Mega Matrix Corp. - Quarter Report: 2021 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q 

1440 Chapin Avenue, Suite 310

Burlingame, California 94010

(Address of Principal Executive Offices)

(650) 340-1888

(Registrant’s Telephone Number Including Area Code)

None

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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

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.

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 August 23, 2021 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

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:

● the expected timing of the hearing for approval of the Bankruptcy Court of the Plan Sponsor Agreement and the plan for the Company’s exit from the bankruptcy process;

● the Company’s anticipated plan for exit from bankruptcy, including the proposed terms of the equity financing with a plan sponsor on the terms set forth in the proposed Plan Sponsor Agreement;

● the expected terms and conditions of the Plan Sponsor Agreement to become effective upon the Bankruptcy Court’s approval, including the terms of the equity investment by the proposed plan sponsor;

● the resolution of the Drake Indebtedness (as defined below) through sale of collateral assets securing such indebtedness within the bankruptcy process, and the expected timing of the closings of the sales and full satisfaction of the Drake Indebtedness;

● the sufficiency of available cash required to fund the Company’s bankruptcy proceeding along with its other ongoing operational costs;

● the possibility that the Company’s operations may be expanded into, or refocused upon, new lines of business, which lines of businesses may be complementary to, or entirely unrelated to the Company’s legacy aircraft leasing business;

● the expectation that the consummation of the Plan Sponsor Agreement and Chapter 11 exit plan will result in satisfaction of the holders of senior claims and interests, such as secured indebtedness, and reinstatement of the outstanding common stock;

● the Company’s use of the PPP Loan proceeds and the potential forgiveness of principal due under such loans;

● the availability and use of debt or equity financing to fund the restart of the Company’s aircraft leasing business upon exit from bankruptcy, expand the existing business line, or expand into new business lines;

● the impact of certain industry trends, and in particular those that relate to the COVID pandemic, on the Company and its performance;

● the ability of the Company and its customers to comply with applicable government and regulatory requirements in the numerous jurisdictions in which the Company and its customers operate;

● the Company’s cyber vulnerabilities and the anticipated effects on the Company if a cybersecurity threat or incident were to materialize;

● general economic, market, political and regulatory conditions, including anticipated changes in these conditions and the impact of such changes on customer demand and other facets of the Company’s business; and

● the impact of any of the foregoing on the prevailing market price and trading volume of the Company’s common stock.

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 others, the factors that could cause such differences include: the Company’s ability to complete its obligations under the Stalking Horse Agreement and thereby resolve its Drake Indebtedness; the Company’s ability to obtain the Bankruptcy Court approvals for motions necessary for the Company to execute its reorganization plan; the ongoing effects on the airline industry and global economy of the COVID-19 pandemic or any other public health emergencies; the impact on the industry from a terrorist attack involving air travel; the ability of the Company to raise debt or equity financing when needed on acceptable terms and in desired amounts, or at all; the Company’s ability to execute its reorganization plan successfully if approved; any economic downturn or other financial crisis; any inability to compete effectively with the Company’s better capitalized competitors; limited trading volume in the Company’s stock; 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

Item 1. Financial Statements.

AeroCentury Corp.

(Debtor-In-Possession)

Condensed Consolidated Balance Sheets

(Unaudited)

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

AeroCentury Corp.

(Debtor-In-Possession)

Condensed Consolidated Statements of Operations

(Unaudited)

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

AeroCentury Corp.

(Debtor-In-Possession)

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

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

AeroCentury Corp.

(Debtor-In-Possession)

Condensed Consolidated Statements of Stockholders’ Equity/(Deficit)

For the Three Months and Six Months Ended June 30, 2020 and June 30, 2021

(Unaudited)

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

AeroCentury Corp.

(Debtor-In-Possession)

Condensed Consolidated Statements of Cash Flows

(Unaudited)

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

During the six months ended June 30, 2021 and 2020, the Company paid interest totaling $186,500 and $2,792,200, respectively. During the six months ended June 30, 2021, the Company paid income taxes totaling $4,000 and received a Federal tax refund of $23,100. During the six months ended June 30, 2020, the Company paid income taxes totaling $222,900.

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

AeroCentury Corp.

(Debtor-In-Possession)

Notes to Condensed Consolidated Financial Statements (Unaudited)

June 30, 2021

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. As discussed in Note 3(a), the Company sold its membership interest in ACY E-175 in March 2021.

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 six-month periods ended June 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021 or for any other period. All intercompany balances and transactions have been eliminated in consolidation.

As discussed below, on March 29, 2021 (the “Petition Date”), AeroCentury and certain of its subsidiaries in the U.S. (collectively, the “Debtors” and the “Debtors-in-Possession”) filed voluntary petitions for relief (collectively, the “Petitions”) under Chapter 11 of Title 11 (“Chapter 11”) of the U.S. Bankruptcy Code (the “Bankruptcy Code”) in the U.S. Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The Chapter 11 cases (the “Chapter 11 Case”) are being jointly administered under the caption In re: AeroCentury Corp., et al., Case No. 21-10636.

Effective on the Petition Date, the Company applied accounting standards applicable to reorganizations, Accounting Standards Codification 852 – Reorganizations, in preparing the accompanying condensed consolidated financial statements, which requires the financial statements, for periods subsequent to the commencement of the Chapter 11 Cases, to distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Accordingly, obligations of the Debtors incurred prior to the Petition Date (“Pre-petition”) that may be impacted by the Chapter 11 Cases have been classified as liabilities subject to compromise in the accompanying unaudited condensed consolidated balance sheet as of June 30, 2021. These liabilities are reported at the amounts the Company anticipates will be allowed by the Bankruptcy Court, even if they may be settled for lesser amounts. See Note 8, “Liabilities Subject to Compromise,” for additional information.

(b) Company Indebtedness

As discussed in Note 4, on October 30, 2020, the lenders (“MUFG Lenders”) under the Company’s previous term loan facility (the “MUFG Loan”) sold the MUFG Loan and the $3.1 million obligation of the Company from termination of the two swaps (the “MUFG Swaps”) related to the MUFG Loan 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 was capitalized.

The Drake Loan Agreement had a stated maturity date of March 31, 2021 and is secured by a lien on substantially all of the Company’s assets but the collection of debt under, and the exercise of rights or remedies pursuant to, the Drake Loan Agreement were stayed due to the Company’s Chapter 11 filing, as discussed below in Note 1(e), “Automatic Stay.”

(c) Voluntary Petitions for Bankruptcy

In connection with the impending maturity of the Company’s indebtedness owed to Drake (“Drake Indebtedness”) and the continuing economic impact from COVID-19, on March 29, 2021, the Debtors filed the Petitions under Chapter 11 in the Bankruptcy Court. The Chapter 11 Cases are being jointly administered under the caption In re: AeroCentury Corp., et al., Case No. 21-10636.

The Bankruptcy Court approved motions filed by the Debtors that were designed primarily to mitigate the impact of the Chapter 11 Cases on the Company’s operations, customers and employees. Pursuant to orders entered by the Bankruptcy Court, the Debtors are authorized to conduct their business activities in the ordinary course, and among other things and subject to the terms and conditions of such orders: (i) pay employees’ wages and related obligations; (ii) pay certain taxes; (iii) continue to maintain certain customer programs; (iv) maintain their insurance program; (v) use cash collateral on an interim basis; and (vi) continue their cash management system.

