UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-KSB
(Mark
One)
x
Annual
Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934
For
the
fiscal year ended December 31, 2006
OR
o
Transition
Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934
For
the
transition period from ____________ to ____________
Commission
File Number:
001-13387
AeroCentury
Corp.
(Name
of
small business issuer in its charter)
|
Delaware
|
94-3263974
|
|
(State
or other jurisdiction of incorporation
or organization)
|
(I.R.S.
Employer Identification
No.)
|
1440
Chapin Avenue, Suite 310
Burlingame,
California 94010
(Address
of principal executive offices) (Zip
Code)
Issuer's
telephone number:
(650)
340-1888
Securities
registered under Section 12(b) of the Exchange Act:
|
Title
of Each Class
|
Name
of Each Exchange on Which
Registered
|
|
Common
Stock, $0.001 par
value
|
American
Stock
Exchange
|
Securities
registered under Section 12(g) of the Exchange Act: None
Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act o
Note:
Checking the box above will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Exchange Act from their obligations
under
these sections.
Check
whether the Issuer: (1) filed all reports required to be filed by Section 13
or
15(d) of the Exchange Act during the past 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: oYes x No
Check
if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained herein, and no disclosure will be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment
to
this Form 10-KSB. x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
YesoNo x
State
issuer’s revenues for its most recent fiscal year: $18,321,990
On
March
12, 2007, the aggregate market value of the voting and non-voting common equity
held by non-affiliates (based upon the closing price as of March 9, 2007) was
$25,071,542.
As
of
March 12, 2007, the Issuer had 1,543,257 shares of Common Stock
outstanding.
Documents
Incorporated by Reference: Part III of this Report on Form 10-KSB incorporates
information by reference from the Registrant’s Proxy Statement for its 2006
Annual Meeting to be filed on or about March 23, 2007.
Transitional
Small Business Disclosure Format (check one): Yes
o
No x
-
1
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PART
I
Forward-Looking
Statements
This
Annual Report on Form 10-KSB 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 plans and objectives for future
operations and any statements of assumptions underlying any of 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 include: (i) in Item 1 “Description of Business”
statements that the Company can purchase assets at an appropriate price and
maintain an acceptable overall on-lease rate for the Company’s assets; that the
Company is able and willing to enter into transactions with a wider range of
lessees than would be possible for traditional, large lending institutions
and
leasing companies; that the Company’s cash flow should be sufficient to cover
maintenance expenses, interest expense, management fees, professional fees
and
insurance and provide excess cash flow; that competition may increase if
competitors who have traditionally neglected the regional air carrier market
begin to focus on that market; and that the Company has a competitive advantage
because JMC has developed a reputation as a global participant in the aircraft
leasing market; (ii) in Item 6 "Management's Discussion and Analysis or Plan
of
Operation -- Liquidity and Capital Resources," statements regarding the
Company's belief that it will continue to be in compliance with all covenants
of
its credit facility; and that it will have adequate cash flow to meet its
ongoing operational needs; (iii) in Item 6 "Management's Discussion and Analysis
or Plan of Operation -- Outlook," statements regarding the Company's belief
that
the lease for an aircraft that expires in April 2007 will be extended; that
the
Company's reported net income may be subject to greater fluctuations from
quarter to quarter than would have been the case had the Company continued
its
use of the accrue-in-advance method of accounting for planned major maintenance
activities; that beginning with its March 31, 2007 financial reporting
requirements, the balance sheet will reflect a catch-up cumulative adjustment
to
increase retained earnings as of January 1, 2006, as a result of the change
to
the new accounting method and the comparative 2006 financial results will be
presented on a restated basis; (iv) in Item 6 "Management's Discussion and
Analysis or Plan of Operation -- Factors that May Affect Future Results,”
statements regarding the Company's belief that it will have sufficient cash
funds to make any payment that arises due to borrowing base limitations caused
by assets scheduled to come off lease in the near term; that it will have
sufficient funds to pay increased Sarbanes-Oxley compliance costs; that it
will
acquire primarily used aircraft equipment; that overseas markets present
business opportunities; and that the Company is competitive because of JMC's
experience and operational efficiency and will benefit because of JMC's
reputation in the marketplace; and (v) in Item 7 “Financial Statements”
statements regarding the Company’s belief that the adoption of Statement 157 or
Statement 159 will not have an impact on its financial condition, results of
operations or cash flows.
These
forward-looking statements involve risks and uncertainties, and it is important
to note that the Company's actual results could differ materially from those
projected or assumed in such forward-looking statements. Among the factors
that
could cause actual results to differ materially are the factors detailed under
the heading "Management's Discussion and Analysis or Plan of Operation --
Factors That May Affect Future Results," including risks related to use of
debt
financing for acquisitions; the compliance of the Company's lessees with
obligations under their respective leases; the Company’s success in finding
additional financing and appropriate assets to acquire with such financing;
general economic conditions, particularly those that affect the air travel
industry; unanticipated sharp increases in interest rates; further disruptions
to the air travel industry due to terrorist attacks; and future trends and
results which cannot be predicted with certainty, as well as any and all risk
factors contained in the periodic reports filed by the Company with the
Securities Exchange Commission. The cautionary statements made in this Report
should be read as being applicable to all related forward-looking statements
wherever they appear herein. All forward-looking statements and risk factors
included in this document are made as of the date hereof, based on information
available to the Company as of the date hereof, and the Company assumes no
obligation to update any forward-looking statement or risk factor.
-
2
-
Item
1. Description
of Business.
Business
of the Company
AeroCentury
Corp. (“AeroCentury”), a Delaware corporation, uses leveraged financing to
acquire leased aircraft assets. AeroCentury was formed in 1997. Financial
information for AeroCentury and its wholly-owned subsidiaries, AeroCentury
Investments V LLC (“AeroCentury V LLC”) and AeroCentury Investments VI LLC
(“AeroCentury VI LLC”) (collectively, the “Company”), is presented on a
consolidated basis. All intercompany balances and transactions have been
eliminated in consolidation.
The
business of the Company is managed by JetFleet Management Corp. ("JMC"),
pursuant to a management agreement between the Company and JMC (“the Management
Agreement”), which is an integrated aircraft management, marketing and financing
business and a subsidiary of JetFleet Holding Corp. ("JHC"). Certain officers
of
the Company are also officers of JHC and JMC and hold significant ownership
positions in both JHC and the Company.
The
Company is engaged in the business of investing in used regional aircraft
equipment leased to foreign and domestic regional air carriers and has been
engaged in such business since its formation. The Company’s principal business
objective is to increase stockholder value by acquiring aircraft assets and
managing those assets in order to provide a return on investment through lease
revenue and, eventually, sale proceeds. The Company strives to achieve its
business objective by reinvesting cash flow and obtaining short-term and
long-term debt and/or equity financing.
The
Company’s success in achieving its objective will depend in large part on its
success in three areas: asset selection, lessee selection and obtaining
acquisition financing.
The
Company acquires additional assets in one of three ways. The Company may
purchase an asset already subject to a lease and assume the rights of the
seller, as lessor under the existing lease. In addition the Company may purchase
an asset, usually from an air carrier, and lease it back to the seller. Finally,
the Company may purchase an asset from a seller and then immediately enter
into
a new lease for the aircraft with a third party lessee. In this last case,
the
Company typically does not purchase an asset unless a potential lessee has
been
identified and has committed to lease the aircraft.
The
Company generally targets used regional aircraft and engines with purchase
prices between $1 million and $10 million, and lease terms less than five years.
In determining assets for acquisition, the Company evaluates, among other
things, the type of asset, its current price and projected future value, its
versatility or specialized uses, the current and projected future availability
of and demand for that asset, and the type and number of future potential
lessees. Because JMC has extensive experience in purchasing, leasing and selling
used regional aircraft, the Company believes it can purchase these assets at
an
appropriate price and maintain an acceptable overall on-lease rate for the
Company’s assets.
In
order
to improve the remarketability of an aircraft after expiration of the lease,
the
Company focuses on having lease provisions for its aircraft that contain
maintenance and return conditions, such that when the lessee returns the
aircraft, the Company receives the aircraft in a condition which allows it
to
expediently re-lease or sell the aircraft, or receives sufficient payments
from
the lessee to cover any maintenance or overhaul of the aircraft required to
bring the aircraft to such a state.
When
considering whether to accept transactions with a lessee, the Company examines
the creditworthiness of the lessee, its short- and long-term growth prospects,
its financial status and backing, the impact of pending governmental regulation
or de-regulation of the lessee’s market, all of which are weighed in determining
the lease rate that is offered to the lessee. In addition, where applicable,
it
is the Company’s policy to monitor the lessee’s business and financial
performance closely throughout the term of the lease, and if requested, provide
assistance drawn from the experience of the Company’s management in many areas
of the air carrier industry. Because of its “hands-on” approach to portfolio
management, the Company believes it is able and willing to enter into
transactions with a wider range of lessees than would be possible for
traditional, large lending institutions and leasing companies.
Working
Capital Needs
The
Company’s portfolio of assets has historically generated revenues which have
exceeded the Company’s cash expenses, which consist mainly of management fees,
maintenance expense, financing interest payments, and professional fees and
insurance.
The
Company's management fees payable to JMC are based upon the size of the asset
pool. Other than the maintenance expense accrued when two aircraft were returned
at lease end in 2006, the majority of the maintenance expense incurred by the
Company during 2006 was paid in cash during the year. As the Company has
continued to use acquisition debt financing under its revolving credit facility,
which expires on October 31, 2007, interest expense has become an increasingly
large portion of the Company’s expenses. Professional fees are paid to third
parties for expenses not covered by JMC under the Management Agreement.
Insurance expense includes amounts paid for directors and officers insurance,
as
well as product liability insurance and aircraft insurance for periods when
an
aircraft is off lease. So long as the Company succeeds in keeping the majority
of its assets on lease and interest rates do not rise significantly and rapidly,
the Company’s cash flow should be sufficient to cover maintenance expenses,
interest expense, management fees, professional fees and insurance and provide
excess cash flow.
Competition
The
Company competes with other leasing companies, banks, financial institutions,
and aircraft leasing partnerships for customers who generally are regional
commercial aircraft operators, who are seeking to lease aircraft under an
operating lease. Management believes that competition may increase if
competitors who have traditionally neglected the regional air carrier market
begin to focus on that market. Because competition is largely based on price
and
lease terms, the entry of new competitors into the market, particularly those
with greater access to capital markets than the Company, could lead to fewer
acquisition opportunities for the Company and/or lease terms less favorable
to
the Company on new acquisitions as well as renewals of existing leases or new
leases of existing aircraft, all of which could lead to lower revenues for
the
Company.
The
Company, however, believes that it has a competitive advantage due to its
experience and operational efficiency in financing the transaction sizes that
are desired by the regional air carrier market. Management believes that the
Company also has a competitive advantage because JMC has developed a reputation
as a global participant in the aircraft leasing market.
Dependence
on Significant Customers
For
the
year ended December 31, 2006, the Company had six significant customers, which
accounted for 15%, 14%, 12%, 11%, 11% and 10%, respectively, of lease revenue,
aggregating 73% of total revenue. Concentration of credit risk with respect
to
lease receivables will diminish in the future only if the Company is able to
lease additional assets or re-lease assets currently on lease to significant
customers to new customers.
Employees
Under
the
Company’s management contract with JMC, JMC is responsible for all
administration and management of the Company. Consequently, the Company does
not
have any employees.
Item 2. Description of Property.
As
of
December 31, 2006, the Company did not own or lease any real property, plant
or
materially important physical properties. The Company maintains its principal
office at 1440 Chapin Avenue, Suite 310, Burlingame, California 94010. However,
since the Company has no employees and the Company’s portfolio of leased
aircraft assets is managed and administered under the terms of the Management
Agreement with JMC, all office facilities are provided by JMC.
At
December 31, 2006, the Company owned eight deHavilland DHC-8-300s, three
deHavilland DHC-8-100s, three deHavilland DHC-6s, fourteen Fokker 50s, two
Saab
340As, six Saab 340Bs and one turboprop engine.
Item
3. Legal
Proceedings.
The
Company is not involved in any material legal proceedings.
Item
4. Submission
of Matters to a Vote of Security Holders.
None.
-
3
-
PART
II
Item
5. Market
for Common Equity and Related Stockholder Matters.
The
shares of the Company’s Common Stock are traded on the American Stock Exchange
(“AMEX”) under the symbol “ACY.”
Market
Information
The
Company’s Common Stock has been traded on the AMEX since January 16, 1998. The
following table sets forth the high and low sales prices reported on the AMEX
for the Company’s Common Stock for the periods indicated:
|
Period
|
High
|
Low
|
|||||
|
Fiscal
year ended December 31, 2007:
|
|||||||
|
First quarter through March 9, 2007
|
$
|
24.50
|
$
|
6.58
|
|||
|
Fiscal
year ended December 31, 2006:
|
|||||||
|
Fourth
Quarter
|
6.79
|
4.77
|
|||||
|
Third
Quarter
|
5.48
|
4.70
|
|||||
|
Second
Quarter
|
5.54
|
4.04
|
|||||
|
First
Quarter
|
4.14
|
3.15
|
|||||
|
Fiscal
year ended December 31, 2005:
|
|||||||
|
Fourth
Quarter
|
4.18
|
2.90
|
|||||
|
Third
Quarter
|
4.50
|
3.26
|
|||||
|
Second
Quarter
|
4.40
|
2.87
|
|||||
|
First
Quarter
|
6.78
|
2.33
|
On
March
9, 2007, the
closing stock sale price on the AMEX was
$21.02 per
share.
Number
of Security Holders
According
to the Company’s transfer agent, the Company had approximately 1,700
stockholders of record as of March 12, 2007.
Dividends
No
dividends have been declared or paid to date. The Company has no plans at this
time to declare or pay dividends, and intends to re-invest any earnings into
acquisition of additional revenue generating aircraft equipment.
Stockholder
Rights Plan
In
April
1998, in connection with the adoption of a stockholder rights plan, the Company
filed a Certificate of Designation detailing the rights, preferences and
privileges of a new Series A Preferred Stock. Pursuant to the plan, the Company
issued rights to its stockholders of record as of April 23, 1998, giving each
stockholder the right to purchase one one-hundredth of a share of Series A
Preferred Stock for each share of Common Stock held by the stockholder. Such
rights are exercisable only under certain circumstances in connection with
a
proposed acquisition or merger of the Company.
