUFG Credit Facility give the swap counterparty the right to terminate the interest rate swaps with any breakage costs being the liability of the Company.

 

In October 2019, the Company determined that it was no longer probable that forecasted cash flows for its two interest rate swaps with a nominal value of $50 million would occur as scheduled as a result of the Company’s defaults under the MUFG Credit Facility. Therefore, those swaps were no longer subject to hedge accounting and changes in fair market value thereafter were recognized in earnings as they occurred. As a result of the forecasted transaction being not probable to occur, accumulated other comprehensive loss of $34,500 and $1,421,800 related to the MUFG Swaps was recognized as interest expense in the third quarter and first nine months of 2020, respectively. The two swaps related to the MUFG Credit Facility were terminated in March 2020 and the Company incurred a $3.1 million obligation in connection with such termination, payment of which is due no later than the March 31, 2021 maturity of the Drake Indebtedness.

 

 

 

The Company has reflected the following amounts in its net loss:

	For the Nine Months Ended September 30,		For the Three Months Ended September 30,
	2020	2019	2020	2019
Change in value of interest rate swaps	$1,980,500	$455,100	$(10,000)	$3,700
Reclassification from other comprehensive income	538,500	5,900	149,100	28,000
Reclassification from other comprehensive income –    forecasted transaction not probable to occur	1,167,700	-	-	-
Included in interest expense	$3,686,700	$461,000	$139,100	$31,700
The following amount was included in other comprehensive income/(loss), before tax:
Unrealized gain/(loss) on derivative instruments	$(575,000)	$(1,985,100)	$-	$(174,500)
Reclassification from other comprehensive income	538,500	5,900	149,100	28,000
Reclassification from other comprehensive income –    forecasted transaction not probable to occur	1,167,700	-	-	-
Change in value of interest rate swaps	$1,131,200	$(1,979,200)	$149,100	$(146,500)

 

Approximately $232,800 of the current balance of accumulated other comprehensive loss is expected to be reclassified in the next twelve months.

 

At September 30, 2020, the fair value of the Company’s interest rate swaps was $874,700.

 

The Company evaluates the creditworthiness of the counterparties under its hedging agreements. The swap counterparties for the Company’s interest rate swaps are large financial institutions in the United States that possess an investment grade credit rating. Based on this rating, the Company believes that the counterparties are creditworthy and that their continuing performance under the hedging agreements is probable.

 

6. Lease Right of Use Asset and Liability

 

The Company was a lessee under a lease of the office space it occupies in Burlingame, California, which expired in June 2020. The lease also provided for two, successive one-year lease extension options for amounts that were substantially below the market rent for the property. The lease provided for monthly rental payments according to a fixed schedule of increasing rent payments. As a result of the below-market extension options, the Company determined that it was reasonably certain that it would extend the lease and, therefore, included such extended term in its calculation of the right of use asset (“ROU Asset”) and lease liability recognized in connection with the lease.

 

In addition to a fixed monthly payment schedule, the office lease also included an obligation for the Company to make future variable payments for certain common areas and building operating and lessor costs, which have been and will be recognized as expense in the periods in which they are incurred. As a direct pass-through of applicable expense, such costs were not allocated as a component of the lease.

 

Effective January 1, 2020, the Company reduced both the size of the office space leased and the amount of rent payable in the future. As such, the Company recognized a reduction in both the capitalized amount related to the surrendered office space and a proportionate amount of the liability associated with its future lease obligations. In January 2020, the Company recorded a loss of $160,000 related to the reduction in its ROU Asset, net of the reduction in its operating lease liability, and expected to recognize amortization of $308,100, $317,600 and $162,600 in 2020, 2021 and the first half of 2022, respectively.

 

In March 2020, the Company elected not to exercise the extension options for its office lease. The lease liability associated with the office lease was calculated at March 31, 2020 and December 31, 2019 by discounting the fixed, minimum lease payments over the remaining lease term, including the below-market extension periods, at a discount rate of 7.25%, which represents the Company’s estimate of the incremental borrowing rate for a collateralized loan for the type of underlying asset that was the subject of the office lease at the time the lease liability was evaluated. As a result of non-exercise of its extension option, the Company reduced the lease liability to reflect only the three remaining rent payments in the second quarter of 2020.