On April 22, 2021, the Bankruptcy Court entered an order authorizing and approving the funding of the Company’s Chapter 11 Cases on a final basis. This final order authorizes the Company’s continued access to funding for its business operations and restructuring process, to the extent that such funding is available. On the same date, the Bankruptcy Court entered an order authorizing and approving marketing and sale procedures with respect to the sale of some or all of the Company’s assets. The Company’s court-supervised sale process required any bids for its assets to be submitted by 5:00 p.m. on May 17, 2021. No third-party qualified bids were received for the Company’s assets in the Court-approved marketing and sale process, so the proposed auction for assets was not conducted, and the sale of the Drake Collateral to Drake under the terms of an Asset Purchase Agreement (“Stalking Horse Agreement”) with Drake was approved by the Bankruptcy Court and is pending. The Company, with Drake’s consent, has sold certain assets that are not collateral for the Drake Indebtedness, including one aircraft that was collateral for a sales-type finance lease and certain aircraft parts that were subject to a consignment arrangement. Pursuant to the Bankruptcy Court’s cash collateral order, the Company retained the proceeds for its operating expenses.

On August 9, 2021, the Company identified Mr. Yucheng Hu (“Lead Investor”) as the lead investor for a group (“Plan Sponsor Group”) of individual investors with whom the Company is negotiating definitive equity investment agreements (“Plan Sponsor Agreements”) in connection with the recapitalization of the Company. On August 16, 2021, the Company filed the form of the Plan Sponsor Agreement and related documents and a hearing is scheduled for August 31, 2021, where the court will hear the motion to approve the Plan Sponsor Agreements. If the Plan Sponsor Agreement is approved by the court, it is anticipated the equity investment provided for in the Plan Sponsor Agreement will close before the end of September. A summary of the Plan Sponsor Agreement is set forth below in Note 13(b) to the Company’s financial statement contained herein. The full text of the forms of Plan Sponsor Agreements and related documents were made public by the Company in its Report on Form 8-K filed with the Securities and Exchange Commission on August 17, 2021, available on the SEC’s EDGAR system at:

https://www.sec.gov/Archives/edgar/data/0001036848/000165495421009126/a8kPSAfiled.htm

(d) Debtors-In-Possession

The Debtors are currently operating as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. In general, as debtors-in-possession under the Bankruptcy Code, the Debtors are authorized to continue to operate as an ongoing business but may not engage in transactions outside the ordinary course of business without the prior approval of the Bankruptcy Court.

(e) Automatic Stay

Subject to certain specific exceptions under the Bankruptcy Code, the Petitions automatically stayed most judicial or administrative actions against the Debtors and efforts by creditors to collect on or otherwise exercise rights or remedies with respect to Pre-petition obligations of the Debtors. Absent an order from the Bankruptcy Court, substantially all of the Debtors’ Pre-petition liabilities are subject to settlement under the Bankruptcy Code.

(f) Borrowing Capacity and Availability

At June 30, 2021, the Company had no borrowing capacity or availability under the Drake Loan Agreement. The filing of the Chapter 11 Cases constituted a default, termination events and/or amortization event with respect to the Drake Indebtedness. As discussed in Note 3(a), in March 2021, the Company sold its ownership interest in ACY E-175 to Drake, and Drake assumed ACY E-175’s indebtedness under its Nord Loan.

(g) Going Concern

At June 30, 2021, the Company had total book assets of approximately $58.7 million and total liabilities of $84.9 million, resulting in a negative book equity of $26.2 million. The largest portion, $80.1 million, of the Company’s debt is owed to Drake Asset Management Jersey Limited (“Drake”) and was payable with accrued interest on March 31, 2021.

The Company did not have the resources to meet its obligations to repay the Drake debt when due on March 31, 2021, which is a principal reason for its decision to file for protection under Chapter 11 of the Bankruptcy Code. The Company anticipates that it will receive the additional funding to continue its operations through the closing of the equity investment provided for under the Plan Sponsor Agreement. Although the Company has agreed to the terms of a Plan Sponsor Agreement and anticipates a closing of the recapitalization pursuant to the Plan Sponsor Agreement, the exit plan and the Plan Sponsor Agreement must be approved by the Bankruptcy Court, and there are several conditions precedent to be satisfied for consummation of the equity investment by the Plan Sponsor. Thus, there is still substantial doubt about the Company’s ability to continue as a going concern. The Company has suffered recurring losses from operations, is in default of its debt obligations under the Drake Indebtedness, and has a net capital deficiency. The Company’s poor financial position, including its poor short-term liquidity given the maturity of the Drake Indebtedness, the amount of liability under the Drake Indebtedness in relation to the fair value of the Company’s assets and the uncertainty of generating sufficient funds over the year after publication of its financial statements to continue operations have led the Company to conclude that there is substantial doubt about its ability to continue as a going concern.

The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern and contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. The Company’s ability to continue as a going concern is contingent upon its ability to successfully implement a plan of reorganization, among other factors, and the realization of assets and the satisfaction of liabilities are subject to uncertainty. Further, any plan of reorganization could materially change the amounts of assets and liabilities reported in the accompanying condensed consolidated financial statements. 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 or as a consequence of its Chapter 11 filing.

(h) 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 Pandemic”). The ongoing COVID-19 Pandemic 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. The Company provided one of its customers, which leases two regional turboprop aircraft, lease payment reductions totaling approximately $0.3 million in the second and fourth quarters of 2020 as well as $0.4 million in the first quarter of 2021 and the customer paid the reduced amounts.

In addition, two other customers, each of which leases an aircraft subject to a sales-type lease, failed to make scheduled lease payments totaling approximately $1.0 million in 2020. The Company sold one of the aircraft to the customer during the second quarter of 2021. The Company has agreed to sell the second aircraft to the customer that leases it and expects the sale to occur in the fourth quarter of 2021. As discussed in Note 2, the Company recorded bad debt allowances of $821,000 and $326,000 in the first and second quarters of 2021, respectively, related to the two sales-type finance leases.

The impact of the COVID-19 Pandemic has also led 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 de-designated its interest rate swaps as hedges in March 2020 since the payments related to the swaps were deemed not probable to occur. Additionally, in December 2020, the Company determined that it was probable that certain future cash flows under its interest rate swaps would not occur, and the Company consequently reclassified accumulated other comprehensive income (“AOCI”) associated with such cash flows into interest expense. As discussed in Note 5, one of the Company’s interest rate swaps was terminated in March 2020, two swaps had maturities in the fourth quarter of 2020 and were terminated when the associated assets were sold and the related debt was paid off and three swaps had maturities in 2025, but were sold in March 2021 as part of the Company’s sale of its membership interest in ACY E-175. As a result, the Company is no longer party to any interest rate swaps.

(i) 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.

(j) 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.

(k) Finance Leases

As of June 30, 2021, the Company had one sales-type lease secured by an aircraft. The lease contains a lessee bargain purchase option at a price substantially below the subject asset’s estimated residual value at the exercise date for the option. Consequently, the Company classified the lease as a finance lease for financial accounting purposes. For such finance lease, 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. During the second quarter of 2021, the Company recorded a bad debt allowance of $326,000 related to the sales-type finance lease as a result of its July 2021 agreement to sell the aircraft to the customer.