-
4
-
Item
6. Management’s
Discussion and Analysis or Plan of Operation.
Overview
The
Company is a lessor of regional aircraft and engines which are used by customers
pursuant to triple net operating
leases. The acquisition of such equipment is generally made using debt
financing. The Company’s profitability and cash flow are dependent in large part
upon its ability to acquire equipment, obtain and maintain favorable lease
rates
on such equipment, and re-lease or sell owned equipment that comes off lease.
The Company is subject to the credit risk of its lessees, both as to collection
of rent and to performance by lessees of obligations for maintaining the
aircraft. Since lease rates for assets in the Company’s portfolio generally
decline as the assets age, the Company’s ability to maintain revenue and
earnings is dependent upon the Company’s ability to grow its asset portfolio.
The
Company’s principal expenditures are for interest costs on its financing,
management fees, and maintenance of its aircraft assets. Maintenance
expenditures are generally incurred only when aircraft are off lease, are being
prepared for re-lease, or require maintenance in excess of lease return
conditions.
The
most
significant non-cash expenses include accruals of maintenance costs to be borne
by the Company and aircraft depreciation, both of which are the result of
significant estimates. Maintenance expenses are estimated and accrued based
upon
utilization of the aircraft. Depreciation is recognized based upon the estimated
residual value of the aircraft at the end of their estimated lives. Deviation
from these estimates could have a substantial effect on the Company’s cash flow
and profitability.
Critical
Accounting Policies, Judgments and Estimates
The
discussion and analysis of the Company’s financial condition and results of
operations are based upon the consolidated financial statements, which have
been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts
of
assets and liabilities, revenues and expenses, and the related disclosure of
contingent assets and liabilities at the date of the financial statements.
Actual results may differ from these estimates under different assumptions
or
conditions.
The
Company’s significant accounting policies are described in Note 1 to the
consolidated financial statements. The Company believes that the most critical
accounting policies include the following: Impairment of Long-lived Assets;
Depreciation Policy, Maintenance Reserves and Accrued Costs; Revenue Recognition
and Allowance for Doubtful Accounts; and Accounting for Income
Taxes.
a. Impairment
of Long-lived Assets
The
Company periodically reviews its portfolio of assets for impairment in
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
“Accounting for the Impairment or Disposal of Long-lived Assets." Such
review necessitates estimates of current market values, re-lease rents, residual
values and component values. The estimates are based on currently
available market data and third-party appraisals and are subject to fluctuation
from time to time.
The Company initiates its review periodically, whenever events or changes in
circumstances indicate that the carrying amount of a long-lived asset may not
be
recoverable. Recoverability of an asset is measured by comparison of its
carrying amount to the expected future undiscounted cash flows (without interest
charges) that the asset is expected to generate. Any impairment to be
recognized is measured by the amount by which the carrying amount of the asset
exceeds its fair market value. Significant management judgment is required
in the forecasting of future operating results which are used in the preparation
of projected undiscounted cash flows and should different conditions prevail,
material write downs may occur.
In
accordance with its periodic review of its portfolio of assets for impairment,
based on the Company’s cash flow analysis and third party appraisals, the
Company recorded no provisions for impairment for its aircraft in
2006.
b. Depreciation
Policy
The
Company’s interests in aircraft and aircraft engines are recorded at cost, which
includes acquisition costs. The Company purchases only used aircraft. It is
the
Company’s policy to hold aircraft for approximately twelve years unless market
conditions necessitate earlier disposition. Depreciation is computed using
the
straight-line method over the twelve year period to an estimated residual value
based on appraisal. Decreases in the market value of aircraft could not only
affect the current value, discussed above, but could also affect the assumed
residual value. The Company periodically obtains a residual value appraisal
for
its assets and, historically, has not had to write down any assets due to
revised estimated residuals.
c. Maintenance
Reserves and Accrued Costs
Maintenance
costs under the Company’s triple net leases are generally the responsibility of
the lessees. Maintenance reserves and accrued costs in the accompanying
consolidated balance sheet include refundable and non-refundable maintenance
payments received from lessees. The Company periodically reviews maintenance
reserves for each of its aircraft for adequacy in light of the number of hours
flown, airworthiness directives issued by the manufacturer or government
authority, and the return conditions specified in the lease, as well as the
condition of the aircraft upon return or inspection. As a result of such review,
if it is probable that the Company has incurred costs for maintenance in excess
of amounts received from lessees, the Company accrues its share of costs for
work to be performed.
Significant
management judgment is required in determining aircraft condition and estimating
maintenance costs. Absent fixed price maintenance agreements, these costs cannot
be determined until such work is completed. Because of the potential magnitude
of maintenance costs, even slight changes in work scope may have a material
impact on operating results.
With
respect to estimated maintenance costs, the Company has found its accruals
to be
generally accurate. Its accruals, however, are based on the assumption that
aircraft will be returned at lease end in accordance with the return conditions
of the lease. Historically, as a result of two situations, the Company incurred
significant maintenance expense when aircraft were returned early and in a
condition worse than required by the lease and for which the Company was unable
to recover the costs of non-compliance from the lessees.
d. Revenue
Recognition and Allowance for Doubtful Accounts
Revenue
from leasing of aircraft assets is recognized as operating lease revenue on
a
straight-line basis over the terms of the applicable lease agreements. The
Company estimates and charges to income a provision for bad debts based on
its
experience in the business and with each specific customer, the level of past
due accounts, and its analysis of the lessees’ overall financial condition. If
the financial condition of the Company’s customers deteriorates, it could result
in actual losses exceeding the estimated allowances.
e. Accounting
for Income Taxes
As
part
of the process of preparing the Company’s consolidated financial statements,
management is required to estimate 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 accounting
purposes. These differences result in deferred tax assets and liabilities,
which
are included in the consolidated balance sheet. Management must also assess
the
likelihood that the Company’s deferred tax assets will be recovered from future
taxable income, and, to the extent management believes it is more likely than
not that some portion or all of the deferred tax assets will not be realized,
the Company must establish a valuation allowance. To the extent the Company
establishes a valuation allowance or changes the allowance in a period, the
Company reflects the corresponding increase or decrease within the tax provision
in the consolidated statements of operations.
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. In the event that actual results differ from these
estimates or the Company adjusts these estimates in future periods, the
Company’s operating results and financial position could be materially
affected.
-
5
-
Results
of Operations
a. Revenues
Operating
lease revenue was approximately $4,122,000 higher in 2006 versus 2005, primarily
because of increased operating lease revenue from aircraft purchased beginning
in April 2005 and revenue from two aircraft which had been off lease in 2005,
the effects of which were partially offset by a decrease in revenue from an
aircraft which was sold in 2006.
Gain
on
sale of aircraft was approximately $409,000 in 2006 as a result of the sale
of
an aircraft in April 2006. Loss on sale of aircraft was approximately $48,000
in
2005 as a result of the sale of one aircraft at a loss of approximately $60,000
and another aircraft at a gain of approximately $12,000.
Other
income was approximately $244,000 higher in 2006 than in 2005, primarily as
a
result of an increase in the amount of non-refundable maintenance reserves
retained by the Company, which were recorded as income at lease
end.
b. Expense
items
Depreciation
was approximately $949,000 higher in 2006 versus 2005, primarily because of
purchases of aircraft beginning in April 2005, the effect of which was partially
offset by aircraft sales in 2005 and 2006. Management fees, which are calculated
on the net book value of the aircraft owned by the Company, were approximately
$410,000 higher 2006 compared to 2005 for the same reasons.
Interest
expense was approximately $1,469,000 higher in 2006 versus 2005, primarily
as a
result of increases in the index rates upon which the Company’s interest rates
are based and a higher average principal balance in 2006 compared to 2005,
the
effect of which was partially offset by a lower margin in 2006 than in
2005.
Maintenance
expense was approximately $1,205,000 higher in 2006 compared to 2005. In 2006
and 2005, the Company retained approximately $2,396,000 and $1,902,000,
respectively, of non-refundable maintenance reserves when aircraft were returned
to the Company at lease end and recorded such amounts as other income, discussed
above. Based on the condition of the aircraft at the time of return, in 2006
and
2005, the Company accrued approximately $2,392,000 and $1,862,000, respectively,
of maintenance expense for which the Company is responsible. The Company also
accrued approximately $1,112,000 and $437,000 of expense to prepare several
aircraft for re-lease in 2006 and 2005, respectively.
Professional
fees and general and administrative expenses were approximately $92,000 higher
in 2006 versus 2005, primarily because of higher accounting fees and legal
fees
related to the Company’s leases in 2006.
The
Company's insurance expense consists primarily of directors and officers
insurance, as well as product liability insurance and insurance for off-lease
aircraft and aircraft engines, which varies depending on the type of assets
insured during each period and the length of time each asset is insured. As
a
result of the combination of assets insured during each period and the length
of
time each was insured, insurance expense was approximately $122,000 lower in
2006 versus 2005.
During
2006, the Company recorded bad debt expense of approximately $49,000 for rent
receivable which was written off in connection with a lessee’s early return of
an aircraft. During 2005, the Company recorded bad debt expense of approximately
$88,000, to fully reserve the balance of a note receivable from the former
lessee of one of the Company’s aircraft, based on a notice received from the
lessee that it had filed for reorganization, and $79,000 to fully reserve the
amount of foreign taxes due from a former lessee which was recorded as other
income in 2005.
The
Company did not record any impairment charges in 2006. In 2005, the Company
recorded an
impairment charge of approximately $12,000 for one of its aircraft, based on
estimated net sales proceeds pursuant to an agreement to sell the
aircraft.
The
Company’s effective tax rates for the years ended December 31, 2006 and 2005
were approximately 37% and 43%, respectively. The change in rate was primarily
a
result of the recognition of tax expense in 2005 related to a lessee’s
non-payment of foreign taxes in a prior year.
-
6
-
Liquidity
and Capital Resources
The
Company is currently financing its assets primarily through credit facility
borrowings, special purpose financing and excess cash flow.
(a) Credit
facility
In
November 2005, the Company’s credit facility was renewed through October 31,
2007. In connection with the renewal, certain financial covenants were modified,
including the applicable margin which is added to the index rate for each of
the
Company’s outstanding loans under the credit facility. The margin, which is
determined by certain financial ratios, was revised from a range of 275 to
375
basis points to a range of 275 to 325 basis points. In May 2006, a
participant was added to the Company’s credit facility and the amount of the
facility was increased from $50 million to $55 million.
During
2006, the Company borrowed $3,900,000 and repaid $3,000,000 of the outstanding
principal under its credit facility. The
balance of the note payable at December 31, 2006 was $50,896,000 and interest
of
$153,250 was accrued.
As
a
result of maintenance expense in connection with preparing one of the Company’s
aircraft for lease in the second quarter, on June 30, 2006, the Company was
out
of compliance with a financial ratio covenant which is based on net income.
The
Company obtained a waiver from its banks regarding that covenant for the quarter
then ended. The
Company is currently in compliance with all covenants and, based on its current
projections, the Company believes it will continue to be in compliance with
all
covenants of its credit facility, but there can be no assurance of such
compliance in the future. See "Factors
That May Affect Future Results - 'Risks of Debt Financing’ and 'Credit Facility
Obligations,”' below.
The
Company's interest expense in connection with the credit facility generally
moves up or down with prevailing interest rates, as the Company has not entered
into any interest rate hedge transactions for the credit facility indebtedness.
Because aircraft owners seeking financing generally can obtain financing
through either leasing transactions or traditional secured debt financings,
prevailing interest rates are a significant factor in determining market lease
rates, and market lease rates generally move up or down with prevailing interest
rates, assuming supply and demand of the desired equipment remain constant.
However, because lease rates for the Company’s assets typically are fixed
under existing leases, the Company normally does not experience any positive
or
negative impact in revenue from changes in market lease rates due to interest
rate changes until existing leases have terminated and new lease rates are
set
as the aircraft is re-leased.
(b) Special
purpose financing
In
September 2000, a special purpose subsidiary acquired a deHavilland DHC-8-100
aircraft using cash and bank financing separate from its credit facility. The
financing resulted in a note obligation in the amount of $3,575,000, due April
15, 2006, which bore interest at
the
rate of one-month LIBOR plus 3%.
The
note
was collateralized by the aircraft and was non-recourse to the Company.
Payments
due under the note consisted of monthly principal and interest and a balloon
principal payment due on the maturity date. The
financing also provided for a six month remarketing period at the expiration
or
early termination of the lease. This note obligation was refinanced in April
2006, using
bank financing from another lender, and the subsidiary was dissolved. The
aircraft was transferred to AeroCentury VI LLC, a newly formed special purpose
limited liability company, which borrowed $1,650,000, due October 15, 2009.
The
note bears interest at an adjustable rate of one-month LIBOR plus 3%.
The
note
is collateralized by the aircraft and the Company’s interest in AeroCentury VI
LLC and is non-recourse to the Company. Payments
due under the note consist of monthly principal and interest through April
20,
2009, interest only from April 20, 2009 until the maturity date, and a balloon
principal payment due on the maturity date. If the aircraft lease agreement
is
terminated on April 15, 2008 pursuant to a lessee early termination option,
the
note will be due October 15, 2008, and the interest only period will be from
April 20, 2008 through October 15, 2008. During 2006, $1,859,550 of principal
was repaid, including $1,566,290 which was repaid to the original lender when
the loan was refinanced. The balance of the note payable at December 31, 2006
was $1,421,350 and interest of $3,960 was accrued. As of December 31, 2006,
the
Company was in compliance with all covenants of this note obligation and is
currently in compliance.
In
November 2005, the Company refinanced two DHC-8-300 aircraft that had been
part
of the collateral base for its credit facility. The financing, by a bank
separate from its credit facility, was provided to a newly formed special
purpose subsidiary, AeroCentury V LLC, to which the aircraft were transferred.
The financing resulted in a note obligation in the amount of $6,400,000, due
November 10, 2008, which bears interest at
the
rate 7.87%.
The
note
is collateralized by the aircraft and is non-recourse to the Company.