 

In July 2020, the lease for the Company’s office lease was extended for one month to July 31, 2020 at a rate of $10,000. The Company has signed a lease for a smaller office suite in the same building effective August 1, 2020. The lease provides for a term of 30 months expiring on January 31, 2023, at a monthly base rate of approximately $7,400, with no rent due during the first six months. The Company recognized an ROU asset and lease liability of $169,800, both of which were non-cash items and are not reflected in the condensed consolidated statement of cash flows. No cash was paid at the inception of the lease, and a discount rate of 3% was used, based on the interest rates available on secured commercial real estate loans available at the time. At September 30, 2020, the weighted average discount rate was 3% and the weighted average remaining lease term was 28 months.

 

The Company estimates that the maturities of operating lease base rent of its office space were as follows as of September 30, 2020 and December 31, 2019:

 

	September 30, 2020	December 31, 2019
2020	$-	$145,000
2021	88,700	147,200
2022	88,700	74,700
	177,400	366,900
Discount	(6,700)	(30,500)
Lease liability	$170,700	$336,400

 

During the quarter ended September 30, 2020, the Company recognized amortization, finance costs and other expense related to the office lease as follows:

 

Fixed rental expense during the quarter	$11,800
Variable lease expense	(1,200)
Total lease expense during the quarter	$10,600

 

Variable rent for the quarter ended September 30, 2020 reflects a refund of previously charged and accrued common area maintenance charges for the Company’s office space.

 

7. Fair Value Measurements

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs, to the extent possible. The fair value hierarchy under GAAP is based on three levels of inputs.

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

 

As of September 30, 2020, the Company measured the fair value of its interest rate swaps of $25,783,000 (notional amount) based on Level 2 inputs, due to the usage of inputs that can be corroborated by observable market data. The Company estimates the fair value of derivative instruments using a discounted cash flow technique and has used creditworthiness inputs that corroborate observable market data evaluating the Company’s and counterparties’ risk of non-performance. The interest rate swaps had a net fair value liability of $874,700 as of September 30, 2020. In the quarter and nine months ended September 30, 2020, $(10,000) and $1,980,500 was realized through the income statement as a (decrease)/increase in interest expense.

 

As of December 31, 2019, the Company measured the fair value of its interest rate swaps of $80,914,500 (notional amount) based on Level 2 inputs, due to the usage of inputs that can be corroborated by observable market data. The Company estimates the fair value of derivative instruments using a discounted cash flow technique and has used creditworthiness inputs that corroborate observable market data evaluating the Company’s and counterparties’ risk of non-performance. The interest rate swaps had a net fair value liability of $1,824,500 as of December 31, 2019. In the year ended December 31, 2019, $255,200 was realized through the income statement as an increase in interest expense.

 

 

 

The following table shows, by level within the fair value hierarchy, the Company’s assets and liabilities at fair value on a recurring basis as of September 30, 2020 and December 31, 2019: 

 

	September 30, 2020				December 31, 2019
	Total	Level 1	Level 2	Level 3	Total	Level 1	Level 2	Level 3
Money market funds	$-	$-	$-	$-	$400	$400	$-	$-
Derivatives	(874,700)	-	(874,700)	-	(1,824,500)	-	(1,824,500)	-
Total	$(874,700)	$-	$(874,700)	$-	$(1,824,100)	$400	$(1,824,500)	$-

 

There were no transfers between Level 1 and Level 2 during the third quarters or nine months ended September 30, 2020 or 2019, and there were no transfers into or out of Level 3 during the same periods.

 

Assets Measured and Recorded at Fair Value on a Nonrecurring Basis

 

The Company determines fair value of long-lived assets held and used, such as aircraft and aircraft engines held for lease and these and other assets held for sale, by reference to independent appraisals, quoted market prices (e.g., offers to purchase) and other factors. These are considered Level 3 within the fair value hierarchy. An impairment charge is recorded when the Company believes that the carrying value of an asset will not be recovered through future net cash flows and that the asset’s carrying value exceeds its fair value. During the third quarter of 2020, the Company recorded impairment losses totaling $300,000 for two of its aircraft held for lease, which were written down to their estimated sales prices, less cost of sale. The Company also recorded a losses of $139,000 for a turboprop aircraft that was written down its estimated sales price, less cost of sale. The Company recorded impairment charges totaling $23,354,600 on two of its assets held for lease and three of its assets held for sale in the third quarter of 2019, which had a fair value of $36,256,500.