(l) 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 three-year cumulative loss through December 31, 2020, the impacts of the COVID-19 Pandemic on the worldwide airline industry and the Company’s recent filing for protection under Chapter 11 of the Bankruptcy Code. 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 $575,000 and $1,701,100 for the three months and six months ended June 30, 2021, respectively. Additionally, the Company has concluded that based on its analysis, some of its foreign net operating loss carrybacks are not expected to be realized based on limitations on the utilization of its foreign net operating losses, and therefore recorded a foreign tax expense of $0 and $54,300 for the reduced tax refund for the three months and six months ended June 30, 2021, respectively.

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

(m) Revenue Recognition, Accounts Receivable and Allowance for Doubtful Accounts

Revenue from leasing of aircraft assets pursuant to operating leases is recognized on a straight-line basis over the terms of the applicable lease agreements. Deferred payments are recorded as accrued rent when the cash rent received is lower than the straight-line revenue recognized. Such receivables decrease over the term of the applicable leases. Interest income is recognized on finance leases based on the interest rate implicit in the lease and the outstanding balance of the lease receivable.

Maintenance reserves retained by the Company at lease-end are recognized as maintenance reserves revenue.

In instances where collectability is not reasonably assured, the Company recognizes revenue as cash payments are received. The Company estimates and charges to income a provision for bad debts based on its experience with each specific customer, the amount and length of payment arrearages, and its analysis of the lessee’s overall financial condition. If the financial condition of any of the Company’s customers deteriorates, it could result in actual losses exceeding any estimated allowances.

The Company had an allowance for doubtful accounts of $1,190,000 and $1,503,000 at June 30, 2021 and December 31, 2020, respectively.

(n) 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 “de-designated.” After de-designation, 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 de-designation 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 de-designated 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 was due no later than the March 31, 2021 maturity of the Drake Indebtedness. 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.

In March 2020, the Company determined that the future hedged interest payments related to its five remaining Nord Loan interest rate hedges (the “Nord Swaps”) were no longer probable of occurring, and consequently de-designated all five swaps from hedge accounting. Additionally, in December 2020, the Company determined that the interest cash flows that were associated with its three remaining swaps were probable of not occurring after February 2021.

(o) Out-Of-Period Adjustment

During the three months ended June 30, 2021, the Company recorded an immaterial out-of-period adjustment related to a lease modification to correct an overstatement of operating lease revenues and understatement of unearned revenues of $318,300 for the three months and as of March 31, 2021. The out-of-period adjustment resulted in a $318,300 reduction of operating lease revenues for the three months ended June 30, 2021. There was no impact on the six months ended June 30, 2021.

(p) 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’s adoption of ASU 2019-12 did not have a material impact on its consolidated financial statements.

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 provided 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.

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 $13.7 million at the end of their lease terms in the second quarter of 2027. 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.

(a) Assets Held for Lease

During the second quarter of 2021, with the exception of one aircraft that is collateral for a sales-type lease receivable, the Company reclassified all of its aircraft to held for sale as a result of a sale order ("Sale Order") approved by the Bankruptcy Court. At December 31, 2020, the Company’s aircraft held for lease consisted of the following:

(b) Sales-Type and Finance Leases

The Company had two sales-type leases, which were substantially modified in January 2020 to reduce the amount of monthly payments and purchase option amounts due under the leases. Although the modifications would ordinarily have given rise to income or loss resulting from the changed term of the agreements, the lessee’s poor compliance with the lease terms led the Company to value the sales-type leases at the fair value of the collateral and, as such, the modifications did not give rise to any effect on income other than that related to the collateral value of the financed aircraft. As a result of payment delinquencies by the two customers, the Company recorded bad debt allowances of $1,170,000 and $333,000 during the first and second quarters of 2020, respectively. During the first quarter of 2021, the Company recorded a bad debt allowance of $821,000 related to one of the two sales-type finance leases as a result of its May 2021 agreement to sell the aircraft to the customer, which occurred in May 2021. During the second quarter of 2021, the Company recorded a bad debt allowance of $326,000 related to the second sales-type finance lease as a result of its July 2021 agreement to sell the aircraft to the customer. The Company expects this sale to occur in the fourth quarter of 2021. The lease remains treated as a sales-type lease.

At June 30, 2021 and December 31, 2020, the net investment included in sales-type leases and direct financing leases receivable were as follows:

As of June 30, 2021, minimum future payments receivable under the remaining finance lease was as follows:

The remaining weighted average lease term of the Company’s assets under sales-type and finance leases was 18 months and 25 months at June 30, 2021 and December 31, 2020, respectively.

The following is a roll forward of the Company’s finance lease receivable allowance for doubtful accounts from December 31, 2020 to June 30, 2021:

3. Assets and Liabilities Held for Sale

The Company’s assets and liabilities classified as held for sale are required to be recorded at the lower of the carrying value or fair value less cost to sell. During the second quarter of 2021, with the exception of one aircraft that is collateral for a sales-type lease receivable, the Company reclassified all of its aircraft to held for sale as a result of the Sale Order approved by the Bankruptcy Court.

In May 2021, the Company agreed to sell most of the remaining inventory of two aircraft that were being sold in parts (“Part-out Assets”) for $290,000, and recorded an impairment loss of $1,940,400 in the first quarter of 2021. During the second quarter of 2021, the Company received $345,400 in cash related to the Part-out Assets. This amount was accounted for as follows: $44,300 reduced accounts receivable for parts sales accrued in the first quarter of 2021; $294,300 reduced the carrying value of the parts; and $6,800 was recorded as gains in excess of the carrying value of the parts. During the second quarter of 2020, the Company received $112,000 in cash and accrued $30,100 in receivables for parts sales. These amounts were accounted for as follows: $77,300 reduced accounts receivable for parts sales accrued in the first quarter of 2020; $43,700 reduced the carrying value of the parts; and $21,100 was recorded as gains in excess of the carrying value of the parts.

The table below sets for the assets and liabilities that were classified as held for sale at June 30, 2021 and December 31, 2020:

As of June 30, 2021, minimum future lease revenue payments receivable under non-cancelable operating leases were as follows:

The remaining weighted average lease term of the Company’s assets under operating leases was 40 months and 29 months at June 30, 2021 and December 31, 2020, respectively.

4. Notes Payable and Accrued Interest

At June 30, 2021 and December 31, 2020, the Company’s notes payable and accrued interest consisted of the following. The Drake Indebtedness and PPP Loan (discussed in Note 4(c)) are included in liabilities subject to compromise at June 30, 2021 in the accompanying condensed consolidated balance sheet.

(a) Drake Indebtedness

On October 30, 2020, the MUFG Lenders under the Company’s MUFG Loan sold the MUFG Loan and the $3.1 million obligation of the Company from termination of the MUFG Swaps to Drake, and the Company and Drake entered into 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.