Payments
due under the note consist of monthly principal and interest through April
22,
2008, interest only from April 22, 2008 until the maturity date, and a balloon
principal payment due on the maturity date. During 2006, AeroCentury V LLC
repaid $896,070 of principal. The balance of the note payable at December 31,
2006 was $5,420,710 and interest of $11,850 was accrued. As of December 31,
2006, the Company was in compliance with all covenants of this note obligation
and is currently in compliance.
The
availability of special purpose financing in the future will depend on several
factors including (1) the availability of funds to be used for the equity
portion of the financing, (2) the type of asset being financed, (3) the
creditworthiness of the underlying lessee and (4) continued compliance with
the
Company’s credit facility covenants. The availability of funds for the equity
portion of the financing will be dependent on the Company's cash flow, as
discussed in "Cash
Flow,"
below.
-
7
-
(c)
Future
maturities of notes payable
As
of
December 31, 2006, principal payments due under the Company’s credit facility
and long-term debt were as follows:
|
Less
than one year
|
$
|
52,178,150
|
||
|
1-3
years
|
5,559,910
|
|||
|
4-5
years
|
-
|
|||
|
After
5 years
|
-
|
|||
|
$
|
57,738,060
|
(d) Cash
flow
The
Company's primary source of revenue is lease rentals of its aircraft assets.
It
is the Company’s policy to monitor each lessee’s needs in periods before leases
are due to expire. If it appears that a customer will not be renewing its lease,
the Company immediately initiates marketing efforts to locate a potential new
lessee or purchaser for the aircraft. The goal of this procedure is to reduce
the time that an asset will be off lease. The Company’s aircraft are subject to
leases with varying expiration dates through November 2011.
Management
believes that the Company will have adequate cash flow to meet its ongoing
operational needs, including required repayments under its credit facility,
based upon its estimates of future revenues and expenditures. The Company’s
expectations concerning such cash flows are based on existing lease terms and
rents, as well as numerous estimates, including (i) rents on assets to be
re-leased, (ii) sale proceeds of certain assets currently under lease, (iii)
the
cost and anticipated timing of maintenance to be performed and (iv) acquisition
of additional aircraft and the lease thereof at favorable lease terms. While
the
Company believes that the assumptions it has made in forecasting its cash flow
are reasonable in light of experience, actual results could deviate from such
assumptions. Among the more significant external factors outside the Company’s
control that could have an impact on the accuracy of cash flow assumptions
are
(i) an increase in interest rates that negatively affects the Company’s
profitability and causes the Company to violate covenants of its credit
facility, requiring repayment of some or all of the amounts outstanding under
its credit facility, (ii) lessee non-performance or non-compliance with lease
obligations (which may affect credit facility collateral limitations as well
as
revenue and expenses) and (iii) an unexpected deterioration of demand for
aircraft equipment.
(i) Operating
activities
The
Company’s cash flow from operations for the year ended December 31, 2006 versus
2005 increased by approximately $1,132,000. The change in cash flow is a result
of changes in several cash flow items during the period, including principally
the following:
Lease
rents, maintenance reserves and security deposits
Payments
received from lessees for rent were approximately $4,057,000 higher in 2006
versus 2005, due primarily to the effect of increased lease revenue from
aircraft purchased beginning in April 2005. Although increased demand generally
in the turboprop market has caused lease rates to stabilize and, in some cases,
rise, it cannot be predicted that rental rates on aircraft to be re-leased
will
not decline, so that, absent additional acquisitions by the Company, aggregate
lease revenues for the current portfolio could decline over the long
term.
Payments
received from lessees for maintenance reserves decreased by approximately
$127,000 in 2006 versus 2005, primarily because the Company received substantial
sums of maintenance reserves for the lessee’s prior use from the sellers of two
aircraft when the Company purchased them in 2005.
Security
deposits received decreased by approximately $295,000 in 2006 versus 2005,
because the rent, on which security deposits are based, for leases initiated
by
the Company during 2006 was lower than in 2005.
Expenditures
for maintenance
Expenditures
for maintenance were approximately $2,620,000 higher in 2006 versus 2005
primarily as a result of higher payments during 2006 for maintenance performed
to prepare several of the Company’s aircraft for remarketing. The effect of
these expenditures was partially offset by lower payments in 2006 by the Company
to lessees for maintenance performed by lessees, which were funded by the payout
of maintenance reserves held by the Company. The amount of expenditures for
maintenance in future periods will be dependent on the amount and timing of
maintenance paid from lessee maintenance reserves held by the Company and the
off-lease status of the Company’s aircraft.
Expenditures
for interest
Expenditures
for interest increased by approximately $1,731,000 in 2006 versus 2005,
primarily as a result of higher average interest rates and a higher average
principal balance in 2006. Interest expenditures in future periods will be
a
product of prevailing interest rates and the outstanding principal balance
on
financings, which may be influenced by future acquisitions and/or required
repayments resulting from changes in the collateral base.
Expenditures
for management fees
Expenditures
for management fees increased by approximately $649,000 in 2006 versus 2005,
as
a result of aircraft purchases since April 2005, the effect of which was
partially offset by sales of aircraft in November 2005 and April
2006.
Expenditures
for acquisition fees
During
2006, the Company paid $314,000 to JMC for the acquisition fee accrued in
December 2005 upon the purchase of four aircraft and which was included in
the
Company’s accounts payable balance at December 31, 2005 and $198,000 in
connection with the acquisition of three aircraft in November 2006.
Expenditures
for professional fees and general and administrative expenses
Expenditures
for professional fees and general and administrative expenses increased by
approximately $274,000 in 2006 versus 2005 primarily as a result of higher
accounting and legal expenditures.
Expenditures
for prepaid expenses
Expenditures
for prepaid expenses were approximately $367,000 lower in 2006 versus 2005,
primarily as a result of purchases in 2005 of equipment which was installed
on
several of the Company’s aircraft in 2006.
Expenditures
for aircraft insurance
Expenditures
for aircraft insurance were approximately $124,000 lower in 2006 than in 2005
primarily as a result of the combination of assets insured during each year
and
the length of time each was insured.
Income
taxes
Income
tax payments were approximately $1,817,000 lower in 2006 compared to 2005
primarily because in early 2005 the Company made a payment of approximately
$1,704,000 for 2004 taxes related to the sale of a portfolio of engines in
December 2004. In addition, the Company had lower taxable income in 2006 than
in
2005.
(ii) Investing
activities
The
$12,867,000 decrease in cash flow used by investing activities in 2006 versus
2005 was primarily due to a decrease in the amount invested in aircraft assets
during 2006, as well as a decrease in the amount received from aircraft sales
in
2006.
(iii) Financing
activities
The
Company borrowed approximately $17,641,000 less in 2006 versus 2005 for aircraft
financing and repaid approximately $8,192,000 less of its outstanding debt
in
2006, including the debt in the special purpose subsidiaries. In 2006, the
Company’s borrowings included $1,650,000 for the refinancing of an aircraft and
repayments included approximately $1,566,000 which was repaid from the
refinancing proceeds.
-
8
-
Outlook
The
Company’s future growth will depend on the availability of additional financing
for acquisitions of leased assets which will need to be leased at higher rental
rates to offset the anticipated stable or decreased lease rates resulting from
future re-leases of the Company’s current portfolio. The
Company is continuing to pursue additional sources of acquisition financing
and
the terms of such financing, especially in an environment of rising interest
rates, will affect the Company’s results.
In
January 2007, the Company and the lessee of the Company's two Saab 340A
aircraft, wihch have leases expiring in May and July 2008, began discussing
the
early return of the aircraft based on the lessee's anticipated financial
difficulties. The Company is seeking re-lease or sale opportunities for
these assets, but there is no assurance when the Company will be successful
in
its efforts. The next scheduled expiration of one of the Company’s aircraft
leases is in April 2007, and the Company expects it will be extended at that
time.
The
Company continually monitors the financial condition of its lessees to avoid
unanticipated creditworthiness issues, and where necessary, works with lessees
to ensure continued compliance with both monetary and non-monetary obligations
under their respective leases. Currently, the Company is closely monitoring
the
performance of two lessees with a total of three aircraft under lease. The
Company continues to work closely with these lessees to ensure compliance with
their current obligations. During
2006, the Company incurred $49,000 of bad debt expense related to amounts owed
by a former lessee at the time the Company and the lessee agreed to the early
termination of the lease. If any of the Company's current lessees are unable
to
meet their lease obligations, the Company's future results could be materially
impacted.
Any
weakening in the aircraft industry may also affect the performance of lessees
that currently appear to the Company to be creditworthy. See "Factors
that May Affect Future Results - General Economic Conditions,"
below.
Due
to
the recent adoption of FASB Staff Position AUG AIR-1, as discussed in Note
1 to
the Financial Statements, the Company must discontinue the accrue-in-advance
method of accounting for planned major maintenance for financial reporting
periods beginning on January 1, 2007. Under the accrue-in-advance method of
accounting, the collection of non-refundable maintenance reserves for planned
major maintenance and disbursements from reserves to lessees to pay for
maintenance performed was reflected only on the Company's balance sheet. The
Company has evaluated the impact of the adoption of this new staff position
and
determined that, going forward, it will use the direct expensing method, under
which actual costs incurred are expensed directly. The new mandated accounting
methods will require the accrual of non-refundable maintenance reserves from
the
Company’s lessees for planned major maintenance to be reflected as income, and
performance of maintenance work in connection with the release of maintenance
reserves to be reflected as an expense when maintenance is actually performed.
Therefore, beginning in the first quarter of 2007, the Company believes that
the
Company's reported net income may be subject to greater fluctuations from
quarter-to-quarter than would have been the case had the Company continued
its
use of the accrue-in-advance method of accounting for planned major maintenance
activities. Furthermore, because this guidance must be applied retroactively,
the Company anticipates that, beginning with its March 31, 2007 financial
reporting requirements, the balance sheet will reflect a catch-up cumulative
adjustment to increase retained earnings as of January 1, 2006, as a result
of
the change to the new accounting method and the comparative 2006 financial
results will be presented on a restated basis.
-
9
-
Factors
that May Affect Future Results
Risks
of Debt Financing.
The
Company’s use of debt as the primary form of acquisition financing subjects the
Company to increased risks of leveraging. With respect to the credit facility,
the loans are secured by the Company’s existing assets as well as the specific
assets acquired with each financing. In addition to payment obligations, the
credit facility also requires the Company to comply with certain financial
covenants, including a requirement of positive annual earnings, interest
coverage and net worth ratios. Any default under the credit facility, if not
waived by the lenders, could result in foreclosure upon not only the asset
acquired using such financing, but also the existing assets of the Company
securing the loan.
Interest
Rate Risk.
The
Company’s current credit facility and the indebtedness of one of its special
purpose subsidiaries carry a floating interest rate based upon either the
lender’s prime rate or a floating LIBOR rate. Lease rates, generally, but not
always, move with interest rates, but market demand for the asset also affects
lease rates. Because lease rates are fixed at the origination of leases,
interest rate increases during the term of a lease have no effect on existing
lease payments. Therefore, if interest rates rise significantly, and there
is
relatively little lease origination by the Company following such rate
increases, the Company could experience lower net earnings. Further, even if
significant lease origination occurs following such rate increases, if the
contemporaneous aircraft market forces result in lower or flat rental rates,
the
Company could experience lower net earnings as well.
Recent
actions by the Federal Reserve Board indicate that its previous moves to
increase the prevailing short term borrowing rates have ceased for the time
being, but there is no assurance that economic circumstances may not cause
the
Board to resume moving short term borrowing rates higher. The Company has not
hedged its variable rate debt obligations and such obligations are based on
short-term interest rate indexes. Consequently, if an interest rate increase
were great enough, the Company might not be able to generate sufficient lease
revenue to meet its interest payment and other obligations and comply with
the
net earnings covenant of its credit facility.
Credit
Facility Obligations.
The
Company is obligated to make repayment of principal under the credit facility
in
order to maintain certain debt ratios with respect to its assets in the
borrowing base. Assets that come off lease and remain off-lease for a period
of
time are removed from the borrowing base. The Company believes it will have
sufficient cash funds to make any payment that arises due to borrowing base
limitations caused by assets scheduled to come off lease in the near term.
The
Company’s belief is based on certain assumptions regarding renewal of existing
leases, a lack of extraordinary interest rate increases, continuing
profitability, no lessee defaults or bankruptcies, and certain other matters
that the Company deems reasonable in light of its experience in the industry.
There can be no assurance that the Company’s assumptions will prove to be
correct. If the assumptions are incorrect (for example, if an asset in the
collateral base unexpectedly goes off lease for an extended period of time)
and
the Company has not obtained an applicable waiver or amendment of applicable
covenants from its lenders to mitigate the situation, the Company may have
to
sell a significant portion of its portfolio in order to maintain compliance
with
covenants or face default on its credit facility.
Concentration
of Lessees and Aircraft Type.
Currently, the Company’s six largest customers are located in Belgium, Taiwan,
the Caribbean, Norway, the United States and Sweden, and currently account
for
approximately 14%, 12%, 12%, 11%, 11% and 10%, respectively, of the Company’s
monthly lease revenue. A lease default by or collection problems with one of
these customers could have a disproportionate negative impact on the Company’s
financial results, and therefore, the Company’s operating results are especially
sensitive to any negative developments with respect to these customers in terms
of lease compliance or collection. Such concentration of lessee credit risk
will
diminish in the future only if the Company is able to lease additional assets
to
new lessees.
The
Company owns fourteen Fokker 50, eight DHC-8-300, three DHC-8-100 and six Saab
340B aircraft, making these four aircraft types the dominant types in the
portfolio and representing 36%, 37%, 10% and 11%, respectively, based on net
book value. As a result, a change in the desirability and availability of any
of
these types of aircraft, which would in turn affect valuations of such aircraft,
would have a disproportionately large impact on the Company’s portfolio value.
Such aircraft type concentration will diminish if the Company acquires
additional assets of other types. Conversely, acquisition of these types of
aircraft will increase the Company’s risks related to its concentration of those
aircraft types.
Increased
Compliance Costs.