 

The following table shows, by level within the fair value hierarchy, the Company’s assets at fair value on a nonrecurring basis as of September 30, 2020 and December 31, 2019:

 

	Assets Written Down to Fair Value								Total Losses
	September 30, 2020				December 31, 2019				For the Nine Months Ended September 30,
		Level				Level
Total		1	2	3	Total	1	2	3	2020	2019
Assets held for lease	$17,000,000	$-	$-	$17,000,000	$-	$-	$-	$-	$7,006,600	$-
Assets held for sale	12,970,000	-	-	12,970,000	25,880,700	-	$-	25,880,700	9,813,900	11,424,900
Total	$29,970,000	$-	$-	$29,970,000	$25,880,700	$-	$-	$25,880,700	$16,820,500	$11,424,900

 

There were no transfers between Level 1 and Level 2 and no transfers into or out of Level 3 in either of the third quarters or nine-month periods ended September 30, 2020 or 2019.

 

Fair Value of Other Financial Instruments

 

The Company’s financial instruments, other than cash and cash equivalents, consist principally of finance leases receivable, amounts borrowed under the MUFG Credit Facility, notes payable under special-purpose financing, its derivative termination liability and its derivative instruments. The fair value of accounts receivable, accounts payable and the Company’s maintenance reserves and accrued maintenance costs approximates the carrying value of these financial instruments because of their short-term maturity. The fair value of finance lease receivables approximates the carrying value as discussed in Note 1(f). The fair value of the Company’s derivative instruments is discussed in Note 5 and in this note above in “Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis.”

 

Borrowings under the Company’s MUFG Credit Facility bore floating rates of interest that reset periodically to a market benchmark rate plus a credit margin. The same is true of the MUFG Loan. The Company believes the effective interest rate under the MUFG Credit Facility approximated then current market rates for such indebtedness at December 31, 2019 and, under the MUFG Loan, approximates current market rates, and therefore that the outstanding principal and accrued interest of $87,349,100 and $84,460,300 at September 30, 2020 and December 31, 2019, respectively, approximate their fair values on such dates. The fair value of the Company’s outstanding balance of its MUFG Credit Facility and MUFG Loan are categorized as a Level 3 input under the GAAP fair value hierarchy.

 

Before their repayment in February 2019 in connection with the Nord Loans refinancing, the amounts payable under the UK LLC SPE Financing were payable through the fourth quarter of 2020 and bore a fixed rate of interest. As discussed above, during February 2019, the UK LLC SPE Financing and four assets that previously served as collateral under the MUFG Credit Facility were refinanced using the Nord Loans. The Company believes the effective interest rate under the special-purpose financings approximates current market rates for such indebtedness at the dates of the condensed consolidated balance sheets, and therefore that the outstanding principal and accrued interest of $25,855,400 and $31,003,800 approximate their fair values at September 30, 2020 and December 31, 2019, respectively. Such fair value is categorized as a Level 3 input under the GAAP fair value hierarchy.

 

There were no transfers in or out of assets or liabilities measured at fair value under Level 3 during the third quarters or nine months ended September 2020 or 2019.

 

8. Commitments and Contingencies

 

In the ordinary course of the Company’s business, the Company may be subject to lawsuits, arbitrations and administrative proceedings from time to time. The Company believes that the outcome of any existing or known threatened proceedings, even if determined adversely, should not have a material adverse effect on the Company's business, financial condition, liquidity or results of operations.

 

9. Income Taxes

 

The Company recorded income tax expense of $604,900 in the third quarter of 2020, or negative 17.4% of pre-tax loss, compared to $2.3 million income tax benefit, or 21.5% of pre-tax loss in the third quarter of 2019. The difference in the effective federal income tax rate from the normal statutory rate was primarily related to the recording of a valuation allowance of $1.4 million in the third quarter on U.S. and foreign deferred tax assets.

 

The Company recorded income tax benefit of $3.4 million for the nine months ended September 30, 2020, or 10.9% of pre-tax loss, compared to $2.6 million income tax benefit, or 21.5% of pre-tax loss, for the nine months ended September 30, 2019. The difference in the effective federal income tax rate from the normal statutory rate was primarily related to the recording of a valuation allowance of $4.6 million for the nine months ended September 30, 2020 on U.S. and foreign deferred tax assets.