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 entire aircraft portfolio, other than one aircraft leased to a Kenyan lessee and certain Part-out Assets. The Drake Indebtedness had a stated maturity date of March 31, 2021, but collection of debt under, and the exercise of rights or remedies pursuant to, the Drake Loan Agreement were stayed due to the Company’s Chapter 11 filing, as discussed in Note 1(e), “Automatic Stay.” The Company has entered into the Stalking Horse Agreement with Drake for the sale of certain of the aircraft assets securing the Drake Indebtedness (the “Drake Collateral”), which has been approved by the Bankruptcy Court as the best and/or highest offer for the Drake Collateral. The Company is proceeding with transfer of title to the Drake Collateral pursuant to the Stalking Horse Agreement. Upon consummation of such transfers of title to Drake pursuant to the Stalking Horse Agreement, the Company’s obligations to Drake under the Drake Indebtedness will be deemed fully satisfied.

(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 with NordDeutsche Landesbank Girozentrale, New York Branch (“Nord”) that provided for six separate term loans (“Nord Loans”) with an aggregate principal amount of $44.3 million. Each of the Nord Loans was 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.

The interest rates payable under the Nord Loans varied by aircraft and were based on a fixed margin above either 30-day or 3-month LIBOR. The maturity of each Nord Loan varied 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 was 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 included covenants that imposed various restrictions and obligations on the LLC Borrowers, including covenants that required the LLC Borrowers to obtain Nord consent before they could take certain specified actions, and certain events of default. The Company was in compliance with all covenants under the Nord Loans at December 31, 2020.

One of the Nord Loan Collateral Aircraft was sold in 2019 and two Nord Loan Collateral Aircraft were sold in 2020. The excess proceeds from the 2020 sales were held as restricted cash by ACY E-175. The restricted cash, the three aircraft held by ACY E-175 and ACY E-175’s Nord Loans and derivative liability were classified as held for sale at December 31, 2020. During March 2021, the Company sold its interest in ACY E-175 and was released from any remaining guarantee obligations under the Nord Loan and interest swap obligations of the special-purpose subsidiary.

(c) Paycheck Protection Program Loans

On May 20, 2020, JetFleet Management Corp. (the “PPP Borrower”), an indirect 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 PPP Loan, which was in the form of a Note dated May 18, 2020 issued by the PPP Borrower, was forgiven during the second quarter of 2021 and the Company recorded $279,200 of loan forgiveness as a negative expense in its condensed consolidated statement of operations.

In February 2021, the Company was granted a second PPP Loan (“Second PPP Loan”) (collectively, with the initial PPP Loan, the “PPP Loans”) in the aggregate amount of $170,002. The Second PPP Loan, in the form of a Note dated February 11, 2021, matures on February 11, 2026 and bears interest at a rate of 1.00% per annum, payable in monthly payments commencing 30 days after the Small Business Administration has made its final determination that any part of the loan will not be forgiven.

The applications for the PPP Loans required the Company to certify in good faith 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 loans attendant to these funds, is dependent on the Company having initially qualified for the loans and qualifying for the forgiveness of such loans based on its future adherence to the forgiveness criteria.

The Second PPP Loan may be prepaid by the PPP Borrower at any time prior to maturity with no prepayment penalties. Funds from the PPP Loans 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 Loans for qualifying expenses. Under the terms of the PPP, certain amounts of the Second PPP 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 Second 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.

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 upon entering into the swaps. Changes in the fair value of the hedged swaps were included in other comprehensive income/(loss), which amounts are reclassified into earnings in the period in which the transaction being hedged affected 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.

(a) MUFG Swaps

The two interest rate swaps entered into by AeroCentury (the “MUFG Swaps”) were intended to protect against the exposure to interest rate increases on $50 million of the Company’s MUFG Credit Facility debt prior to its sale to Drake during the fourth quarter of 2020. The MUFG Swaps 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 gave 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 $1,167,700 related to the MUFG Swaps was recognized as interest expense in the first quarter of 2020. The two swaps related to the MUFG Credit Facility were terminated in March 2020 and the Company incurred a $3.1 million obligation, recorded as interest expense and derivative termination liability, in connection with such termination, payment of which was due no later than the March 31, 2021 maturity of the Drake Indebtedness.

(b) Nord Swaps

With respect to the interest rate swaps entered into by the LLC Borrowers (“the Nord Swaps”), 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 Nord Swaps were entered into by the LLC Borrowers and provided for reduced notional amounts that mirrored the amortization under the Nord Loans entered into by the LLC Borrowers, effectively converting each of the related Nord Loans from a variable to a fixed interest rate, ranging from 5.38% to 6.30%. Each of Nord Swaps extended for the duration of the corresponding Nord Loan. Two of the swaps had maturities in the four quarter of 2020 and were terminated when the associated assets were sold and the related debt was paid off. The other three Nord Swaps had maturities in 2025, but were sold in March 2021 as part of the Company’s sale of its membership interest in ACY E-175.

As discussed in Note 4, in March 2020, the Company determined that the future hedged interest payments related to its Nord Swaps were no longer probable of occurring, as a result of lease payment defaults for the aircraft owned by ACY 19002 and ACY 19003 and conversations with the lessee for the three aircraft owned by ACY E-175 regarding likely rent concessions, and consequently de-designated all five Nord Swaps as hedges because the lease payments that were used to service the Nord Loans associated with the Nord Swaps were no longer probable to occur. As a result of de-designation, future changes in market value were recognized in ordinary income and AOCI was reclassified to ordinary income as the forecasted transactions occurred. In December 2020, the Company determined that the payments after February 2021 for the three remaining Nord Swaps were probable not to occur as a result of the Company’s agreement to sell its interest in ACY E-175 during the first quarter of 2021. Accumulated other comprehensive income of $2,600 and $48,100 related to the Nord Swaps was recognized as an expense in the first quarters of 2021 and 2020, respectively.

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

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.

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 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 June 30, 2021, the weighted average discount rate was 3% and the weighted average remaining lease term was 22 months.

The Company estimates that the maturities of operating lease base rent of its office space were as follows as of June 30, 2021:

During the quarter ended June 30, 2021, the Company recognized amortization, finance costs and other expense related to the office lease as follows:

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

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 Company had no interest rate swaps as of June 30, 2021 or during the quarter then ended. As of December 31, 2020, the Company measured the fair value of its interest rate swaps of $14,091,300 (notional amount) based on Level 2 inputs, due to the usage of inputs that can be corroborated by observable market data. The interest rate swaps had a net fair value liability of $767,900 as of December 31, 2020. In the year ended December 31, 2020, $1,979,800 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 June 30, 2021 and December 31, 2020:

There were no transfers into or out of Level 3 during the six months ended June 30, 2021 or 2020.

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. The independent appraisals utilized the market approach which uses recent sales of comparable assets, making appropriate adjustments to reflect differences between them and the subject property being analyzed. Certain assumptions are used in the management’s estimate of the fair value of aircraft including the adjustments made to comparable assets, identifying market data of similar assets, and estimating cost to sell. 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 second quarter of 2021, the Company recorded impairment losses totaling $2,264,000 on five assets held for sale, based on appraised values or expected sales proceeds, which had an aggregate fair value of $29,333,100. During the second quarter of 2020, the Company recorded impairment losses totaling $6,706,600 for two of its aircraft held for lease, which were written down to their estimated sales prices, less cost of sale.

The following table shows, by level within the fair value hierarchy, the Company’s assets at fair value on a nonrecurring basis as of June 30, 2021 and December 31, 2020:

There were no transfers into or out of Level 3 during the six months ended June 30, 2021 or 2020.