Current
Sarbanes-Oxley Act requirements applicable to the Company effective for the
year
ended December 31, 2007 relating to internal controls could result in
significantly higher fees and expenses in connection with auditor services
beginning in 2007. The increase will generally arise from increased auditor
responsibilities, including broadening of the scope of the auditor's examination
to include the Company's internal controls. If the regulations remain unchanged,
the Company anticipates that it will have sufficient funds to pay for the
increased compliance costs.
Lessee
Credit Risk. If
a
customer defaults upon its lease obligations, the Company may be limited in
its
ability to enforce remedies. Most of the Company’s lessees are small regional
passenger airlines, which may be even more sensitive to airline industry market
conditions than the major airlines. As a result, the Company’s inability to
collect rent under a lease or to repossess equipment in the event of a default
by a lessee could have a material adverse effect on the Company’s revenue. If a
lessee that is a certified U.S. airline is in default under the lease and seeks
protection under Chapter 11 of the United States Bankruptcy Code, Section 1110
of the Bankruptcy Code would automatically prevent the Company from exercising
any remedies for a period of 60 days. After the 60-day period has passed, the
lessee must agree to perform the obligations and cure any defaults, or the
Company will have the right to repossess the equipment. This procedure under
the
Bankruptcy Code has been subject to significant recent litigation, however,
and
it is possible that the Company’s enforcement rights may be further adversely
affected by a declaration of bankruptcy by a defaulting lessee. Most of the
Company’s lessees are foreign and not subject to U.S. bankruptcy laws but there
may be similar applicable foreign bankruptcy debtor protection schemes available
to foreign carriers.
Leasing
Risks.
The
Company’s successful negotiation of lease extensions, re-leases and sales may be
critical to its ability to achieve its financial objectives, and involves a
number of risks. Demand for lease or purchase of the assets depends on the
economic condition of the airline industry which is, in turn, sensitive to
general economic conditions. The ability to remarket equipment at acceptable
rates may depend on the demand and market values at the time of remarketing.
The
Company anticipates that the bulk of the equipment it acquires will be used
aircraft equipment. The market for used aircraft is cyclical, and generally
reflects economic conditions and the strength of the travel and transportation
industry. The demand for and value of many types of used aircraft in the recent
past has been depressed by such factors as airline financial difficulties,
increased fuel costs, the number of new aircraft on order and the number of
aircraft coming off-lease. Values may also increase for certain aircraft types
that become desirable based on market conditions and changing airline capacity.
If the Company were to purchase an aircraft during a period of increasing
values, it would need a corresponding higher lease rate.
The
Company’s current concentration in a limited number of turboprop airframe and
aircraft engine types subjects the Company to economic risks if an airframe
or
engine type owned by the Company should significantly decline in value relative
to the assets’ purchase price. If “regional jets” were to be used on short
routes previously served by turboprops, even though regional jets are more
expensive to operate than turboprops on those routes, the demand for turboprops
could lessen. This could result in lower lease rates and values for the
Company’s existing turboprop aircraft.
-
10
-
Risks
Related to Regional Air Carriers. Because
the Company has concentrated its existing leases, and intends to continue to
concentrate future leases, on regional air carriers, it is subject to additional
risks. Some of the lessees in the regional air carrier market are companies
that
are start-up, low capital, low margin operations. Often, the success of such
carriers is dependent upon contractual arrangements with major trunk carriers
or
franchises from governmental agencies that provide subsidies for operating
essential air routes, both of which may be subject to termination or
cancellation with short notice periods,. Because of this exposure, the Company
typically is able to obtain generally higher lease rates from these types of
lessees. In the event of a business failure of the lessee or its bankruptcy,
the
Company can generally regain possession of its aircraft, but the aircraft could
be in substantially worse condition than would be the case if the aircraft
were
returned in accordance with the provisions of the lease at lease expiration.
The
Company evaluates the credit risk of each lessee carefully, and attempts to
obtain a third party guaranty, letters of credit or other credit enhancements,
if it deems them necessary. There is no assurance, however, that such
enhancements will be available or that, if obtained, they will fully protect
the
Company from losses resulting from a lessee default or bankruptcy. Also, a
significant area of market growth is outside of the United States, where
collection and enforcement are often more difficult and complicated than in
the
United States. During
2006 and 2005, the Company incurred bad debt expense related to amounts owed
by
three former lessees. This expense materially affected the Company's financial
performance. If any of the Company's current lessees are unable to meet their
lease obligations, the Company's future results could be materially
impacted.
Reliance
on JMC. All
management of the Company is performed by JMC under a management agreement
which
is in the ninth year of a 20-year term and provides for an asset-based
management fee. JMC is not a fiduciary to the Company or its stockholders.
The
Company’s Board of Directors has ultimate control and supervisory responsibility
over all aspects of the Company and owes fiduciary duties to the Company and
its
stockholders. The
Board
has no control over the internal operations of JMC, but the Board does have
the
ability and responsibility to manage the Company's relationship with JMC and
the
performance of JMC's obligations to the Company under the management agreement,
as it would have for any third party service provider to the Company.
While
JMC
may not owe any fiduciary duties to the Company by virtue of the management
agreement, the officers of JMC are also officers of the Company, and in that
capacity owe fiduciary duties to the Company and its stockholders. In addition,
certain officers of the Company hold significant ownership positions in the
Company and JHC, the parent company of JMC.
The
JMC
management agreement may be terminated if JMC defaults on its obligations to
the
Company. However, the agreement provides for liquidated damages in the event
of
its wrongful termination by the Company. All of the officers of JMC are also
officers of the Company, and certain directors of the Company are also directors
of JMC. Consequently, the directors and officers of JMC may have a conflict
of
interest in the event of a dispute between the Company and JMC. Although the
Company has taken steps to prevent conflicts of interest arising from such
dual
roles, such conflicts may still occur.
JMC
has
acted as the management company for two other aircraft portfolio owners,
JetFleet III, which raised approximately $13,000,000 from investors, and
AeroCentury IV, Inc. (“AeroCentury IV”), which raised approximately $5,000,000
from investors. In the first quarter of 2002, AeroCentury IV defaulted on
certain obligations to noteholders. In June 2002, the indenture trustee for
AeroCentury IV’s noteholders repossessed AeroCentury IV’s assets and took over
management of AeroCentury IV’s remaining assets. JetFleet III defaulted on its
bond obligation of $11,076,350 in May 2004. The indenture trustee for JetFleet
III bondholders repossessed JetFleet III’s unsold assets in late May
2004.
Ownership
Risks. The
Company’s portfolio is leased under operating leases, where the terms of the
leases are less than the entire anticipated useful life of an asset. The
Company’s ability to recover its purchase investment in an asset subject to an
operating lease is dependent upon the Company’s ability to profitably re-lease
or sell the asset after the expiration of the initial lease term. Some of the
factors that have an impact on the Company’s ability to re-lease or sell include
worldwide economic conditions, general aircraft market conditions, regulatory
changes that may make an asset’s use more expensive or preclude use unless the
asset is modified, changes in the supply or cost of aircraft equipment and
technological developments which cause the asset to become obsolete. In
addition, a successful investment in an asset subject to an operating lease
depends in part upon having the asset returned by the lessee in the condition
as
required under the lease. If the Company is unable to remarket its aircraft
equipment on favorable terms when the operating leases for such equipment
expire, the Company’s business, financial condition, cash flow, ability to
service debt and results of operations could be adversely affected.
Furthermore,
an asset impairment charge against the Company’s earnings may result from the
occurrence of unexpected adverse changes that impact the Company’s estimates of
expected cash flows generated from such asset. The Company periodically reviews
long-term assets for impairments, in particular, when events or changes in
circumstances indicate the carrying value of an asset may not be recoverable.
An
impairment loss is recognized when the carrying amount of an asset is not
recoverable and exceeds its fair value. The Company may be required to recognize
asset impairment charges in the future as a result of a prolonged weak economic
environment, challenging market conditions in the airline industry or events
related to particular lessees, assets or asset types.
-
11
-
International
Risks.
The
Company has focused on leases in overseas markets, which the Company believes
present opportunities. Leases with foreign lessees, however, may present
somewhat different risks than those with domestic lessees.
Foreign
laws, regulations and judicial procedures may be more or less protective of
lessor rights than those which apply in the United States. The Company could
experience collection or repossession problems related to the enforcement of
its
lease agreements under foreign local laws and the remedies in foreign
jurisdictions. The protections potentially offered by Section 1110 of the
Bankruptcy Code do not apply to non-U.S. carriers, and applicable local law
may
not offer similar protections. Certain countries do not have a central
registration or recording system with which to locally establish the Company’s
interest in equipment and related leases. This could make it more difficult
for
the Company to recover an aircraft in the event of a default by a foreign
lessee.
A
lease
with a foreign lessee is subject to risks related to the economy of the country
or region in which such lessee is located, which may be weaker than the U.S.
economy. On the other hand, a foreign economy may remain strong even though
the
U.S. economy does not. A foreign economic downturn may impact a foreign lessee’s
ability to make lease payments, even though the U.S. and other economies remain
stable. Furthermore, foreign lessees are subject to risks related to currency
conversion fluctuations. Although the Company’s current leases are all payable
in U.S. dollars, the Company may agree in the future to leases that permit
payment in foreign currency, which would subject such lease revenue to monetary
risk due to currency fluctuations. Even with U.S. dollar-denominated lease
payment provisions, the Company could still be affected by a devaluation of
the
lessee’s local currency that would make it more difficult for a lessee to meet
its U.S. dollar-denominated lease payments, increasing the risk of default
of
that lessee, particularly if its revenue is primarily derived in the local
currency.
Government
Regulation.
There
are a number of areas in which government regulation may result in costs to
the
Company. These include aircraft registration, safety requirements, required
equipment modifications, and aircraft noise requirements. Although it is
contemplated that the burden and cost of complying with such requirements will
fall primarily upon lessees of equipment, there can be no assurance that the
cost will not fall on the Company. Furthermore, future government regulations
could cause the value of any non-complying equipment owned by the Company to
decline substantially.
Competition.
The
aircraft leasing industry is highly competitive. The Company competes with
aircraft manufacturers, distributors, airlines and other operators, equipment
managers, leasing companies, equipment leasing programs, financial institutions
and other parties engaged in leasing, managing or remarketing aircraft, many
of
which have significantly greater financial resources. However, the Company
believes that it is competitive because of JMC’s experience and operational
efficiency in identifying and obtaining financing for the transaction types
desired by regional air carriers. This market segment, which is characterized
by
transaction sizes of less than $10 million and lessee credits that may be
strong, but are generally unrated, is not well served by the Company’s larger
competitors. JMC has developed a reputation as a global participant in this
segment of the market, and the Company believes that JMC’s reputation benefits
the Company. There is, however, no assurance that the lack of significant
competition from larger aircraft leasing companies will continue or that the
reputation of JMC will continue to be strong in this market segment.
Casualties,
Insurance Coverage.
The
Company, as owner of transportation equipment, may be named in a suit claiming
damages for injuries or damage to property caused by its assets. As a triple
net
lessor, the Company is generally protected against such claims, since the lessee
would be responsible for, insure against and indemnify the Company for such
claims. Further, some protection may be provided by the United States Aviation
Act with respect to the Company’s aircraft assets. It is, however, not clear to
what extent such statutory protection would be available to the Company, and
the
United States Aviation Act may not apply to aircraft operated in foreign
countries. Also, although the Company’s leases generally require a lessee to
insure against likely risks, there may be certain cases where the loss is not
entirely covered by the lessee or its insurance. Though this is a remote
possibility, an uninsured loss with respect to the equipment, or an insured
loss
for which insurance proceeds are inadequate, would result in a possible loss
of
invested capital in and any profits anticipated from, such equipment, as well
as
a potential claim directly against the Company.
General
Economic Conditions. The
Company’s business is dependent upon general economic conditions and the
strength of the travel and transportation industry. The industry has experienced
a severe cyclical downturn which began in 2001. There are signs that the
industry is beginning to recover from the downturn, but it is unclear whether
any recovery will be a sustained one. Any recovery could be stalled or reversed
by any number of events or circumstances, including the global economy slipping
back into recession, or specific events related to the air travel industry,
such
as terrorist attacks, or an increase in operational or labor costs. Recent
spikes in oil prices, if they persist, may have a negative effect on airline
profits and increase the likelihood of weakening results for airlines that
have
not hedged aircraft fuel costs, and in the most extreme cases, may initiate
or
accelerate the failure of many already marginally profitable
carriers.
Since
regional carriers are generally not as well-capitalized as major air carriers,
any economic setback in the industry may result in the increased possibility
of
an economic failure of one or more of the Company’s lessees, particularly since
many carriers are undertaking expansion of capacity to accommodate the
recovering air passenger traffic. If lessees experience financial difficulties,
this could, in turn, affect the Company’s financial performance.
During
any periods of economic contraction, carriers generally reduce capacity, in
response to lower passenger loads, and as a result, there is a reduced demand
for aircraft and a corresponding decrease in market lease rental rates and
aircraft values. This reduced market value for aircraft could affect the
Company’s results if the market value of an asset or assets in the Company’s
aircraft portfolio falls below carrying value, and the Company determines that
a
write-down of the value on the Company’s balance sheet is appropriate.
Furthermore, as older leases expire and are replaced by lease renewals or
re-leases at decreasing lease rates, the lease revenue of the Company from
its
existing portfolio is likely to decline, with the magnitude of the decline
dependent on the length of the downturn and the depth of the decline in market
rents.
Economic
downturns can affect specific regions of the world exclusively. As the Company’s
portfolio is not entirely globally diversified, a localized downturn in one
of
the key regions in which the Company leases aircraft (e.g., Europe or Asia)
could have a significant adverse impact on the Company.
Possible
Volatility of Stock Price.
The
market price of the Company’s common stock could be subject to fluctuations in
response to the Company’s operating results, changes in general conditions in
the economy, the financial markets, the airline industry, changes in accounting
principles or tax laws applicable to the Company or its lessees, or other
developments affecting the Company, its customers or its competitors, some
of
which may be unrelated to the Company’s performance. Also, because the Company
has a relatively small capitalization of approximately 1.5 million shares,
there
is a correspondingly limited amount of trading of the Company’s shares.
Consequently, a single or small number of trades could result in a market
fluctuation not related to any business or financial development concerning
the
Company.
-
12
-
Item
7. Financial
Statements.