 

In March of 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) became law. The CARES Act included tax provisions under which net operating losses from 2018, 2019 and 2020 can be carried back for five years, modifying the law that had previously not permitted any carryback, and also increased the amount of deductible interest from 30% to 50% of adjusted taxable income for the 2019 and 2020 years. These changes have not had any effect on the Company’s expected cash tax expenditures or income tax expense. The CARES Act also accelerated the ability to receive refunds of AMT credits from prior year, which allowed the Company to accelerate $11,400 of the refund of such credit into its 2019 return.

 

10. Computation of Loss Per Share

 

Basic and diluted loss per share are calculated as follows:

 

	For the Nine Months Ended September 30,		For the Three Months Ended September 30,
	2020	2019	2020	2019
Net loss	$(27,777,200)	$(9,617,100)	$(4,081,100)	$(8,231,400)
Weighted average shares outstanding for the period	1,545,884	1,545,884	1,545,884	1,545,884
Basic loss per share	$(17.97)	$(6.22)	$(2.64)	$(5.32)
Diluted loss per share	$(17.97)	$(6.22)	$(2.64)	$(5.32)

 

Basic loss per common share is computed using net loss and the weighted average number of common shares outstanding during the period. Diluted loss per common share is computed using net (loss)/income and the weighted average number of common shares outstanding, assuming dilution. Weighted average common shares outstanding, assuming dilution, include potentially dilutive common shares outstanding during the period. There were no anti-dilutive shares outstanding during the three months or nine months ended September 30, 2020 or 2019.

 

11. Subsequent Events

 

(a) MUFG’s Sale of Indebtedness to Drake

 

On October 30, 2020, Drake Asset Management Jersey Limited (“Drake”), purchased from the MUFG Lenders all of the outstanding indebtedness of the Company under such loan, totaling approximately $87.9 million as well as all of the Company's indebtedness to MUFG Bank, Ltd. of approximately $3.1 million for termination of interest rate swaps entered into with respect to such Loan Agreement indebtedness (such total indebtedness with Drake as Lender referred to as the “Drake Indebtedness”).  The purchase and sale was consented to by the Company pursuant to a Consent and Release Agreement of Borrower Parties, entered into by the Company and its subsidiaries.  The closing of this debt purchase transaction satisfied the requirement under the Loan Agreement for execution of a Strategic Alternative with respect to the MUFG Loan indebtedness satisfactory to the MUFG Lenders.

 

On the same day, the Company entered into an Amendment No. 1 to the Loan Agreement (“Amendment No. 1”) with Drake and UMB Bank, N.A., the replacement Administrative Agent under the Loan Agreement, to amend the Loan Agreement (such Loan Agreement as amended, with Drake as Lender thereunder, referred to as the “Drake Loan Agreement”) as follows:

 

 

 

 

 

  

 

The Drake Indebtedness is secured by a first priority lien held by Drake, which lien is documented in an amended and restated mortgage and security agreement assigned to Drake,  on all of the Company's assets, including the Company’s aircraft portfolio, except for two aircraft on lease to Kenyan lessees and five aircraft, two of which were sold in October 2020, that are subject to special purpose financing held by subsidiaries of the Company.

 

The Company and Drake are currently engaged in discussions regarding the satisfaction and discharge of the Drake Indebtedness.

 

(b) Sale of Aircraft

 

In October 2020, the Company sold two aircraft to the lessee that were subject to Nord Loans, and fully repaid the indebtedness on such aircraft with the proceeds of the sale. The excess proceeds from the purchase were applied to the remaining Nord Term Loan indebtedness owed by a special-purpose subsidiary of the Company secured by three regional jets on lease to a U.S. regional airline.

 

 

 

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

 

The following discussion and analysis should be read together with the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2019 and the audited consolidated financial statements and notes included therein (collectively, the “2019 Annual Report”), as well as the Company’s unaudited condensed consolidated financial statements and the related notes included in this report. Pursuant to Instruction 2 to paragraph (b) of Item 303 of Regulation S-K promulgated by the SEC, in preparing this discussion and analysis, the Company has presumed that readers have access to and have read the disclosure under the same heading contained in the 2019 Annual Report. This discussion and analysis contains forward-looking statements. Please see the cautionary note regarding these statements at the beginning of this report.

 

Overview

 

The Company provides leasing and finance services to regional airlines worldwide. The Company is principally engaged in leasing its aircraft portfolio, primarily consisting of mid-life regional aircraft, through operating leases and finance leases to its customer base of eight airlines in six countries. In addition to leasing activities, the Company sells aircraft from its operating lease portfolio to third parties, including other leasing companies, financial services companies, and airlines. Its operating performance is driven by the composition of its aircraft portfolio, the terms of its leases, and the interest rate of its debt, as well as asset sales.