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 Drake Indebtedness, 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(k). 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.”

The Drake Indebtedness bears floating rates of interest that reset periodically to a market benchmark rate plus a credit margin. The Company believes the effective interest rate of the Drake Indebtedness approximates current market rates, and therefore that the outstanding principal and accrued interest of $80,060,900 at June 30, 2021 approximates its fair values on such date. The fair value of the Company’s outstanding balance of its Drake Indebtedness is categorized as a Level 3 input under the GAAP fair value hierarchy. Pursuant to rules related to its bankruptcy filing, the Company reported the liability of the Drake Indebtedness as subject to compromise at the amount expected to be allowed.

The Company believes the effective interest rate under the Nord Loans approximated 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 $0 and $14,150,300 approximate their fair values at June 30, 2021 and December 31, 2020, respectively. Such fair value is categorized as a Level 3 input under the GAAP fair value hierarchy.

As discussed in Note 2(b), as a result of payment delinquencies by the Company’s two customers of aircraft subject to sales-type finance leases, the Company recorded bad debt allowances of $821,000 and $326,000 during the first and second quarters of 2021, respectively. The aircraft securing one of the sales-type finance leases was sold to the lessee during the second quarter. The finance lease receivable for the Company’s remaining finance lease is valued at the cash flow from the expected sale during the fourth quarter of 2021.

There were no transfers in or out of assets or liabilities measured at fair value under Level 3 during the three months or nine months ended June 30, 2021 or 2020.

8. Liabilities Subject to Compromise

The accompanying unaudited condensed consolidated balance sheet as of June 30, 2021 includes amounts classified as liabilities subject to compromise, which represents Pre-petition liabilities the Company anticipates will be allowed as claims in the Chapter 11 Cases. These amounts represent the Company’s current estimate of known or potential obligations to be resolved in connection with the Chapter 11 Cases and may differ from actual settlement amounts. The Company will continue to evaluate these liabilities throughout the Chapter 11 process and adjust amounts as necessary. Such adjustments could be material and will be recorded in reorganization items, net in the accompanying unaudited condensed statements of operations.

The following table summarizes liabilities subject to compromise at June 30, 2021:

9. Reorganization Items, Net

The Debtors have incurred and will continue to incur costs associated with the reorganization, including professional and consulting fees. Charges associated with the Chapter 11 Cases are recorded as reorganization items in the Company’s condensed consolidated statements of operations. For the three months ended June 30, 2021, the Company incurred $952,800 of such expenses, all of which was comprised of professional fees. The Company paid $453,700 during the three months ended June 30, 2021 and $499,100 is recorded in accrued liabilities in the accompanying unaudited condensed consolidated balance sheet as of June 30, 2021.

10. 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.

11. Income Taxes

The Company recorded income tax expense of $3,600 in the second quarter of 2021, or negative 0.11% of pre-tax loss, compared to $1.3 million income tax benefit, or 8.67% of pre-tax loss in the second quarter of 2020. The difference in the effective federal income tax rate from the normal statutory rate in the second quarter of 2021 was primarily related to the recording of a valuation allowance of $575,000 for the second quarter of 2021 on U.S. deferred tax assets.

The Company recorded an income tax expense of $52,800 for the six months ended June 30, 2021, or negative 0.62% of pre-tax loss, compared to a $4.0 million income tax benefit, or 14.4% of pre-tax loss, for the six months ended June 30, 2020. 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 $1.7 million for the six months ended June 30, 2021 on U.S. deferred tax assets not supported by either future taxable income or availability of future reversals of existing taxable temporary differences, partially offset by deferred foreign tax assets that are supported by existing temporary differences.

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 June 30, 2021, the impacts of the COVID-19 Pandemic on the worldwide airline industry and the Company’s recent filing for protection under Chapter 11 of the Bankruptcy Code. Based on this 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 $575,000 and $1.7 million for the three months and six months ended June 30, 2021, respectively. Additionally, the Company has concluded that based on its analysis, some of its foreign net operating loss carrybacks are not expected to be realized based on limitations on the utilization of its foreign net operating losses, and therefore has recorded a foreign tax expense of $0 and $54,300 for the reduced tax refund for the three months and six months ended June 30, 2021, respectively. The tax treatment of the bankruptcy is dependent on the interpretation and the application of the Stalking Horse Agreement and the Sale Order.  Depending on the final resolution of these matters and the occurrence or nonoccurrence of certain future events, there may be a future tax liability associated with the disposition of the aircraft pursuant to the Stalking Horse Agreement.

12. Condensed Combined Debtor-in-Possession Financial Information

The following financial statements represent the unaudited condensed combined financial statements of the Debtors. The results of the non-debtor entities are not included in these financial statements. Intercompany transactions among the Debtors have been eliminated in the following financial statements. Intercompany transactions among the Debtor and non-debtor entities have not been eliminated in the following financial statements.

The Debtors

Condensed Combined Balance Sheet

June 30, 2021

(Unaudited)

The Debtors

Condensed Combined Statements of Operations

(Unaudited)

The Debtors

Condensed Combined Statements of Cash Flows

For the Six Months Ended June 30, 2021

(Unaudited)

13. Subsequent Events

(a) Sale of assets

In August 2021, the Company sold one on-lease regional jet aircraft, three off-lease regional jet aircraft and one off-lease turboprop aircraft to Drake. Pursuant to the Stalking Horse Agreement, the sales resulted in the full satisfaction and cancellation of $40,001,900 of the Drake Indebtedness.

(b) Plan Sponsor Agreements

On August 16, 2021, the Company entered into a Plan Sponsor Agreement with a group of investors led by Mr. Yucheng Hu with respect to the terms of an $11 million equity investment in the Company (“Plan Sponsor Agreement”), which is subject to approval of the Bankruptcy Court. If court approval is received, following a scheduled August 31, 2021 hearing, the Company anticipates closing of the equity investment on a date in mid to late September 2021 (the “Effective Date”). The principal terms of the Plan Sponsor Agreement are below:

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, 2020 and the audited consolidated financial statements and notes included therein (collectively, the “2020 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 2020 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 has historically provided leasing and finance services to regional airlines worldwide and has been principally engaged in leasing mid-life regional aircraft to customers worldwide under operating leases and finance leases. In addition to leasing activities, the Company has also sold 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. As discussed below, the Company has entered into a definitive agreement with an investment sponsor for a plan of reorganization to exit the Chapter 11 Cases and provide $11 million in equity financing to the Company. It is possible that a sponsor may only be willing to invest in the Company if the Company’s operations are broadened to include and focus on new lines of business other than the aircraft leasing business.

The COVID-19 Pandemic has led to significant cash flow issues for many lessors. Some of the Company’s lessees were unable to timely meet their obligations under their lease obligations with the Company during 2020 and in the quarter ended June 30, 2021. This in turn has caused those lessees to make requests for lease payment concessions and/or deferrals from the Company, which in turn impacted the Company’s cash flow. The onset of the COVID-19 Pandemic substantially impeded the Company’s ability to regain compliance with its debt covenants under its credit facility with lenders led by agent bank MUFG Union Bank (the “MUFG Lenders”), which credit facility was in default prior to the COVID-19 Pandemic due to the failure of the Company’s largest customer, a European regional carrier.