(a) Financial
Statements and Schedules
(1) Financial
statements for the Company:
Report
of
Independent Registered Accounting Firm,
BDO
Seidman, LLP
Report
of
Independent Registered Accounting Firm,
PricewaterhouseCoopers
LLP
Consolidated
Balance Sheet as of December 31, 2006
Consolidated
Statements of Operation for the Years Ended December 31, 2006 and
2005
Consolidated
Statements of Stockholders’ Equity for the Years Ended December
31, 2006 and 2005
Consolidated
Statements of Cash Flows for the Years Ended December
31, 2006 and 2005
Notes
to
Consolidated Financial Statements
(2) Schedules:
|
All
schedules have been omitted since the required information is presented
in
the financial statements or is not
applicable.
|
-
13
-
Report
of Independent Registered Public Accounting Firm
Board
of
Directors and Stockholders
AeroCentury
Corp.
Burlingame,
California
We
have
audited the accompanying consolidated balance sheet of AeroCentury Corp. and
subsidiaries as of December 31, 2006 and the related consolidated statements
of
operations, stockholders’ equity, and cash flows for the year then ended.
These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose
of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit
also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of AeroCentury Corp. and
subsidiaries at December 31, 2006, and the results of its operations and its
cash flows for the year then ended,
in
conformity with accounting principles generally accepted in the United States
of
America.
As
discussed in Note 1 to the consolidated financial statements, the Company
adopted the provisions of Staff Accounting Bulletin No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements, as
of
January 1, 2006.
/s/
BDO
Seidman, LLP
BDO
Seidman, LLP
March
12,
2007
San
Francisco, California
-
14
-
Report
of Independent Registered Accounting Firm
To
the
Stockholders of AeroCentury Corp.:
In
our
opinion, the accompanying consolidated statements of operations, stockholders’
equity and cash flows present fairly, in all material respects, the results
of
operations and cash flows of AeroCentury Corp. for the year ended December
31,
2005 in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with auditing standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our
opinion.
/s/
PricewaterhouseCoopers LLP
PricewaterhouseCoopers
LLP
San
Francisco, California
March
7,
2006
-
15
-
AeroCentury
Corp.
Consolidated
Balance Sheet
|
ASSETS
|
||||
|
December
31, 2006
|
||||
|
Assets:
|
||||
|
Cash
and cash equivalents
|
$
|
3,383,880
|
||
|
Accounts
receivable
|
864,410
|
|||
|
Aircraft
and aircraft engines held for lease,
net
of accumulated depreciation of $22,004,790
|
93,674,970
|
|||
|
Prepaid
expenses and other
|
581,820
|
|||
|
Total
assets
|
$
|
98,505,080
|
||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||
|
Liabilities:
|
||||
|
Accounts
payable and accrued expenses
|
$
|
351,190
|
||
|
Notes
payable and accrued interest
|
57,907,120
|
|||
|
Maintenance
reserves and accrued costs
|
14,110,530
|
|||
|
Security
deposits
|
4,187,470
|
|||
|
Prepaid
rent
|
473,620
|
|||
|
Deferred
taxes
|
1,127,180
|
|||
|
Total
liabilities
|
78,157,110
|
|||
|
Stockholders’
equity:
|
||||
|
Preferred
stock, $0.001 par value, 2,000,000 shares
authorized,
no shares issued and outstanding
|
-
|
|||
|
Common
stock, $0.001 par value, 3,000,000 shares
authorized,
1,606,557 shares issued and outstanding
|
1,610
|
|||
|
Paid
in capital
|
13,821,200
|
|||
|
Retained
earnings
|
7,029,230
|
|||
|
20,852,040
|
||||
|
Treasury
stock at cost, 63,300 shares
|
(504,070
|
)
|
||
|
Total
stockholders’ equity
|
20,347,970
|
|||
|
$
|
98,505,080
|
|||
The
accompanying notes are an integral part of these statements.
-
16
-
AeroCentury
Corp.
Consolidated
Statements of Operations
|
For
the Years Ended
December
31,
|
|||||||
|
2006
|
|
|
2005
|
||||
|
Revenues
and other income:
|
|||||||
|
Operating
lease revenue
|
$
|
15,508,840
|
$
|
11,386,950
|
|||
|
Gain/(loss)
on sale of aircraft
|
408,840
|
(48,130
|
)
|
||||
|
Other
income
|
2,404,310
|
2,160,500
|
|||||
|
18,321,990
|
13,499,320
|
||||||
|
Expenses:
|
|||||||
|
Depreciation
|
4,979,530
|
4,030,950
|
|||||
|
Interest
|
4,954,300
|
3,484,970
|
|||||
|
Management
fees
|
2,750,010
|
2,339,750
|
|||||
|
Maintenance
|
3,503,840
|
2,298,750
|
|||||
|
Professional
fees and general and administrative
|
589,410
|
497,570
|
|||||
|
Insurance
|
206,400
|
328,600
|
|||||
|
Bad
debt expense
|
48,820
|
167,520
|
|||||
|
Provision
for impairment in value of aircraft
|
-
|
12,180
|
|||||
|
17,032,310
|
13,160,290
|
||||||
|
Income
before tax provision
|
1,289,680
|
339,030
|
|||||
|
Tax
provision
|
472,370
|
146,120
|
|||||
|
Net
income
|
$
|
817,310
|
$
|
192,910
|
|||
|
Weighted
average common shares outstanding
|
1,543,257
|
1,543,257
|
|||||
|
Basic
and diluted earnings per share
|
$
|
0.53
|
$
|
0.13
|
|||
The
accompanying notes are an integral part of these statements.
-
17
-
AeroCentury
Corp.
Consolidated
Statements of Stockholders’ Equity
For
the
Years Ended December 31, 2006 and 2005
|
Common
Stock
|
Paid-in
Capital
|
Retained
Earnings
|
Treasury
Stock
|
Total
|
||||||||||||
|
|
||||||||||||||||
|
Balance,
December 31,2004
|
$
|
1,610
|
$
|
13,821,200
|
$
|
5,478,440
|
$
|
(504,070
|
)
|
$
|
18,797,180
|
|||||
|
Net
income
|
-
|
-
|
192,910
|
-
|
192,910
|
|||||||||||
|
Balance,
December 31, 2005
|
1,610
|
13,821,200
|
5,671,350
|
(504,070
|
)
|
18,990,090
|
||||||||||
|
Cumulative
effect of adoption of
SAB
108, net of taxes
|
-
|
-
|
540,570
|
-
|
540,570
|
|||||||||||
|
Net
income
|
-
|
-
|
817,310
|
-
|
817,310
|
|||||||||||
|
Balance,
December 31, 2006
|
$
|
1,610
|
$
|
13,821,200
|
$
|
7,029,230
|
$
|
(504,070
|
)
|
$
|
20,347,970
|
The
accompanying notes are an integral part of these statements.
-
18
-
AeroCentury
Corp.
Consolidated
Statements of Cash Flows
|
|
|
For
the Years Ended
December
31,
|
|||||
|
2006
|
|
|
2005
|
|
|||
|
Operating
activities:
|
|||||||
|
Net
income
|
$
|
817,310
|
$
|
192,910
|
|||
|
Adjustments
to reconcile net income to net cash
provided
by operating activities:
|
|||||||
|
|
|||||||
|
(Gain)/loss
on sale of aircraft
|
(408,840
|
)
|
48,130
|
||||
|
Depreciation
|
4,979,530
|
4,030,950
|
|||||
|
Provision
for impairment in value of aircraft
|
-
|
12,180
|
|||||
|
Provision
for bad debts
|
48,820
|
167,520
|
|||||
|
Deferred
taxes
|
461,220
|
(40,270
|
)
|
||||
|
Reversal
of allowance on note receivable
|
-
|
(3,610
|
)
|
||||
|
Change
in operating assets and liabilities:
|
|||||||
|
Accounts
receivable
|
227,230
|
(252,440
|
)
|
||||
|
Prepaid
expenses and other
|
454,440
|
(626,390
|
)
|
||||
|
Accounts
payable and accrued expenses
|
(823,600
|
)
|
511,980
|
||||
|
Accrued
interest on notes payable
|
(224,270
|
)
|
104,420
|
||||
|
Maintenance
reserves and accrued costs
|
1,512,310
|
3,075,210
|
|||||
|
Security
deposits
|
1,062,560
|
1,349,620
|
|||||
|
Prepaid
rent
|
26,560
|
42,130
|
|||||
|
Unearned
income
|
-
|
(2,590
|
)
|
||||
|
Taxes
payable
|
(47,800
|
)
|
(1,655,910
|
)
|
|||
|
Net
cash provided by operating activities
|
8,085,470
|
6,953,840
|
|||||
|
Investing
activities:
|
|||||||
|
Payments
received on note receivable
|
-
|
210,080
|
|||||
|
Proceeds
from sales of aircraft, net of re-sale fees
|
1,056,000
|
9,034,650
|
|||||
|
Purchases
of aircraft
|
(6,170,880
|
)
|
(27,226,270
|
)
|
|||
|
Net
cash used by investing activities
|
(5,114,880
|
)
|
(17,981,540
|
)
|
|||
|
Financing
activities:
|
|||||||
|
Issuance
of notes payable
|
5,550,000
|
23,191,000
|
|||||
|
Repayment
of notes payable
|
(5,755,620
|
)
|
(13,948,020
|
)
|
|||
|
Net
cash (used)/provided by financing activities
|
(205,620
|
)
|
9,242,980
|
||||
|
Net
increase/(decrease) in cash and cash equivalents
|
2,764,970
|
(1,784,720
|
)
|
||||
|
Cash
and cash equivalents, beginning of year
|
618,910
|
2,403,630
|
|||||
|
Cash
and cash equivalents, end of year
|
$
|
3,383,880
|
$
|
618,910
|
|||
During
the years ended December 31, 2006 and 2005, the Company paid interest totaling
$5,170,660 and $3,423,910, respectively, and income taxes totaling $48,800
and
$1,865,380, respectively.
The
accompanying notes are an integral part of these statements.
-
19
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
1. Organization
and Summary of Significant Accounting Policies
(a)
Basis
of Presentation
AeroCentury
Corp., a Delaware corporation, uses leveraged financing to acquire leased
aircraft assets. The Company (as defined below) purchases used regional aircraft
on lease to foreign and domestic regional carriers. Financial information for
AeroCentury Corp. and its wholly-owned subsidiaries, AeroCentury Investments
V
LLC (“AeroCentury V LLC”) and AeroCentury Investments VI LLC (“AeroCentury VI
LLC”) (collectively, the “Company”), is presented on a consolidated basis. All
intercompany balances and transactions have been eliminated in consolidation.
(b) Cash
and Cash Equivalents/Deposits
The
Company considers highly liquid investments readily convertible into known
amounts of cash, with original maturities of 90 days or less from the date
of
acquisition, as cash equivalents.
(c) Aircraft
and Aircraft Engine Held For Lease and Held for Sale
The
Company’s interests in aircraft and aircraft engines are recorded at cost, which
includes acquisition costs. The Company purchases only used aircraft. It is
the
Company’s policy to hold aircraft for approximately twelve years unless market
conditions necessitate earlier disposition. Depreciation is computed using
the
straight-line method over the twelve year period to an estimated residual value
based on appraisal.
Decreases in the market value of aircraft could not only affect the current
value, but could also affect the assumed residual value. The Company
periodically obtains a residual value appraisal for its assets and,
historically, has not written down any estimated residuals. The Company’s
aircraft which are held for sale are not subject to depreciation.
(d) Impairment
of Long-lived Assets
The
Company periodically reviews its portfolio of assets for impairment in
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
“Accounting for the Impairment or Disposal of Long-lived Assets." Such
review necessitates estimates of current market values, re-lease rents and
residual values. The estimates are based on currently available market
data and are subject to fluctuation from time to time.
The Company initiates its review periodically, whenever events or changes in
circumstances indicate that the carrying amount of a long-lived asset may not
be
recoverable. Recoverability of an asset is measured by comparison of its
carrying amount to the expected future undiscounted cash flows (without interest
charges) that the asset is expected to generate. Any impairment to be
recognized is measured by the amount by which the carrying amount of the asset
exceeds its fair market value. Significant management judgment is required
in the forecasting of future operating results which are used in the preparation
of projected undiscounted cash flows and, should different conditions prevail,
material write downs may occur.
-
20
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
1. Organization
and Summary of Significant Accounting Policies (continued)
(e) Loan
Commitment and Related Fees
To
the
extent that the Company is required to pay loan commitment fees and legal fees
in order to secure debt, such fees are amortized over the life of the related
loan.
(f) Maintenance
Reserves and Accrued Costs
Maintenance
costs under the Company’s triple net leases are generally the responsibility of
the lessees. The accompanying consolidated balance sheet reflects liabilities
for maintenance reserves and accrued costs, which include refundable and
non-refundable maintenance payments received from lessees based on usage. At
December 31, 2006, the Company’s maintenance reserves and accruals consisted of
the following:
|
Refundable
maintenance reserves
|
$
|
2,820,760
|
||
|
Non-refundable
maintenance reserves
|
7,443,080
|
|||
|
Accrued
costs
|
3,846,690
|
|||
|
$
|
14,110,530
|
Maintenance
reserves received by the Company are accounted for as a liability, which is
reduced when maintenance work is performed during the lease. Maintenance
reserves which are refundable to the lessee are refunded after all return
conditions specified in the lease and, in some cases, any other payments due
under the lease, are satisfied. Any refundable reserves retained by the Company
to satisfy return conditions are reclassified to the Company’s own maintenance
payable account at lease end. Maintenance reserves which are non-refundable
to
the lessee are recorded as income at lease end, which is reported in other
income. If an aircraft is returned early, any collected reserves are
reclassified to the Company’s own maintenance payable account.
The
Company periodically reviews its maintenance reserves and maintenance accruals
for adequacy in light of the number of hours flown, airworthiness directives
issued by the manufacturer or government authority, and the return conditions
specified in the lease, as well as the condition of the aircraft upon return
or
inspection. As a result of such review, when it is probable that the Company
has
incurred costs for maintenance in excess of amounts accrued, the Company records
an expense for the additional work to be performed. Such costs include
maintenance such as engine and propeller overhauls, structural inspections
and
work to comply with airworthiness directives.