 

The COVID-19 pandemic has led to significant cash flow issues for airlines, and some of the Company’s customers were unable to timely meet their obligations under their lease obligations with the Company during the first nine months of 2020. This in turn has caused lessees to make requests for lease payment concessions and/or deferrals from the Company, which requires the Company to reach accommodations with its lenders to allow the Company corresponding concessions under its debt financings. The Company expects these circumstances to continue for the foreseeable future.

 

The Company did not purchase or sell any aircraft during the third quarter of 2020. The Company ended the quarter with a total of eleven aircraft held for lease, with a net book value of approximately $96 million. This represents a 11% decrease compared to the net book value of the Company’s aircraft and engines held for lease at December 31, 2019. In addition to the aircraft held for lease at quarter-end, the Company held two aircraft subject to finance leases and held four aircraft and airframe parts from two aircraft held for sale. In October 2020, the Company sold two aircraft that had been held for lease.

 

Average portfolio utilization was approximately 89% and 97% during the third quarters of 2020 and 2019, respectively. The year-to-year decrease was due to aircraft that were on lease in the 2019 period, but off lease in the 2020 period.

 

Net loss for the third quarters of 2020 and 2019 was $4.1 million and $8.2 million, respectively, resulting in basic and diluted loss per share of $(2.64) and $(5.32), respectively. Pre-tax profit margin (which the Company calculates as its (loss)/income before income tax (benefit)/provision as a percentage of its revenues and other income) was (100%) in the third quarter of 2020 compared to (44%) for the third quarter of 2019.

 

As discussed above, the Company is currently in discussions with Drake regarding repayment terms for the Drake Indebtedness. While discussions are ongoing, the Company is not required to make cash payment on the accruing interest on the Drake Indebtedness and such interest is being added to the principal as it accrues. The Company does not have sufficient cash to repay the entire Drake Indebtedness, so the Company may need to raise additional debt or equity funds to meet its debt obligations. If additional cash is not available, it is likely that the value of the assets the Company currently holds is not sufficient to repay the entire indebtedness if the assets are sold in the current market environment or foreclosed upon. 

 

As a result of these factors, there is substantial doubt regarding the Company’s ability to continue as a going concern.

 

 

 

Fleet Summary

 

(a) Assets Held for Lease

 

Key portfolio metrics of the Company’s aircraft held for lease as of September 30, 2020 and December 31, 2019 were as follows:

 

	September 30, 2020	December 31, 2019
Number of aircraft and engines held for lease	11	11
Weighted average fleet age	12.7 years	11.8 years
Weighted average remaining lease term	35 months	41 months
Aggregate fleet net book value	$96,052,100	$108,368,600

 

	For the Nine Months Ended September 30,		For the Three Months Ended September 30,
	2020	2019	2020	2019
Average portfolio utilization	88%	98%	89%	97%

 

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 September 30, 2020 and December 31, 2019:

 

	September 30, 2020		December 31, 2019
Type	Number owned	% of net book value	Number owned	% of net book value
Turboprop aircraft:
Bombardier Dash-8-400	2	21%	2	20%
Regional jet aircraft:
Embraer 175	3	29%	3	26%
Canadair CRJ-1000	2	15%	2	21%
Canadair CRJ-700	3	21%	3	20%
Canadair CRJ-900	1	14%	1	13%

 

During the third quarter and first nine months of 2020, the Company did not purchase or sell any aircraft that are held for lease. During the first nine months of 2020, the Company sold one aircraft that had been held for sale, one aircraft that had been held under a sales-type lease and three aircraft that had been held under direct financing leases, and sold certain aircraft parts that were held for sale. In October 2020, the Company sold two aircraft that had been held for lease.

 

During the third quarter of 2019, the Company purchased no aircraft, sold one aircraft, an engine and certain aircraft parts that were held for sale and reclassified two aircraft from held for lease to held for sale. During the first nine months of 2019, the Company purchased no aircraft, sold two aircraft, an engine and certain aircraft parts that were held for sale, reclassified two aircraft from held for lease to held for sale and reclassified one aircraft from held for lease to a finance lease receivable.