In October 2020, the Company’s MUFG indebtedness, which consisted of $87.9 million loan indebtedness to the MUFG Lenders, including deferred interest, and approximately $3.1 million owed to MUFG Bank, Ltd for termination of interest rate swaps entered into with respect to the Drake Indebtedness (collectively, the “MUFG Indebtedness”) was sold to Drake Asset Management Jersey Limited (“Drake”).

In March 2021, the Company’s special purpose financing debt owed to Nord LB related to three of the Company’s assets was repaid in full as a result of dispositions of the three aircraft over the course of the last two years. In March 2021, the Company sold its membership interest in ACY E-175 LLC (“ACY E-175”), and the buyer assumed the remaining debt owed to Nord LB.

On March 29, 2021, AeroCentury and two of its subsidiaries, JetFleet Holding Corp. and JetFleet Management Corp. (“the Debtors”) filed a voluntary petition for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware on March 29, 2021. After the bankruptcy filing, the Company has continued to operate its businesses in the ordinary course as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code. The Bankruptcy Court has granted the Company’s motions designed primarily to minimize the effect of bankruptcy on the Company’s operations, customers and employees and make it possible for the Company to continue existing operations without interruption during the pendency of the Chapter 11 Cases.

The Bankruptcy Court also approved the conduct of a process to market and sell the Company’s assets as part of the Chapter 11 proceeding in order to permit the Company to satisfy the Company’s obligations to its creditors, including its sole secured creditor, Drake. The Company entered into a Stalking Horse Agreement with Drake for the sale of certain of the aircraft assets securing the Drake Indebtedness (the “Drake Collateral”), which was approved by the Bankruptcy Court as the best and/or highest offer for the Drake Collateral. Upon consummation of the transfers of title of the Drake Collateral to Drake or their nominees, the Company’s obligations to Drake under the Drake Indebtedness will be deemed fully satisfied.

Finally, during the first quarter of 2021, the Company entered into negotiations for the sale of an aircraft securing a sales-type finance lease receivable to the customer and recorded a bad debt allowance of $821,000. The Company entered into an agreement to sell such aircraft to the current lessee in May of 2021 for a purchase price of $700,000, subject to Bankruptcy Court approval, and the sale occurred in the second quarter of 2021. In June 2021, the Company entered into an agreement to sell a second aircraft securing a sales-type finance lease receivable to the customer and recorded a bad debt allowance of $326,000. The Company expects the sale to occur in the fourth quarter of 2021. In addition, in May 2021, the Company agreed to sell most of the Part-out Assets for $290,000, and recorded an impairment loss of $1,940,400 in the first quarter of 2021. The sale occurred during the second quarter of 2021.

Average portfolio utilization was 81% and 91% during the second quarters of 2021 and 2020, respectively. The year-to-year decrease was due to aircraft sales during 2020 and 2021 and aircraft that were on lease in in the 2020 period, but off lease in the 2021 period.

Net loss for the second quarters of 2021 and 2020 was $3.2 million and $13.5 million, respectively, resulting in basic and diluted loss per share of $(2.07) and $(8.74), 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 (181%) and (308%) in the second quarters of 2021 and 2020, respectively.

The Company ended the second quarter of 2021 with a total of ten aircraft and an inventory of spare parts held for sale, with a net book value of approximately $53 million. In addition to the assets held for sale at quarter-end, the Company held one aircraft subject to a finance lease.

Fleet Summary

(a) Assets Held for Lease

Key portfolio metrics of the Company’s aircraft held for lease as of June 30, 2021 and December 31, 2020 were as follows:

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 June 30, 2021 and December 31, 2020:

The Company did not purchase any aircraft during the quarter ended June 30, 2021. As a result of its Chapter 11 filing in March 2021 and a sale order approved by the Bankruptcy Court during the second quarter, the Company reclassified all of its aircraft, comprised of seven regional jet aircraft and three turboprop aircraft, from held for lease to held for sale.

The following table sets forth the net book value and percentage of the net book value of the Company’s assets that were held for lease at June 30, 2021 and December 31, 2020 in the indicated regions (based on the domicile of the lessee):

For the three months ended June 30, 2021, approximately 43%, 40% and 17% of the Company’s operating lease revenue was derived from customers in Croatia, Canada and the United States, 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:

At June 30, 2021 and December 31, 2020, the Company also had one and two finance lease receivables collateralized by aircraft, respectively. The Company did not record any finance lease revenue during the quarter ended June 30, 2021.

(b) Assets Held for Sale

Assets held for sale at June 30, 2021 consisted of ten aircraft and engine parts from a turboprop aircraft. As a result of its Chapter 11 filing in March 2021 and a sale order approved by the Bankruptcy Court during the second quarter, the Company reclassified all of its aircraft, comprised of seven regional jet aircraft and three turboprop aircraft, from held for lease to held for sale.

In May 2021, the Company sold most of the Part-out Assets for $290,000, for which the Company recorded an impairment loss of $1,940,400 in the first quarter of 2021.

Results of Operations

(a) Quarter ended June 30, 2021 compared to the quarter ended June 30, 2020

(i) Revenues and Other Income

Revenues and other income decreased by 66% to $1.5 million in the second quarter of 2021 from $4.4 million in the second quarter of 2020. The decrease was primarily a result of a 66% decrease in operating lease revenues to $1.5 million in the second quarter of 2021 from $4.4 million in the second quarter of 2020 as a result of reduced rent income from the sale of aircraft during the fourth quarter of 2020 and first quarter of 2021 and reduced rent for three assets in the 2021 quarter as a result of lease extensions and related rent reductions, the effects of which were partially offset by reduced rent for two assets in the 2020 period as a result of lease amendments related to the COVID-19 Pandemic.

(ii) Expenses

Total expenses decreased by 76% to $4.7 million in the second quarter of 2021 from $19.2 million in the second quarter of 2020. The decrease was primarily a result of decreases in asset impairment losses, interest expense, professional fees and general and administrative expenses and depreciation, the effects of which were partially offset by increases in reorganization costs and bad debt expense. Expenses in the second quarter of 2021 also included ($0.3) million of Paycheck Protection Program (“PPP”) Loan forgiveness.

During the second quarter of 2021, the Company recorded impairment charges totaling $2.3 million on five assets held for sale, based on appraised values or expected sales proceeds. During the second quarter of 2020, the Company recorded impairment charges of (i) $6.7 million on two assets held for lease, based on estimated future cash flow, (ii) $2.9 million on three assets held for sale, based on appraised values and (iii) $0.1 million on a fourth asset held for sale, based on expected net sales proceeds.

The Company’s interest expense decreased by 100% to $1,900 in the second quarter of 2021 from $4.5 million in the second quarter of 2020, as a result of the Company’s Chapter 11 filing in late March 2021, after which the Company did not accrue interest on the Drake Indebtedness. The second quarter of 2020 included a $1.5 million write-off of a portion of the Company’s unamortized debt issuance costs related to the MUFG Credit Facility.

Professional fees, general and administrative and other expenses decreased 94% to $0.1 million in the second quarter of 2021 from $2.1 million in the second quarter of 2020. The 2020 period included legal fees related to the May 2020 MUFG Indebtedness amendment and litigation brought by 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.