When
an
aircraft is sold, any remaining accrual is reversed and included in the
Company’s gain or loss on sale calculation. During the years ended December 31,
2006 and 2005, $378,770 and $636,540,
respectively, of excess accruals were so included.
-
21
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
1. Organization
and Summary of Significant Accounting Policies (continued)
(f) Maintenance
Reserves and Accrued Costs (continued)
Additions
to and deductions from the Company’s accruals during the year ended December 31,
2006 and 2005 for maintenance work were as follows:
|
For
the Years Ended
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
Additions:
|
|||||||
|
Charged
to expense
|
$
|
3,175,330
|
$
|
2,303,800
|
|||
|
Charged
to other -
|
|||||||
|
Reclassification
of reserves collected from lessees
to
the Company’s own liability account
|
359,450
|
100,880
|
|||||
|
3,534,780
|
2,404,680
|
||||||
|
Deductions:
|
|||||||
|
Paid
for previously accrued maintenance
|
2,606,640
|
680,470
|
|||||
|
Reversals
of over-accrued maintenance
|
53,110
|
33,760
|
|||||
|
Included
in gain/(loss) on sale of aircraft and aircraft engines
|
378,770
|
636,540
|
|||||
|
3,038,520
|
1,350,770
|
||||||
|
Net
increase in accrued maintenance costs
in
excess of amounts received under the leases
|
496,260
|
1,053,910
|
|||||
|
Balance,
beginning of year
|
3,350,430
|
2,296,520
|
|||||
|
Balance,
end of year
|
$
|
3,846,690
|
$
|
3,350,430
|
|||
(g) Security
deposits
The
Company’s leases are typically structured so that if any event of default occurs
under a lease, the Company may apply all or a portion of the lessee’s security
deposit to cure such default. If such application of the security deposit is
made, the lessee typically is required to replenish and maintain the full amount
of the deposit during the remaining term of the lease. All of the security
deposits received by the Company are refundable to the lessee at the end of
the
lease, upon satisfaction of all lease terms.
(h) Income
Taxes
As
part
of the process of preparing the Company’s consolidated financial statements,
management is required to estimate 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 accounting
purposes. These differences result in deferred tax assets and liabilities,
which
are included in the consolidated balance sheet. Management must also assess
the
likelihood that the Company’s deferred tax assets will be recovered from future
taxable income, and, to the extent management believes it is more likely than
not that some portion or all of the deferred tax assets will not be realized,
the Company must establish a valuation allowance. To the extent the Company
establishes a valuation allowance
-
22
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
1. Organization
and Summary of Significant Accounting Policies (continued)
(h) Income
Taxes (continued)
or
changes the allowance in a period, the Company reflects the corresponding
increase or decrease within the tax provision in the consolidated statement
of
operations.
(i) Revenue
Recognition and Allowance for Doubtful Accounts
Revenue
from leasing of aircraft assets is recognized as operating lease revenue on
a
straight-line basis over the terms of the applicable lease agreements. The
Company estimates and charges to income a provision for bad debts based on
its
experience in the business and with each specific customer, the level of past
due accounts, and its analysis of the lessees’ overall financial condition. If
the financial condition of the Company’s customers deteriorates, it could result
in actual losses exceeding any estimated allowances.
(j) Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 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 financial statements are the residual
values of the aircraft, the useful lives of the aircraft, the amount and timing
of cash flow associated with each aircraft that are used to evaluate impairment,
if any, accrued maintenance costs in excess of amounts received from lessees,
the amounts recorded as bad debt allowances and accounting for income
taxes.
(k) Comprehensive
Income
The
Company does not have any comprehensive income other than the revenue and
expense items included in the consolidated statements of operations. As a
result, comprehensive income equals net income for the years ended December
31,
2006 and 2005.
(l) Reclassifications
Certain
of the prior period financial statement amounts have been reclassified to
conform to the current year presentation. These reclassifications had no impact
on previously reported net income or cash flows.
-
23
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
1. Organization
and Summary of Significant Accounting Policies
(continued)
(m) Recent
Accounting Pronouncements
SFAS
153,
Exchanges
of Nonmonetary Assets,
addresses the measurement of exchanges of nonmonetary assets. It eliminates
the
exception from fair value measurement for nonmonetary exchanges of similar
productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting
for Nonmonetary Transactions,
and
replaces it with an exception for exchanges that do not have commercial
substance. SFAS 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The provisions of SFAS 153 are
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. The adoption of SFAS 153 had no effect on the Company’s
consolidated financial condition or results of operations.
In
March
2005,
the
FASB issued
interpretation No. 47, Accounting
for Conditional Asset Retirement Obligations ("FIN
47"). FIN 47 clarifies
that the term conditional
asset retirement obligation as
used
in SFAS 143, Accounting
for Asset Retirement Obligations,
refers
to a legal obligation to perform an asset retirement activity in which the
timing and (or) method of settlement are conditional on a future event that
may
or may not be within the control of the entity. FIN 47 is applicable to fiscal
years ending after December 15, 2005. The
adoption of FIN 47 had no material effect on the Company’s consolidated
financial condition or results of operations.
SFAS
123(R), Share-based
Payment,
requires compensation cost relating to share-based payment transactions be
recognized in financial statements. SFAS 123(R) is effective for small business
issuers as of the beginning of the first interim or annual reporting period
that
began after December 15, 2005, supercedes APB Opinion No. 25, Accounting
for Stock Issued to Employees,
and
replaces SFAS No. 123, Accounting
for Stock-based Compensation.
The
pro-forma disclosure previously permitted under SFAS No. 123 is no longer an
acceptable alternative to recognition of expenses in the financial statements.
The adoption of SFAS 123(R) had no effect on the Company’s consolidated
financial condition or results of operations.
In
July
2006, the FASB issued Interpretation No. 48, Accounting
for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109
(“FIN
48”). FIN 48 is effective for fiscal years beginning after December 15, 2006.
FIN 48 prescribes a comprehensive model for how a company should recognize,
measure, present, and disclose in its financial statements uncertain tax
positions that a company has taken or expects to take on a tax return (including
a decision whether to file or not to file a return in a particular
jurisdiction). Under the Interpretation, the financial statements will reflect
expected future tax consequences of such positions presuming the taxing
authorities' full knowledge of the position and all relevant facts, but without
considering time values. The Company is required to implement FIN 48 in the
year
beginning January 1, 2007. The Company will adopt Interpretation No. 48 on
January 1, 2007 and is currently assessing the potential impact on its financial
statements.
FASB
Staff Position AUG AIR-1, Accounting
for Planned Major Maintenance Activities (“FSP
AUG
AIR-1”), was posted in September 2006 and prohibits the use of the
accrue-in-advance method of accounting for planned major maintenance activities
in annual and interim financial reporting periods. FSP AUG AIR-1 must be applied
to the first fiscal year beginning after December 15, 2006. FSP AUG AIR-1 allows
major maintenance activities to be accounted for in one of three ways: (i)
the
built-in overhaul method, (ii) the deferral method or (iii) the direct expensing
method. The Company has evaluated the impact of the adoption of this new staff
position and determined that, going forward, it will use the direct expensing
method, under which actual costs incurred are expensed directly. The new
mandated accounting methods will require the accrual of non-refundable
maintenance reserves from the Company’s lessees for planned major maintenance to
be reflected as income on the income statements, and performance of maintenance
work in connection with the release of maintenance reserves to be reflected
as
an expense when maintenance is actually performed. Because the total amount
of
maintenance reserves accrued in any given period usually exceeds the amount
of
maintenance expense, it is likely that the Company’s net income under the new
accounting method will be higher than it would have been under the previous
method. In addition, because the net effect of income from maintenance reserves
and maintenance expense in any given period will vary, it is likely that the
new
accounting method will result in uneven effects on the Company’s results of
operations. The following financial statement line items as of December 31,
2006
would have been affected by the change in accounting method if it had been
applied to the year ended December 31, 2006.
|
As
reported
herein
|
As
reported
under
FSP
AUG
AIR-1
|
Increase/
(decrease)
effect
of
change
|
||||||||
|
Total
assets
|
$
|
98,505,080
|
$
|
96,739,380
|
$
|
(1,765,700
|
)
|
|||
|
Total
liabilities
|
$
|
78,157,110
|
$
|
70,248,800
|
$
|
(7,908,310
|
)
|
|||
|
Retained
earnings
|
$
|
7,029,230
|
$
|
13,171,840
|
$
|
6,142,610
|
In
September
2006, the SEC staff issued Staff Accounting Bulletin No. 108 (SAB Topic 1N),
“Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements” (“SAB 108”), which outlines
the approach it believes registrants should use to quantify the misstatement
of
current year financial statements that results from misstatements of prior
year
financial statements. The SAB will change practice by requiring
registrants to use a combination of two approaches, the “rollover” approach,
which quantifies a misstatement based on the amount of the error originating
in
the current year income statement and the “iron curtain” approach, which
quantifies a misstatement based on the effects of correcting the misstatement
existing in the balance sheet at the end of the current year. The SAB requires
registrants to adjust their financial statements if the new approach results
in
a conclusion that an error is material. SAB 108 is effective for fiscal
years ending after November 15, 2006. In the course of evaluating balance sheet
amounts under the provisions of SAB 108, the Company identified the following
adjustments as of January 1, 2006: (i) as a result of non-refundable maintenance
reserves received at the time four aircraft were purchased in 1999 which should
have been treated as a tax basis reduction rather than a liability for
maintenance reserves, a net decrease to the Company’s deferred tax liability in
the amount of $269,340; (ii) as a result of funds received from the seller
when
the Company purchased an aircraft in 2004, which should have been treated as
a
reduction in the purchase price rather than as a liability for maintenance
reserves,
and the incorrect tax treatment of a portion of maintenance reserves as
non-refundable instead of refundable, a decrease of $287,650 to both the cost
basis of the Company’s aircraft and maintenance reserves and accrued costs, a
decrease of $33,960 in accumulated depreciation, an increase of $12,180 in
accounts receivable, and an increase of $14,790 in deferred tax liabilities;
(iii) as a result of a reversal of tax liabilities due to a lower anticipated
state tax rate than was provided for at the time of the Company’s incorporation,
a decrease of $136,800 to deferred tax liabilities and (iv) as a result of
the
incorrect treatment of interest related to maintenance reserves for one aircraft
as additional reserves rather than income, a decrease of $103,080 to refundable
maintenance reserves. These
amounts were recorded in immaterial amounts prior to 2006. However, using the
dual evaluation approach prescribed by SAB 108, correction of the above amounts
would be material to current year earnings. These adjustments resulted in a
net
addition to retained earnings in the amount of $540,570.
In
September 2006, the FASB issued Statement 157, “Fair
Value Measurements”.
This
Statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles (GAAP), and expands disclosures
about fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is
the
relevant measurement attribute. Accordingly, this Statement does not require
any
new fair value measurements. However, for some entities, the application of
this
Statement will change current practice. This statement is effective for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal
years. The Company believes the adoption of Statement 157 will not have an
impact on its financial condition, results of operations or cash
flows.
On
February 15, 2007, the FASB issued FASB Statement No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities.
This Statement permits companies to make a one-time election to carry eligible
types of financial assets and liabilities at fair value, even if fair value
measurement is not required under GAAP. Statement 159 is effective for
fiscal years beginning after November 15, 2007. Early adoption is permitted
if
the decision to adopt the standard is made after the issuance of the Statement
but within 120 days after the first day of the fiscal year of adoption, provided
no financial statements have yet been issued for any interim period and provided
the requirements of Statement 157, Fair
Value Measurements,
are
adopted concurrently with Statement 159. The Company believes the adoption
of Statement 159 will not have an impact on its financial condition, results
of
operations or cash flows.
-
24
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
2. Aircraft
and Aircraft Engine Held for Lease
At
December 31, 2006, the Company owned eight deHavilland DHC-8-300s, three
deHavilland DHC-8-100s, three deHavilland DHC-6s, fourteen Fokker 50s, two
Saab
340As, six Saab 340Bs and one turboprop engine which are held for
lease. At
December 31, 2006, all of the Company’s aircraft were on lease. See Note 9
regarding the status of the Company’s two Saab 340A aircraft subsequent to year
end.
During
2006, the Company acquired three Saab 340B aircraft with lease terms of 60
months. The Company sold a Shorts SD 3-60 aircraft, which resulted in a gain
of
approximately $409,000. The Company also extended the leases for several of
its
aircraft.
In
accordance with its periodic review of its portfolio of assets for impairment,
based on the Company’s cash flow analysis and thirty party appraisals, the
Company recorded no provisions for impairment for its aircraft in
2006.
3. Operating
Segments
The
Company operates in one business segment, leasing of regional aircraft to
regional airlines, primarily foreign, and therefore does not present separate
segment information for lines of business.
Approximately
7% and 1% of
the
Company’s operating lease revenue was derived from lessees domiciled in the
United States during 2006 and 2005, respectively. All revenues relating to
aircraft leased and operated internationally are denominated and payable in
U.S.
dollars.
The
tables below set forth geographic information about the Company’s operating
leased aircraft equipment, grouped by domicile of the lessee:
|
Operating
Lease Revenue for the
Years
Ended December 31,
|
|||||||
|
2006
|
|
|
2005
|
||||
|
Europe
and United Kingdom
|
$
|
6,016,490
|
$
|
3,679,520
|
|||
|
Asia
|
3,947,550
|
5,593,300
|
|||||
|
Caribbean
|
3,234,160
|
1,503,420
|
|||||
|
United
States and Canada
|
1,080,650
|
71,100
|
|||||
|
Africa
|
689,990
|
43,750
|
|||||
|
South
America
|
540,000
|
495,860
|
|||||
|
$
|
15,508,840
|
$
|
11,386,950
|
||||
|
Net
book value
aircraft
and
aircraft
engines
held
for lease
at
December 31,
2006
|
|||||||
|
Europe
and United Kingdom
|
$
|
32,680,670
|
|||||
|
Asia
|
22,312,540
|
||||||
|
Caribbean
|
16,817,090
|
||||||
|
United
States
|
12,299,060
|
||||||
|
Africa
|
5,485,890
|
||||||
|
South
America
|
4,079,720
|
||||||
|
$
|
93,674,970
|
||||||
-
25
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
4. Concentration
of Credit Risk
Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of cash deposits and receivables. The Company places
its deposits with financial institutions and other creditworthy issuers and
limits the amount of credit exposure to any one party.