 

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 September 30, 2020 and December 31, 2019 in the indicated regions (based on the domicile of the lessee):

 

	September 30, 2020		December 31, 2019
Region	Net book value	% of net book value	Net book value	% of net book value
North America	$61,533,300	64%	$63,799,600	59%
Europe	34,518,800	36%	44,569,000	41%
	$96,052,100	100%	$108,368,600	100%

 

 

For the three months ended September 30, 2020, approximately 60%, 21% and 18% of the Company’s operating lease revenue was derived from customers in the United States, Croatia and Canada, 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 Nine Months Ended September 30,				For the Three Months Ended September 30,
	2020		2019		2020		2019
Region	Number of lessees	% of operating lease revenue	Number of lessees	% of operating lease revenue	Number of lessees	% of operating lease revenue	Number of lessees	% of operating lease revenue
Europe	3	39%	4	62%	3	22%	4	62%
North America	3	61%	4	37%	3	78%	3	38%
Asia	-	-%	1	1%	-	-%	-	-%

 

At September 30, 2020 and December 31, 2019, the Company also had two aircraft and six aircraft, respectively, subject to finance leases. The Company did not record any finance lease revenue during the quarter ended September 30, 2020.

 

(b) Assets Held for Sale

 

Assets held for sale at September 30, 2020 consisted of three Canadair 900 aircraft, one Bombardier Dash-8-300 aircraft and airframe parts from two turboprop aircraft.

 

Results of Operations

 

(a) Quarter ended September 30, 2020 compared to the quarter ended September 30, 2019

 

(i) Revenues and Other Income

 

Revenues and other income decreased by 85% to $3.5 million in the third quarter of 2020 from $24.0 million in the third quarter of 2019. The decrease was primarily a result of decreased operating lease, finance lease and maintenance reserves revenues in the third quarter of 2020.

 

Operating lease revenue decreased by 52% to $3.2 million in the third quarter of 2020 from $6.7 million in the third quarter of 2019, primarily due to reduced rent income resulting from the early termination of four aircraft leases with one of the Company’s customers in the third quarter of 2019.

 

Maintenance reserves that are retained by the Company at lease end are recorded as revenue at that time. The Company recorded $0.2 million of such revenue during the third quarter of 2020 when an aircraft that had been on lease was returned to the Company and the lease was terminated. During the third quarter of 2019, the Company recorded $17.0 million of such revenue, arising from maintenance reserves retained upon the termination of four aircraft leases with one customer.

 

The Company recorded no finance lease revenue in the third quarter of 2020, compared to $0.3 million in the third quarter of 2019, as a result of the sale of three assets that were subject to direct finance leases during the first quarter of 2020 and the Company’s cash-basis accounting for its two sales-type leases in 2020.

 

(ii) Expenses

 

Total expenses decreased by 80% to $7.0 million in the third quarter of 2020 from $34.5 million in the third quarter of 2019. The decrease was primarily a result of decreases in asset impairment losses, depreciation and bad debt expense, the effects of which were partially offset by increases in interest expense and professional fees and general and administrative expenses.

 

During the third quarter of 2020, the Company recorded impairment charges of $0.3 million on two assets held for lease, based on estimated future cash flow and $0.1 million on an asset held for sale, based on expected net sales proceeds. During the third quarter of 2019, the Company recorded impairment charges totaling $23.4 million for two assets held for lease and one asset held for sale, based on appraised values, and three assets held for sale, based on expected sales proceeds. As a result of four lease terminations during the quarter, the appraised values were based on the maintenance-adjusted condition of the aircraft, rather than the previous basis, which reflected future cash flows under the leases.

 

Depreciation expense decreased 55% to $1.3 million in the third quarter of 2020 from $3.0 million in the third quarter of 2019 primarily as a result of the reclassification of four aircraft from held for lease to held for sale during the third quarter of 2019, as well as a decrease in depreciation for two aircraft that were written down to their estimated sale values during the second quarter of 2020.

 

As a result of payment delinquencies by two customers that lease three of the Company’s aircraft subject to finance leases, during the third quarter of 2019, the Company also recorded a bad debt expense of $3.9 million.

 

The Company’s interest expense increased by 29% to $3.0 million in the third quarter of 2020 from $2.3 million in the third quarter of 2019, primarily as a result of a higher average interest rate, the effect of which were partially offset by a lower average debt balance.

 

Professional fees, general and administrative and other expenses increased 45% to $1.4 million in the third quarter of 2020 from $0.9 million in the third quarter of 2019, primarily due to increased legal fees related to the May 2020 MUFG Indebtedness amendment and litigation brought by an activist shareholder and consulting fees related to the May 2020 MUFG Indebtedness amendment.