Depreciation expense decreased 77% to $0.5 million in the second quarter of 2021 from $2.0 million in the second quarter of 2020, primarily as a result of the reclassification of aircraft from held for lease to held for sale during the fourth quarter of 2020 and second quarter of 2021, 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 and were sold during the fourth quarter.

During the second quarter of 2021, the Company recorded $1.0 million of reorganization costs as a result of its March 29, 2021 Chapter 11 filing.

Based on an agreement to sell an aircraft that secures a sales-type finance lease receivable, the Company recorded bad debt expense totaling $0.3 million during the second quarter of 2021. The Company recorded no such expense during the second quarter of 2020.

The Company had a tax expense of $3,600 in the second quarter of 2021 compared to tax benefit of $1.3 million in the second quarter of 2020. The effective tax rate for the second quarter of 2021 was a negative 0.11% tax expense compared to a 8.67% tax benefit for the second quarter of 2020. The difference in the effective income tax rate from the normal statutory rate in the second quarter of 2021 was primarily related to the recording of a valuation allowance in the current period on the Company’s U.S. deferred tax assets. In assessing the valuation of deferred tax assets, the Company considered 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 June 30, 2021, the impacts of the COVID-19 Pandemic on the worldwide airline industry and the Company’s recent filing for protection under Chapter 11 of the Bankruptcy Code. Based on this analysis, the Company concluded that a valuation allowance is necessary for the Company’s net 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 $575,000 in the second quarter of 2021 compared to a valuation allowance of $3.1 million in the second quarter of 2020.

(b) Six months ended June 30, 2021 compared to the six months ended June 30, 2020

(i) Revenues and Other Income

Revenues and other income decreased by 56% to $4.0 million in the first six months of 2021 from $9.2 million in the same period of 2020. The decrease was primarily a result of a 54% decrease in operating lease revenues to $4.2 million in the first six months of 2021 from $9.1 million in the same period of 2020 as a result of reduced rent income from the sale of aircraft during the fourth quarter of 2020 and first quarter of 2021 and reduced rent for three assets in the 2021 quarter as a result of lease extensions and related rent reductions.

(ii) Expenses

Total expenses decreased by 66% to $12.6 million in the first six months of 2021 from $36.9 million in the same period of 2020. The decrease was primarily a result of decreases in asset impairment losses, interest expense, professional fees and general and administrative expenses and depreciation, the effects of which were partially offset by an increase in reorganization costs. Expenses in the first six months of 2021 also included ($0.3) million of PPP Loan forgiveness.

During the first six months of 2021, the Company recorded impairment charges totaling $4.2 million on seven assets held for sale, based on appraised values or expected sales proceeds. During the six months ended June 30, 2020, the Company recorded impairment charges of (i) $6.7 million on two assets held for lease, based on estimated future cash flow and (ii) $9.7 million on five assets held for sale, based on appraised values or expected sales proceeds.

The Company’s interest expense decreased by 82% to $1.9 million in the first six months of 2021 from $10.5 million in the same period of 2020, as a result of the Company’s Chapter 11 filing in late March 2021, after which the Company did not accrue interest on the Drake Indebtedness. The second quarter of 2020 included $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.

Professional fees, general and administrative and other expenses decreased 43% to $1.7 million in the first six months of 2021 from $3.0 million in the first six months of 2020, primarily as a result of decreases in legal fees related to the May 2020 MUFG Indebtedness amendment and litigation brought by an activist shareholder, consulting fees related to the May 2020 MUFG Indebtedness amendment and amortization related to the Company’s office lease right of use.

Depreciation expense decreased 72% to $1.2 million in the six months ended June 30, 2021 from $4.2 million in the six months ended June 30, 2020 primarily as a result of the reclassification of aircraft from held for lease to held for sale during the fourth quarter of 2020 and second quarter of 2021, 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 and were sold during the fourth quarter.

During the first six months of 2021, the Company recorded $1.0 million of reorganization costs as a result of its March 29, 2021 Chapter 11 filing.

The Company had a tax expense of $52,800 for the six months ended June 30, 2021 compared to tax benefit of $4.0 million for the six months ended June 30, 2020. The effective tax rate for the six months ended June 30, 2021 was a negative 0.62% tax expense compared to a 14.4% tax benefit for the six months ended June 30, 2020. The difference in the effective income tax rate from the normal statutory rate for the six months ended June 30, 2021 was primarily related to the recording of a valuation allowance in the current period on the Company’s U.S. deferred tax assets. In assessing the valuation of deferred tax assets, the Company considered 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 June 30, 2021, the impacts of the COVID-19 Pandemic on the worldwide airline industry and the Company’s recent filing for protection under Chapter 11 of the Bankruptcy Code. Based on this analysis, the Company concluded that a valuation allowance is necessary for the Company’s net 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 $1.7 million for the six months ended June 30, 2021 compared to a valuation allowance of $3.2 million for the six months ended Junes 30, 2020. Additionally, the Company has concluded that based on its analysis, some of its foreign net operating loss carrybacks are not expected to be realized based on limitations on the utilization of its foreign net operating losses, and therefore recorded a foreign tax expense of $54,300 for the reduced tax refund for the six months ended June 30, 2021.

Liquidity and Capital Resources

At June 30, 2021, the Company had total book assets of approximately $58.7 million and total liabilities of $84.9 million, resulting in a negative book equity of $26.2 million. The largest portion, $80.1 million, of the Company’s debt is owed to Drake. The maturity date of the Drake Indebtedness was March 31, 2021.

The Company did not have the resources to meet its obligations to repay the Drake Indebtedness when due on March 31, 2021, which is a principal reason for its decision to file for protection under Chapter 11 of the Bankruptcy Code on March 29, 2021, as discussed in Note 1(c). The Company requires additional funding to continue its operations and has not identified a source for such funding to date. Although the Company is seeking to secure additional funding and has entered into a Plan Sponsor Agreement with a proposed equity investor as part of its plan for exit from Bankruptcy, the agreement must be approved by the Bankruptcy Court and there are terms and conditions precedent to the equity investment that must be fulfilled by the Company prior to consummation of the investment. Therefore, the Company cannot conclude that it is probable that succeed in doing so in order to mitigate the conditions that led to substantial doubt about the Company’s ability to continue as a going concern. The Company’s poor financial position, including the amount of liability under the Drake Indebtedness in relation to the fair value of the Company’s remaining assets and the uncertainty of generating sufficient revenue to continue operations have led the Company to conclude that there is substantial doubt about its ability to continue as a going concern.

The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern and contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. The Company’s ability to continue as a going concern is contingent upon its ability to successfully implement a plan of reorganization, among other factors, and the realization of assets and the satisfaction of liabilities are subject to uncertainty. Further, any plan of reorganization could materially change the amounts of assets and liabilities reported in the accompanying condensed consolidated financial statements. 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 or as a consequence of its Chapter 11 filing.

(a) MUFG Credit Facility and Drake Indebtedness

On October 30, 2020, 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 MUFG Loan Agreement indebtedness. The purchase and sale were consented to by the Company pursuant to a Consent and Release Agreement of Borrower Parties, entered into by the Company and its subsidiaries.