For
the
year ended December 31, 2006, the Company had six customers, which accounted
for
15%, 14%, 12%, 11%, 11% and 10%, respectively, of lease revenue. For the year
ended December 31, 2005, the Company had three significant customers, which
accounted for 34%, 14% and 12%, respectively, of lease revenue.
At
December 31, 2006, the Company had significant receivables from four lessees,
which accounted for 22%, 22%, 16% and 12%, respectively, of the Company’s total
receivables.
As
of
December 31, 2006, minimum future operating lease revenue payments receivable
under noncancelable leases were as follows:
|
Year
|
|
|
|
2007
|
$
|
12,970,350
|
|
2008
|
|
7,091,050
|
|
2009
|
|
3,932,640
|
|
2010
|
|
1,636,200
|
|
2011
|
|
935,550
|
|
|
$
|
26,565,790
|
-
26
-
5. Notes
Payable and Accrued Interest
(a) Credit
facility
In
November 2005, the Company’s $50 million credit facility was renewed through
October 31, 2007. In connection with the renewal, certain financial covenants
were modified, including the applicable margin which is added to the index
rate
for each of the Company’s outstanding loans under the credit facility. The
margin, which is determined by certain financial ratios, was revised from a
range of 275 to 375 basis points to a range of 275 to 325 basis
points.
In May
2006, a
participant was added to the Company’s credit facility and the amount of the
facility was increased to $55 million. During 2006, the Company borrowed
$3,900,000 and repaid $3,000,000 of the outstanding principal under its credit
facility. As
a
result of maintenance expense in connection with preparing one of the Company’s
aircraft for lease in the second quarter, on June 30, 2006, the Company was
out
of compliance with a financial ratio covenant which is based on net income.
The
Company obtained a waiver from its banks regarding that covenant for the quarter
then ended. As
of
December 31, 2006, the Company was in compliance with all covenants under its
credit facility agreement, $50,896,000 was outstanding under the credit
facility, and interest of $153,250 was accrued.
(b) Special
purpose financing
In
September 2000, a special purpose subsidiary acquired a deHavilland DHC-8-100
aircraft using cash and bank financing separate from its credit facility. The
financing resulted in a note obligation in the amount of $3,575,000, due April
15, 2006, which bore interest at
the
rate of one-month LIBOR plus 3%.
The
note
was collateralized by the aircraft, which was leased to a third-party lessee,
and was non-recourse to the Company. Payments
due under the note consisted of monthly principal and interest and a balloon
principal payment due on the maturity date. The
financing also provided for a six month remarketing period at the expiration
or
early termination of the lease. This note obligation was refinanced in April
2006, using
bank financing from another lender, and the subsidiary was dissolved. The
aircraft was transferred to AeroCentury VI LLC, a newly formed special purpose
limited liability company, which borrowed $1,650,000, due October 15, 2009.
The
note bears interest at an adjustable rate of one-month LIBOR plus 3%.
The
note
is collateralized by the aircraft and the Company’s interest in AeroCentury VI
LLC and is non-recourse to the Company. Payments
due under the note consist of monthly principal and interest through April
20,
2009, interest only from April 20, 2009 until the maturity date, and a balloon
principal payment due on the maturity date. If the aircraft lease agreement
is
terminated on April 15, 2008 pursuant to a lessee early termination option,
the
note will be due October 15, 2008, and the interest only period will be from
April 20, 2008 through October 15, 2008. During 2006, $1,859,550 of principal
was repaid on these notes, including $1,566,290 used to pay off the note
obligation which matured in April 2006. The balance of the note payable at
December 31, 2006 was $1,421,350 and interest of $3,960 was accrued. As of
December 31, 2006, the Company was in compliance with all covenants of this
note
obligation.
In
November 2005, the Company refinanced two DHC-8-300 aircraft that had been
part
of the collateral base for its credit facility. The financing, by a bank
separate from its credit facility, was provided to a newly formed special
purpose subsidiary, AeroCentury V LLC, to which the aircraft were transferred.
The financing resulted in a note obligation in the amount of $6,400,000, due
November 10, 2008, which bears interest at
the
rate 7.87%.
The
note
is collateralized by the aircraft and is non-recourse to the Company.
Payments
due under the note consist of monthly principal and interest through April
22,
2008, interest only from April 22, 2008 until the maturity date, and a balloon
principal payment due on the maturity date. During the first nine months of
2006, AeroCentury V LLC repaid $665,040 of principal. The balance of the note
payable at December 31, 2006 was $5,420,710 and interest of $11,850 was accrued.
As of December 31, 2006, the Company was in compliance with all covenants of
this note obligation.
(c)
Future
maturities of notes payable
As
of
December 31, 2006, principal payments due under the Company’s credit facility
and long-term debt were as follows:
|
Year
|
|
|
|
2007
|
$
|
52,178,150
|
|
2008
|
|
4,789,280
|
|
2009
|
|
770,630
|
|
2010
|
|
-
|
|
2011
|
|
-
|
|
|
$
|
57,738,060
|
-
27
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
6. Stockholder
Rights Plan
On
April
8, 1998, the Company’s Board of Directors adopted a stockholder rights plan
granting a dividend of one stock purchase right for each share of the Company’s
common stock outstanding as of April 23, 1998. The rights become exercisable
only upon the occurrence of certain events specified in the plan, including
the
acquisition of 15% of the Company’s outstanding common stock by a person or
group. Each right entitles the holder to purchase one one-hundredth of a share
of Series A Preferred Stock of the Company at an exercise price of $66.00 per
one-one-hundredth of a share. Each right entitles the holder, other than an
“acquiring person,” to acquire shares of the Company’s common stock at a 50%
discount to the then prevailing market price. The Company’s Board of Directors
may redeem outstanding rights at a price of $0.01 per right.
7. Income
Taxes
The
items
comprising income tax expense are as follows:
|
For
the Years Ended
December
31,
|
|||||||
|
2006
|
|
|
2005
|
||||
|
Current
tax provision:
|
|||||||
|
Federal
|
$
|
-
|
$
|
184,030
|
|||
|
State
|
11,140
|
2,360
|
|||||
|
Current
tax provision
|
11,140
|
186,390
|
|||||
|
Deferred
tax provision/(benefit):
|
|||||||
|
Federal
|
434,770
|
(9,210
|
)
|
||||
|
State
|
26,460
|
(31,060
|
)
|
||||
|
Deferred
tax provision/(benefit)
|
461,230
|
(40,270
|
)
|
||||
|
Total
provision for income taxes
|
$
|
472,370
|
$
|
146,120
|
|||
Total
income tax expense differs from the amount that would be provided by applying
the statutory federal income tax rate to pretax earnings as illustrated
below:
|
For
the Years Ended
December
31,
|
|||||||
|
2006
|
|
|
2005
|
||||
|
Income
tax provision at statutory federal income tax rate
|
$
|
438,680
|
$
|
115,270
|
|||
|
State
tax provision, net of federal benefit
|
11,200
|
120
|
|||||
|
Federal
tax adjustment
|
-
|
47,600
|
|||||
|
Tax
rate differences
|
17,210
|
(29,230
|
)
|
||||
|
Other
|
5,280
|
12,360
|
|||||
|
Total
income tax provision
|
$
|
472,370
|
$
|
146,120
|
|||
Tax
rate
differences reflect (i) the change in effective state tax rates that resulted
from changes in state income tax apportionments related to changed nexus of
aircraft leasing activities among various states.
-
28
-
AeroCentury
Corp.
Notes
to
Consolidated Financial Statements
December
31, 2006
7. Income
Taxes (continued)
Temporary
differences and carry-forwards that give rise to a significant portion of
deferred tax assets and liabilities as of December 31, 2006 are as
follows:
|
Deferred
tax assets:
|
||||
|
Deferred
maintenance
|
$
|
1,737,300
|
||
|
Maintenance
reserves
|
2,152,740
|
|||
|
Current
year tax losses
|
1,040,730
|
|||
|
Basis
adjustments
|
223,810
|
|||
|
Prepaid
rent and other
|
183,700
|
|||
|
Deferred
tax assets
|
5,338,280
|
|||
|
Deferred
tax liabilities:
|
||||
|
Accumulated
depreciation on aircraft and aircraft engines
|
(6,465,460
|
)
|
||
|
Net
deferred tax liabilities
|
$
|
(1,127,180
|
)
|
Basis
adjustments represent amounts available through amended tax returns resulting
from the adjustments recorded pursuant to SAB 108 as discussed in Note
1(m).
No
valuation allowance is deemed necessary, as the Company has concluded that,
based on an assessment of all available evidence, it is more likely than not
that future taxable income will be sufficient to realize the tax benefits of
all
the deferred tax assets on the consolidated balance sheet. The current year
tax
losses not utilized in the current year will be available to offset taxable
income in each of the two preceding tax years and in future years through
2026.
8. Related
Party Transactions
The
Company has no employees. Its portfolio of leased aircraft assets is managed
and
administered under the terms of a management agreement with JMC, which is an
integrated aircraft management, marketing and financing business and a
subsidiary of JetFleet Holding Corp. ("JHC"). Certain officers of the Company
are also officers of JHC and JMC and hold significant ownership positions in
both JHC and the Company. Under the management agreement, JMC receives a monthly
management fee based on the net asset value of the assets under management.
JMC
may also receive an acquisition fee for locating assets for the Company,
provided that the aggregate purchase price, including chargeable acquisition
costs and any acquisition fee, does not exceed the fair market value of the
asset based on appraisal, and a remarketing fee in connection with the sale
or
re-lease of the Company’s assets. The Company recorded management fees of
$2,750,010 and
$2,339,750
during
the years ended December 31, 2006 and 2005, respectively. The Company incurred
acquisition fees totaling $198,000 and $954,900, payable to JMC, during 2006
and
2005, respectively, which are included in the cost basis of the aircraft
purchased. The
Company recorded remarketing fees totaling $44,000 and $73,250 to JMC in
connection with the sale of aircraft in 2006 and 2005, respectively, which
are
included in the computation of the gain/(loss) on sale of aircraft..
9. Subsequent
Events
In
January 2007, the lease for one of the Company’s DHC-6 aircraft was extended
through April 30, 2009.
In
January 2007, the Company and the lessee of the Company's two Saab 340A
aircraft, wihch have leases expiring in May and July 2008, began discussing
the
early return of the aircraft based on the lessee's anticipated financial
difficulties.
-
29
-
Item
8. Changes
in and Disagreements With Accountants
on
Accounting and Financial Disclosure.
Incorporated
by reference to the Company's Current Report on Form 8-K filed on October 16,
2006 disclosing the dismissal of PricewaterhouseCoopers LLP, and the engagement
of BDO Seidman, LLP as the Company's auditors.
Item
8A. Controls
and Procedures.
Quarterly
evaluation of the Company’s Disclosure Controls and Internal
Controls.
As of
the end of the period covered by this report, the Company evaluated the
effectiveness of the design and operation of its “disclosure controls and
procedures” (“Disclosure Controls”), and its “internal controls over financial
reporting” (“Internal Controls”). This evaluation (the “Controls Evaluation”)
was done under the supervision and with the participation of management,
including the Company’s Chief Executive Officer (“CEO”) and Chief Financial
Officer (“CFO”). Rules adopted by the Securities and Exchange Commission (“SEC”)
require that in this section of the Report, the Company present the conclusions
of the CEO and the CFO about the effectiveness of our Disclosure Controls and
Internal Controls based on and as of the date of the Controls
Evaluation.
CEO
and CFO Certifications.
Attached
as exhibits to this report are two separate forms of “Certifications” of the CEO
and the CFO. The first form of Certification is required in accordance with
Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certification”).
This section of the report is the information concerning the Controls Evaluation
referred to in the Section 302 Certifications and this information should be
read in conjunction with the Section 302 Certifications for a more complete
understanding of the topics presented.
Disclosure
Controls and Internal Controls.
Disclosure Controls are procedures that are designed with the objective of
ensuring that information required to be disclosed in the Company’s reports
filed under the Securities Exchange Act of 1934 (the “Exchange Act”), such as
this report, is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms. Disclosure Controls are also
designed with the objective of ensuring that such information is accumulated
and
communicated to the Company’s management, including the CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure. Internal
Controls are procedures which are designed with the objective of providing
reasonable assurance that (1) the Company’s transactions are properly
authorized; (2) the Company’s assets are safeguarded against unauthorized or
improper use; and (3) the Company’s transactions are properly recorded and
reported, all to permit the preparation of the Company’s consolidated financial
statements in conformity with generally accepted accounting
principles.
Limitations
on the Effectiveness of Controls.
The
Company’s management, including the CEO and CFO, does not expect that its
Disclosure Controls or its Internal Controls will prevent all errors and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in
all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have
been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based
in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur
and
not be detected.
Scope
of the Controls Evaluation.
The
CEO/CFO evaluation of the Company’s Disclosure Controls and the Company’s
Internal Controls included a review of the controls objectives and design,
the
controls implementation by the Company and the effect of the controls on the
information generated for use in this report. In the course of the Controls
Evaluation, the CEO and CFO sought to identify data errors, controls problems
or
acts of fraud and to confirm that appropriate corrective action, including
process improvements, were being undertaken. This type of evaluation is be
done
on a quarterly basis so that the conclusions concerning controls effectiveness
can be reported in the Company’s quarterly reports on Form 10-QSB and annual
report on Form 10-KSB. The Company’s Internal Controls are also evaluated on an
ongoing basis by other
personnel in the Company’s finance organization and by the Company’s independent
auditors in connection with their audit and review activities. The overall
goals
of these various evaluation activities are to monitor the Company’s Disclosure
Controls and the Company’s Internal Controls and to make modifications as
necessary; the Company’s intent in this regard is that the Disclosure Controls
and the Internal Controls will be maintained as dynamic systems that change
(reflecting improvements and corrections) as conditions warrant.