 

The Company had a tax expense of $604,900 in the third quarter of 2020 compared to tax benefit of $2.3 million in the third quarter of 2019. The effective tax rate for the third quarter of 2020 was a 17.4% tax expense compared to a 21.6% tax benefit in the third quarter of 2019. The difference in the effective income tax rate from the normal statutory rate was primarily related to the recording of a $1.4 million valuation allowance in the current period on the Company’s U.S. and foreign deferred tax assets after concluding that a valuation allowance is necessary for the Company’s net U.S. and foreign deferred tax assets not supported by either future taxable income or availability of future reversals of existing taxable temporary differences.

 

In March of 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) became law. The CARES Act included tax provisions under which net operating losses from 2018, 2019 and 2020 can be carried back for five years, modifying the law that had previously not permitted any carryback, and also increased the amount of deductible interest from 30% to 50% of adjusted taxable income for the 2019 and 2020 years. These changes have not had any effect on the Company’s expected cash tax expenditures or income tax expense. The CARES Act also accelerated the ability to receive refunds of alternative minimum tax credits from prior years, which allowed the Company to accelerate $11,400 of the refund of such credit into its 2019 return.

 

(b) Nine months ended September 30, 2020 compared to the nine months ended September 30, 2019

 

(i) Revenues and Other Income

 

Revenues and other income decreased by 67% to $12.7 million in the first nine months of 2020 from $38.7 million in the same period of 2019. The decrease was primarily a result of decreased operating lease, finance lease and maintenance reserves revenues in the 2020 period.

 

Operating lease revenue decreased by 40% to $12.4 million in the first nine months of 2020 from $20.8 million in the same period of 2019, primarily due to reduced rent income resulting from the early termination of four aircraft leases with one of the Company’s customers in the third quarter of 2019 and reduced rent for two assets in the 2020 period as a result of lease amendments related to the COVID-19 Outbreak, as well as the sale of an asset in the first quarter of 2019 that had been on lease until the time of sale.

 

Maintenance reserves that are retained by the Company at lease end are recorded as revenue at that time. The Company recorded $0.2 million of such revenue during the first nine months of 2020 when an aircraft that had been on lease was returned to the Company and the lease was terminated. During the nine months ended September 30, 2019, the Company recorded $17.0 million of such revenue, arising from maintenance reserves retained upon the termination of four aircraft leases with one customer.

 

Finance lease revenue decreased by 93% to $0.1 million in the first nine months of 2020, compared to $0.8 million in the same period of 2019, as a result of the sale of three assets that were subject to direct finance leases during the first quarter of 2020 and the Company’s cash-basis accounting for its two sales-type leases, for which it received no payments in the 2020 period.

 

(ii) Expenses

 

Total expenses decreased by 14% to $43.8 million in the first nine months of 2020 from $51.0 million in the same period of 2019. The decrease was primarily a result of decreases in asset impairment losses, depreciation and bad debt expense, the effects of which were partially offset by increases in interest expense and professional fees and general and administrative expenses.

 

During the nine months ended September 30, 2020, the Company recorded impairment charges of (i) $7.0 million on two assets held for lease, based on estimated future cash flow and (ii) $9.8 million on five assets held for sale, based on appraised values or expected sales proceeds. During the nine months ended September 30, 2019, the Company recorded impairment charges totaling $24.9 million on two assets held for lease and two assets held for sale, based on appraised values, and five assets held for sale, based on expected sales proceeds. As a result of four lease terminations during the third quarter of 2019, the appraised values were based on the maintenance-adjusted condition of the aircraft, rather than the previous basis, which reflected future cash flows under the leases.

 

Depreciation expense decreased 40% to $5.5 million in the first nine months of 2020 from $9.1 million in the first nine months of 2019 primarily as a result of the reclassification of four aircraft from held for lease to held for sale during the third quarter of 2019, as well as a decrease in depreciation for two aircraft that were written down to their estimated sale values during the second quarter of 2020.

 

As a result of payment delinquencies by two of the Company’s customers under its two sales-type leases and decreases in the appraised values of the underlying assets, the Company recorded a bad debt expense of $1.2 million in the first nine months of 2020. As a result of payment delinquencies by two customers that lease three of the Company’s aircraft subject to finance leases, during the first nine months of 2019, the Company also recorded a bad debt expense of $3.9 million.