On the same day, the Company entered into an Amendment No. 1 to the MUFG Loan Agreement (“Amendment No. 1”) with Drake and UMB Bank, N.A., the replacement Administrative Agent under the MUFG Loan Agreement, to amend the MUFG Loan Agreement to: (i) defer the cash component of any monthly interest payments due under the MUFG Loan Agreement, commencing with the payments due for March 2020, and capitalize and add such deferred interest to the principal balance of the indebtedness until such time as the indebtedness is repaid; (ii) require lender approval for any material changes in lease terms with respect to the collateral; and (iii) delete certain financial reporting requirements and change required frequency of certain other surviving reporting requirements. The indebtedness continues to be secured by a first priority lien on all of the Company’s assets, including the Company’s aircraft portfolio.

The Company and Drake have entered into an Asset Purchase Agreement (“Stalking Horse Agreement”) for the sale of the Drake Collateral, subject to better and higher offers. The Stalking Horse Agreement was entered into in conjunction with the filing by the Company of the Chapter 11 Cases. No other third-party bids were received for the Company’s assets in the Court-approved marketing and sale process, so the proposed auction (“Auction Sale”) for assets was not conducted. Since approval of the Stalking Horse Agreement, the Company and Drake have consummated the transfer of a significant portion of the Drake Collateral on the terms set forth in the Stalking Horse Agreement and expect the remaining Drake Collateral held by the Company to be completed by the end of September 2021. Upon the final transfer of assets, the Company’s indebtedness to Drake will be deemed fully satisfied.

Following is a summary of the principal terms and conditions of the Stalking Horse Agreement:

(b) Special-purpose Financing and 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 provided for six separate term loans (“Nord Loans”) with an aggregate principal amount of $44.3 million. Each of the Nord Loans was 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.

The interest rates payable under the Nord Loans varied by aircraft, and were based on a fixed margin above either 30-day or 3-month LIBOR. The maturity of each Nord Loan varied 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 was 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.

One of the Nord Loan Collateral Aircraft was sold in 2019 and two Nord Loan Collateral Aircraft were sold in 2020. The excess proceeds from the 2020 sales were held as restricted cash by ACY E-175. The restricted cash, the three aircraft held by ACY E-175 and ACY E-175’s Nord Loans and derivative liability were classified as held for sale at December 31, 2020. During March 2021, the Company sold its interest in ACY E-175 and was released from any remaining guarantee obligations under the Nord Loan and interest swap obligations of the special-purpose subsidiary.

(c) Paycheck Protection Program Loans

On May 20, 2020, JetFleet Management Corp. (the “PPP Borrower”), an indirect 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 PPP under Division A, Title I of the CARES Act, which was enacted March 27, 2020. The PPP Loan, which was in the form of a Note dated May 18, 2020 issued by the PPP Borrower, was forgiven during the second quarter of 2021 and the Company recorded $279,200 of loan forgiveness as a reduction in expense.

In February 2021, the Company was granted a second PPP Loan (“Second PPP Loan”) (collectively, with the initial PPP Loan, the “PPP Loans”) in the aggregate amount of $170,002. The Second PPP Loan, in the form of a Note dated February 11, 2021, matures on February 11, 2026 and bears interest at a rate of 1.00% per annum, payable in monthly payments commencing 30 days after the Small Business Administration has made its final determination that any part of the loan will not be forgiven.

The applications for the PPP Loans required the Company to certify in good faith 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 loans attendant to these funds, is dependent on the Company having initially qualified for the loans and qualifying for the forgiveness of such loans based on its future adherence to the forgiveness criteria.

The Second PPP Loan may be prepaid by the PPP Borrower at any time prior to maturity with no prepayment penalties. Funds from the PPP Loans 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 Loans for qualifying expenses. Under the terms of the PPP, certain amounts of the Second PPP 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 Second PPP Loan will be forgiven, no assurance can be provided that the Company will obtain such forgiveness.

(d) Cash Flow

The Company’s primary sources of cash from operations are payments due under the Company’s operating and finance leases, maintenance reserves, which are billed monthly to lessees based on asset usage, and proceeds from the sale of aircraft and engines.

The Company’s primary uses of cash are for (i) salaries, employee benefits and general and administrative expenses, (ii) professional fees and legal expenses with respect to the Company’s Chapter 11 Cases and restructuring and recapitalization effort; (iii) maintenance expense and (iv) reimbursement to lessees from collected maintenance reserves. The Company’s cash flow is subject to a cash collateral order issued by the Bankruptcy Court.

During 2019, the Company engaged B. Riley Securities, Inc. as an investment banking advisor to help (i) negotiate with the Company’s stakeholders and formulate and analyze the Company’s various strategic financial alternatives with respect to its plan of reorganization and (ii) locate and negotiate with potential lenders, investors or transaction partners who would play a role in recapitalization of the Company.

The Company’s ability to develop and obtain approval for its plan of reorganization is subject to a variety of factors, as discussed under Factors that May Affect Future Results and Liquidity – Risks Related to Chapter 11 Case.

The Company’s payments for maintenance consist of reimbursements to lessees for eligible maintenance costs under their leases and maintenance incurred directly by the Company for preparation of off-lease assets for re-lease to new customers. The timing and amount of such payments may vary widely between quarterly and annual periods, as the required maintenance events can vary greatly in magnitude and cost, and the performance of the required maintenance events by the lessee or the Company, as applicable, are not regularly scheduled calendar events and do not occur at uniform intervals.

Though the Company’s maintenance payments typically constitute a large portion of its cash outflow, this is not likely to be the case in the near term. One of the Company’s lessees that pays maintenance reserves has agreed with the Company that if the Company is unable or unwilling to repay its maintenance reimbursement obligations to the lessee, the reimbursement obligation will be offset against the lessee’s monthly rental obligations to the Company until such maintenance reimbursement obligations are repaid in full. The one lessee that pays maintenance reserves under its sales-type lease is currently in arrearage under the lease and will not be eligible to submit maintenance reserve claims until it has cured its arrearages. When and if the sale of the Company’s aircraft portfolio pursuant to the Stalking Horse Agreement, or any successor agreement, is consummated, any existing reimbursement obligations under the Company’s leases sold at such sale will be assumed by the asset buyer.

Actual results could deviate substantially from the assumptions management has made in forecasting the Company’s future cash flow. As discussed in Liquidity and Capital Resources – (a) MUFG Credit Facility and Drake Indebtedness and in Outlook and Factors that May Affect Future Results and Liquidity, there are a number of factors that may cause actual results to deviate from these forecasts. If these assumptions prove to be incorrect and the Company’s cash requirements exceed its cash flow, the Company would need to pursue additional sources of financing to satisfy these requirements, which may not be available when needed, on acceptable terms or at all. See Factors that May Affect Future Results and Liquidity for more information about financing risks and limitations.

(i) Operating activities

The Company’s cash flow from operations increased by $1.7 million in the first six months of 2021 compared to the first six months of 2020. As discussed below, the increase in cash flow was primarily a result of decreases in payments made for interest and maintenance, the effects of which were partially offset by decreases in payments received for rent and maintenance reserves.

(A) Payments for interest

Payments made for interest decreased by $2.6 million in the first six months of 2021 compared to the same period of 2020 as a result of the deferral of the interest due on the Company’s Drake Indebtedness in the 2021 period.

(B) Payments for maintenance