Among
other matters, the Company sought in its evaluation to determine whether there
were any “significant deficiencies” or “material weaknesses” in the Company’s
Internal Controls, or whether the Company had identified any acts of fraud
involving personnel who have a significant role in the Company’s Internal
Controls. This information was important both for the Controls Evaluation
generally and because item 5 in the Section 302 Certifications of the CEO and
CFO requires that the CEO and CFO disclose that information to the Audit
Committee of the Company’s Board and to the Company’s independent auditors and
report on related matters in this section of the Report. In the professional
auditing literature, “significant deficiencies” are referred to as “reportable
conditions”; these are control issues that could have a significant adverse
effect on the ability to record, process, summarize and report financial data
in
the financial statements. A “material weakness” is defined in the auditing
literature as a particularly serious reportable condition where the internal
control does not reduce to a relatively low level the risk that misstatements
caused by error or fraud may occur in amounts that would be material in relation
to the financial statements and not be detected within a timely period by
employees in the normal course of performing their assigned functions. The
Company also sought to deal with other controls matters in the Controls
Evaluation, and in each case if a problem was identified, the Company considered
what revision, improvement and/or correction to make in accordance with the
on-going procedures.
In
accordance with SEC requirements, the CEO and CFO note that there has been
no
significant change in Internal Controls that occurred during the most recent
fiscal quarter that has materially affected or is reasonably likely to
materially affect the Company’s Internal Controls.
Conclusions.
Based
upon the Controls Evaluation, the Company’s CEO and CFO have concluded that, (i)
the Company’s Disclosure Controls are effective to ensure that the information
required to be disclosed by the Company in the reports that it files under
the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Commission’s rules and forms and then accumulated and
communicated to Company management, including the CEO and CFO, as appropriate
to
make timely decisions regarding required disclosures, and (ii) that the
Company’s Internal Controls are effective to provide reasonable assurance that
the Company’s consolidated financial statements are fairly presented in
conformity with generally accepted accounting principles.
Item
8B. Other
Information.
None.
-
30
-
PART
III
Item
9. Directors,
Executive Officers, Promoters, Control Persons and
Corporate
Governance; Compliance with Section 16(a) of the Exchange
Act.
Information
relating to the Company’s board of directors and executive officers, including
the independence of the audit committee and audit committee financial expert,
will be incorporated by reference from the Company’s definitive proxy statement
(“the “2007 Proxy Statement”) for its annual stockholders’ meeting to be held on
May 2, 2007 in the section entitled “Information Regarding the Company’s
Directors and Officers.”
The
Company has adopted a code of business conduct and ethics, or code of conduct.
The code of conduct qualifies as a “code of ethics” within the meaning of
Section 406 of the Sarbanes-Oxley Act of 2002 and the rules promulgated
thereunder. A copy of the code of conduct is available on the Company’s website
at
www.aerocentury.com
or
upon
written request to the Investor Relations Department, 1440 Chapin Avenue, Suite
310, Burlingame, California 94010. To the extent required by law, any amendments
to, or waivers from, any provision of the code will be promptly disclosed
publicly. To the extent permitted by such requirements, the Company intends
to
make such public disclosure on its website in accordance with SEC
rules.
Item
10. Executive
Compensation.
Incorporated
by reference to the section of the 2007 Proxy Statement entitled “Information
Regarding the Company’s Directors and Officers — Employee
Compensation.”
Item
11. Security
Ownership of Certain Beneficial Owners and Management and
Related
Stockholder Matters.
Incorporated
by reference to the section of the 2007 Proxy Statement entitled “Security
Ownership of Certain Beneficial Owners and Management.”
Item
12. Certain
Relationships and Related Transactions, and Director
Independence.
Incorporated
by reference to the section of the 2007 Proxy Statement entitled “Related Party
Transactions.”
-
31
-
Item
13. Exhibits.
(a) Exhibits
3.1 Certificate
of Incorporation of the Company, incorporated by reference to Exhibit 3.08
to
the registration statement on Form S-4/A filed with the Securities and
Exchange Commission on July 24, 1997.
3.2 Form
of
Certificate of Amendment of Certificate of Incorporation of the Company,
incorporated by reference to Exhibit 3.07 to the registration statement on
Form
S-4/A filed with the Securities and Exchange Commission on June 10,
1997.
3.3 Amended
and Restated Bylaws of the Company dated January 22, 1999, incorporated by
reference to Exhibit 3.1 to the Report on Form 10-KSB for the fiscal year ended
December 31, 1998.
3.4 Certificate
of Designation of the Company dated April 15, 1998, incorporated by reference
to
Exhibit 3.2 to the Report on Form 10-KSB for the fiscal year ended December
31,
1998.
3.5 Amended
and Restated Stockholder Rights Agreement, dated January 22, 1999, incorporated
by reference to Exhibit 1 to Form 8-A/A filed with the Securities and Exchange
Commission on February 4, 1999.
4.1 Reference
is made to Exhibit 3.5.
*
10.1 Employment
Agreement between the Company and Neal D. Crispin, dated April 24, 2003,
incorporated by reference to Exhibit 10.1 to the Report on Form 10-KSB for
the
fiscal year ended December 31, 2003.
10.3 Credit
Agreement between First Union National Bank and the Company, dated June 30,
1998, incorporated by reference to Exhibit 10.1 to the Report on Form 8-K filed
with the Securities and Exchange Commission on July 2, 1998.
10.4 Form
of
Indemnity Agreement between the Company and each of its directors and officers,
incorporated by reference to Exhibit 10.03 to the Report on Form 10-KSB for
the
fiscal year ended December 31, 1997.
10.5 Amended
and Restated Management Agreement, dated April 23, 1998, between the Company
and
JetFleet Management Corp., incorporated by reference to Exhibit 10.5 to the
Report on Form 10-KSB for the fiscal year ended December 31, 1999.
10.6 Certificate
of Designation of the Company dated April 15, 1998, incorporated by reference
to
exhibit 3.2 to Report on Form 10-KSB for the fiscal year ended December 31,
1998.
10.7 Amended
and Restated Credit Agreement, dated June 28, 2000, between the Company and
National City Bank, as agent, and California Bank & Trust and Sanwa Bank
California, incorporated by reference to Exhibit 10.1 to the Report on Form
8-K
filed with the Securities and Exchange Commission on July 21, 2000.
10.8 Amendment
to Amended and Restated Credit Agreement, between National City Bank, as agent,
and California Bank & Trust and United California Bank, dated March 7, 2002,
incorporated by reference to Exhibit 10.1 to the Report on Form 8-K filed with
the Securities and Exchange Commission on March 12, 2002.
10.9 Second
Amendment to Amended and Restated Credit Agreement between National City Bank,
as agent, and California Bank & Trust and Bank of the West, Successor in
Interest to United California Bank, formerly known as Sanwa Bank California,
dated January 1, 2003, incorporated by reference to Exhibit 10.1 to the Report
on Form 8-K filed with the Securities and Exchange Commission on February 20,
2003.
10.10 Third
Amendment to Amended and Restated Credit Agreement between National City Bank,
as agent, and California Bank & Trust and Bank of the West, Successor in
Interest to United California Bank, formerly known as Sanwa Bank California,
dated June 28, 2003, incorporated by reference to Exhibit 10.1 to the Report
on
Form 8-K filed with the Securities and Exchange Commission on July 1,
2003.
10.11 Fourth
Amendment to Amended and Restated Credit Agreement between National City Bank,
as agent, and California Bank & Trust, dated August 28, 2003, incorporated
by reference to Exhibit 10.1 to the Report on Form 8-K filed with the Securities
and Exchange Commission on August 28, 2003.
10.12 Fifth
Amendment to Amended and Restated Credit Agreement between National City Bank,
as agent, and California Bank & Trust and Bank of the West, Successor in
Interest to United California Bank, formerly known as Sanwa Bank California,
dated as of August 28, 2003, incorporated by reference to Exhibit 10.1 to the
Report on Form 8-K filed with the Securities and Exchange Commission on October
1, 2003.
10.13
Sixth
Amendment to Amended and Restated Credit Agreement between National City Bank,
as agent, and California Bank & Trust and Bank of the West, Successor in
Interest to United California Bank, formerly known as Sanwa Bank California,
dated January 2, 2004, incorporated by reference to Exhibit 10.1 to the Report
on Form 8-K filed with the Securities and Exchange Commission on January 2,
2004.
10.14
Seventh
Amendment to Amended and Restated Credit Agreement between the Company, National
City Bank, as agent, and National City Bank, California Bank & Trust
California Bank & Trust and First Bank dba
First
Bank & Trust, as lenders, dated August 30, 2004, incorporated by reference
to Exhibit 10.1 to the Report on Form 8-K filed with the Securities and Exchange
Commission on August 31, 2004
10.15
Eighth
Amendment to Amended and Restated Credit Agreement between the Company, National
City Bank, as agent, and National City Bank, California Bank & Trust
California Bank & Trust and First Bank dba
First
Bank & Trust, as lenders, dated October 28, 2004, incorporated by reference
to Exhibit 10.1 to the Report on Form 8-K filed with the Securities and Exchange
Commission on October 29, 2004.
10.16
Ninth
Amendment to Amended and Restated Credit Agreement between the Company, National
City Bank, as agent, and National City Bank, California Bank & Trust
California Bank & Trust and First Bank dba
First
Bank & Trust, as lenders, dated November 4, 2004, incorporated by reference
to Exhibit 10.1 to the Report on Form 8-K filed with the Securities and Exchange
Commission on November 8, 2004.
*
10.18
Employment
Agreement between the Company and Marc J. Anderson dated December 19,
2005.
10.19 Tenth
Amendment to Amended and Restated Credit Agreement between the Company, National
City Bank, as agent, and National City Bank, California Bank & Trust
California Bank & Trust and First Bank dba
First
Bank & Trust, as lenders, dated October 31, 2005
10.20 Eleventh
Amendment to Amended and Restated Credit Agreement between the Company, National
City Bank, as agent, and National City Bank, California Bank & Trust
California Bank & Trust and First Bank dba
First
Bank & Trust, as lenders, dated November 9, 2005, incorporated by reference
to Exhibit 10.1 to the Report on Form 8-K filed with the Securities and Exchange
Commission on November 9, 2005.
10.21
Twelfth
Amendment to Amended and Restated Credit Agreement between the Company, National
City Bank, as agent, and National City Bank, California Bank & Trust
California Bank & Trust and First Bank dba
First
Bank & Trust, as lenders, dated December 19, 2005, incorporated by reference
to Exhibit 10.1 to the Report on Form 8-K filed with the Securities and Exchange
Commission on December 20, 2005.
10.22 Purchase
Agreement with Denim Air Lease & Finance B.V. and Purchase Agreement with
VLM Airlines, N.V. incorporated by reference to Exhibit 10.1 and 10.2 to the
Report on Form 8-K filed with the Securities and Exchange Commission on December
28, 2005.
10.23
Credit
Agreement between the Company, AeroCentury Investments VI LLC & Landsbanki
Islands HF, dated April 19, 2006, incorporated by reference to Exhibit 10.1
to
the Report on Form 8-K filed with the Securities and Exchange Commission on
April 19, 2006.
10.24 Agreement
of Joinder and Thirteenth Amendment to Amended and Restated Credit Agreement
between the Company, National City Bank, as agent, and National City Bank,
California Bank & Trust, First Bank dba First Bank & Trust and Bridge
Bank, National Association, as lenders, dated May 15, 2006, incorporated by
reference to Exhibit 10.1 to the Report on Form 8-K filed with the Securities
and Exchange Commission on May 17, 2006.
10.25
Waiver
to
Amended and Restated Credit Agreement between the Company, National City Bank,
as agent, and National City Bank, California Bank & Trust California Bank
& Trust and First Bank dba
First
Bank & Trust, as lenders, dated July 19, 2006, incorporated by reference to
Exhibit 10.1 to the Report on Form 8-K filed with the Securities and Exchange
Commission on July 24, 2006.
16 Letter
from PricewaterhouseCoopers LLP, dated October 13, 2006, incorporated by
reference to Exhibit 16 to the Report on Form 8-K filed with the Securities
and
Exchange Commission on October 26, 2006.
21 Subsidiaries
of the Company.
31.1 Certification
of Neal D. Crispin, Chief Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification
of Toni M. Perazzo, Chief Financial Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification
of Neal D. Crispin, Chief Executive Officer, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification
of Toni M. Perazzo, Chief Financial Officer, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
____________________
*
Indicates
management contract or compensatory plan or arrangement.
Item
14. Principal
Accountant Fees and Services.
Incorporated
by reference to the section of the 2007 Proxy Statement entitled “Information
Regarding Auditors - Audit Fees.”
-
32
-
SIGNATURES
In
accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has
caused this Report on Form 10-KSB to
be
signed on its behalf by the undersigned, thereunto duly authorized on March
12,
2007.
| AEROCENTURY CORP. | ||
| |
|
|
| Date: March 12, 2007 | By: | /s/ Toni M. Perazzo |
|
|
||
| Title: Senior Vice President-Finance and Chief Financial Officer | ||
-
33
-
POWER
OF ATTORNEY
KNOW
ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Neal D. Crispin and Toni M. Perazzo, and each of them,
his or her attorneys-in-fact, each with the power of substitution, for him
or
her in any and all capacities, to sign any amendments to this Report on Form
10-KSB and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his or
her
substitute or substitutes, may do or cause to be done by virtue hereof.
In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant
and in the capacities indicated on March 12, 2007.
| /s/ Neal D. Crispin | /s/ Toni M. Perazzo | ||
|
|
|
||
|
Name:
Neal
D. Crispin (Principal Executive Officer)
Title: Director, President and Chairman of the Board of Directors of Registrant |
Name:
Toni M.
Perazzo (Principal Financial and Accounting Officer) Title: Senior Vice President-Finance and Secretary of Registrant |
| /s/ Marc J. Anderson | /s/ Thomas G. Hiniker | ||
|
|
|
||
| Name:
Marc
J. Anderson Title: Director, Chief Operating Officer, Senior Vice President of Registrant |
Name:
Thomas
G. Hiniker Title: Director of Registrant |
| /s/ Evan M. Wallach | /s/ Thomas W. Orr | ||
|
|
|
||
| Name:
Evan
M. Wallach Title: Director of Registrant |
Name:
Thomas
W. Orr Title: Director of Registrant |
-
34
-