 

The Company’s interest expense increased by 74% to $13.5 million in the first nine months of 2020 from $7.7 million in the same period of 2019, primarily as a result of a higher average interest rate, $2.0 million of valuation charges related to the Company’s interest rate swaps and a $2.0 million write-off of a portion of the Company unamortized debt issuance costs related to the MUFG Credit Facility, the effects of which were partially offset by a lower average debt balance.

 

Professional fees, general and administrative and other expenses increased 66% to $4.4 million in the first nine months of 2020 from $2.6 million in the first nine months of 2019, primarily due to increased legal fees related to the May 2020 MUFG Indebtedness amendment and litigation relating to an activist shareholder, consulting fees related to the May 2020 MUFG Indebtedness amendment and increased amortization related to the Company’s office lease right of use.

 

The Company had a tax benefit of $3.4 million for the nine months ended September 30, 2020 compared to a tax benefit of $2.6 million for the nine months ended September 30, 2019. The effective tax rate for the nine months ended September 30, 2020 was a 10.9% tax benefit compared to a 21.6% tax benefit for the nine months ended September 30, 2019. The difference in the effective income tax rate from the normal statutory rate was primarily related to the recording of a $4.6 million valuation allowance in the current period on the Company’s U.S. and foreign deferred tax assets after concluding that a valuation allowance is necessary for the Company’s net U.S. and foreign deferred tax assets not supported by either future taxable income or availability of future reversals of existing taxable temporary differences.

 

Liquidity and Capital Resources

 

As a result of the factors discussed below, there is substantial doubt regarding the Company’s ability to continue as a going concern.

 

(a) MUFG Credit Facility and Drake Indebtedness

 

On May 1, 2020, the Company and the MUFG Lenders entered into a Fourth Amended and Restated Loan and Security Agreement (the "MUFG Loan Agreement"), which, amended and restated the existing agreement regarding the Company's indebtedness to the MUFG Lenders and included the following changes to the terms and provisions of such indebtedness:

 

 

 

 

 

 

 

 

 

 

 

On July 8, 2020, the agent bank for the MUFG Lenders delivered a Reservation of Rights Letter to the Company which contained notice of defaults with respect to failure to deliver a lessee acknowledgment of the MUFG Lender’s mortgage from one of the Company’s lessees (which was delayed due to extended negotiations between MUFG and the lessee relating to form of such acknowledgment) and (ii) the failure to make a deferred interest payment as required under the Loan Agreement that was due and payable on the earlier of July 1, 2020 or the date of the sale of a certain aircraft scheduled to be sold upon its return from its lessee (the closing of which sale has been delayed beyond July 1, 2020).

 

In March 2019, the Company entered into interest rate swaps (the “MUFG Swaps”) with respect to the variable interest rate payment amounts due for $50 million of the $84 million of outstanding MUFG Credit Facility debt.  On March 12, 2020, MUFG notified the Company that it had terminated the MUFG Swaps. The Company incurred a liability to the swap counterparties of $3.1 million in connection with such termination, payment of which is due no later than the March 31, 2021 maturity of the MUFG Loan. As a result of the forecasted transaction being not probable to occur, accumulated other comprehensive loss of $1,167,700 related to the MUFG Swaps was recognized as interest expense in the first quarter of 2020.

 

The Company has engaged B. Riley FBR as an investment banking advisor to assist in executing the required Strategic Alternative under the MUFG Loan Agreement, as well as assist with the development and execution of a recapitalization plan for the Company.

 

On October 30, 2020, Drake Asset Management Jersey Limited (“Drake”), purchased all of the indebtedness of the Company under the MUFG Loan, totaling approximately $87.9 million as well as all of the Company's indebtedness to MUFG Bank, Ltd. of approximately $3.1 million for termination of interest rate swaps entered into with respect to such Loan Agreement indebtedness.  The purchase and sale was consented to by the Company pursuant to a Consent and Release Agreement of Borrower Parties, entered into by the Company and its subsidiaries.  The closing of this debt purchase transaction satisfied the requirement under the Loan Agreement for execution of a Strategic Alternative with respect to the MUFG Loan indebtedness satisfactory to the MUFG Lenders.

 

On the same day, the Company entered into an Amendment No. 1 to the Loan Agreement (“Amendment No. 1”) with Drake and UMB Bank, N.A., the replacement Administrative Agent under the Loan Agreement, to amend the Loan Agreement as follows: