News Column

AEROCENTURY CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 13, 2014

The following discussion should be read in conjunction with the Company's Form 10-K for the year ended December 31, 2013 and the unaudited financial statements and related notes that appear elsewhere in this report.

Critical Accounting Policies, Judgments and Estimates

The Company's discussion and analysis of its financial condition and results of operations are based upon the 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. In the event that actual results differ from these estimates or the Company adjusts these estimates in future periods, the Company's operating results and financial position could be materially affected. For a discussion of Critical Accounting Policies, Judgments and Estimates, refer to Note 1 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q.

For a discussion of the Company's accounting policies regarding maintenance reserves, refer to Note 4 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q. For a discussion of the Company's change in method of accounting for certain maintenance reserves and lessor maintenance obligations and its application to prior periods, refer to Note 2 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q.

Results of Operations

Quarter ended June 30, 2014 compared to the quarter ended June 30, 2013

The Company recorded a net loss of $3.9 million in the quarter ended June 30, 2014 compared to net income of $1.3 million in the same period of 2013.

Quarterly operating lease revenue increased 14% from $4.7 million in the quarter ended June 30, 2013 to $5.3 million in the second quarter of 2014, primarily as a result of increases in operating lease revenue from assets purchased during 2013 and 2014. These increases were partially offset by the effect of: (i) assets on lease in the 2013 period but off lease in the 2014 period; (ii) asset sales during 2013; and (iii) lower revenue received from those lessees from which the Company records revenue only on cash receipt as a result of substantial uncertainty of collectability.

Maintenance reserves revenue increased 44% from $1.2 million in the quarter ended June 30, 2013 to $1.7 million in the quarter ended June 30, 2014. The amount recorded in the 2013 period represents maintenance reserves retained at lease end for one aircraft. The amount recorded in the 2014 period represents maintenance reserves retained at lease end when six aircraft were returned to the Company.

The average net book value of assets held for lease during the second quarters of 2014 and 2013 was approximately $173.7 million and $141.7 million, respectively, representing an increase of 22%. The average portfolio utilization during the quarters ended June 30, 2014 and 2013 was 77% and 75%, respectively.

During the second quarter of 2014, the Company recorded a net gain of $0.8 million related to the sale of two aircraft and an aircraft engine. During the second quarter of 2013, the Company recorded a gain of $1.9 million related to the sale of one aircraft and the finance lease of an engine.

During the second quarter of 2014, the Company recorded impairment charges totaling $6.8 million for five of its Fokker 100 aircraft, based on the appraised values of those aircraft. There were no recorded impairment charges of long-lived assets during the second quarter of 2013.

During the second quarters of 2014 and 2013, the Company added equipment to the lease portfolio of approximately $1.8 million and $2.4 million, respectively. The 2014 amount was comprised of capital equipment added to aircraft and the reclassification of two aircraft engines from finance lease receivables to aircraft and aircraft engines held for lease. The Company sold equipment with a book value of approximately $5.3 million and $2.1 million during the second quarters of 2014 and 2013, respectively. Depreciation and management fees in the second quarter of 2014 increased by 11% and 24%, respectively, over the previous year, primarily as a result of acquisitions and changes in residual assumptions from year to year.

The Company's interest expense increased by 26% from $1.0 million in the second quarter of 2013 to $1.3 million in the second quarter of 2014, primarily as a result of a higher average Credit Facility balance.

The Company's professional fees, general and administrative and other expenses increased by 177% from $0.3 million in the second quarter of 2013 to $0.8 million in the second quarter of 2014, primarily as a result of pilot, fuel, insurance and other expenses incurred in connection with the return of six aircraft and two General Electric CT7-9B engines by one of the Company's customers when it ceased operations in the 2014 period.

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Six months ended June 30, 2014 compared to the six months ended June 30, 2013

The Company recorded a net loss of $3.6 million in the six months ended June 30, 2014 compared to net income of $5.2 million in the same period of 2013.

Quarterly operating lease revenue increased 17% from $9.6 million in the first half of 2013 to $11.2 million in the first half of 2014, primarily as a result of increases in operating lease revenue from assets purchased during 2013 and 2014. The effect of these increases was partially offset by the effect of: (i) assets that were on lease in the 2013 period but off lease in the 2014 period, (ii) asset sales during 2013 and (iii) lower revenue received from those lessees from which the Company records revenue only on cash receipt as a result of substantial uncertainty of collectability.

Maintenance reserves revenue decreased 56% from $7.7 million in the first half of 2013 to $3.4 million in the first half of 2014. The amount recorded in the 2013 period was received from the prior lessee of two of the Company's aircraft when the leases were assigned to a new lessee in 2012 and recognized as maintenance reserves revenue upon termination of those leases in the first quarter of 2013, and from maintenance reserves retained at lease end for another aircraft. The amount recorded in the 2014 period represents maintenance reserves retained at lease end when seven aircraft were returned to the Company

The average net book value of assets held for lease during the six months ended June 30, 2014 and 2013 was approximately $177.9 million and $142.8 million, respectively, representing an increase of 25%. The average portfolio utilization during the six months ended June 30, 2014 and 2013 was 79% and 76%, respectively.

During the first half of 2014, the Company recorded net gains totaling $1.2 million related to the sale of four aircraft and an aircraft engine. During the six months ended June 30, 2013, the Company recorded net gains of $2.2 million related to the sale of two aircraft and the finance lease of an engine.

During the first half of 2014, the Company recorded impairments totaling $6.8 million for five of its Fokker 100 aircraft, based on appraisal. There were no recorded impairments of long-lived assets during the first half of 2013.

During the six months ended June 30, 2014 and 2013, the Company added equipment to the lease portfolio of approximately $33.0 million and $4.3 million, respectively. The Company sold equipment with a book value of approximately $7.9 million and $4.4 million during the six months ended June 30, 2014 and 2013, respectively. Depreciation and management fees in the first six months of 2014 increased by 9% and 22%, respectively, over the previous year, primarily as a result of acquisitions and changes in residual assumptions from year to year.

The Company's interest expense increased by 24% from $2.1 million in the first six months of 2013 to $2.6 million in the same period of 2014, primarily as a result of a higher average Credit Facility balance.

The Company's professional fees, general and administrative and other expenses increased by 81% from $0.6 million in the first half of 2013 to $1.1 million in the first half of 2014, primarily as a result of pilot, fuel, insurance and other expenses incurred in connection with the return of six aircraft and two General Electric CT7-9B engines by one of the Company's customers when it ceased operations in the 2014 period.

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Liquidity and Capital Resources

The Company is currently financing its assets primarily through debt financing and excess cash flows.

(a)Credit Facility

During May 2014, the Company's $130 million Credit Facility (the "Credit Facility"), which is provided by a syndicate of banks, was increased to $180 million and extended through May 31, 2019. The Credit Facility is secured by all of the assets of the Company, including its aircraft and engine portfolio.

In November 2013, the Company obtained a waiver of compliance with a lessee concentration covenant under its Credit Facility agreement at the September 30, 2013 and December 31, 2013 calculation dates. The Company was in compliance with all covenants other than the waived covenant under the Credit Facility agreement at December 31, 2013.

As of June 30, 2014, the Company was out of compliance with a profitability covenant. The non-compliance resulted primarily from the Company recognizing aircraft impairment charges totaling $6.8 million at June 30, 2014. Based on its current projections, the Company believes that it may be out of compliance with this covenant, which is calculated on a trailing 12 months basis, at subsequent calculation dates. The Company is in discussions with the agent bank to amend the credit facility agreement to exclude impairment charges from the profitability covenant calculation, and retroactively cure the covenant default on June 30, 2014 and subsequent calculation dates. The Company believes that the Credit Facility banks will agree to such an amendment during the third quarter of 2014; there is, however, no assurance that such an amendment agreement will eventually be entered into between the Company and the Credit Facility banks. Furthermore, if such an amendment is agreed to, the Credit Facility banks could require terms and conditions that increase the cost of the Credit Facility to the Company and/or that are less favorable to the Company than the current agreement. The Company was in compliance with all other covenants at June 30, 2014.

For additional information regarding the Company's credit facility, refer to Note 5 to the Company's financial statements in Item 1 of this Quarterly Report on Form 10-Q.

(b)Cash flow

The Company's primary sources of cash are (i) rent payments due under the Company's operating and finance leases and (ii) maintenance reserves billed monthly to lessees based on asset usage.

The Company's primary uses of cash are for purchase of aircraft and engines, maintenance expense and reimbursement to lessees from collected maintenance reserves, management fees, professional fees, insurance, and Credit Facility interest and principal payments. The amount of interest paid by the Company depends on the outstanding balance of its Credit Facility, which carries a floating interest rate as well as an interest rate margin, and is therefore also dependent on changes in prevailing interest rates.

The timing and amount of the Company's payments for maintenance vary, depending on the timing of lessee-performed maintenance that is eligible for reimbursement, the aggregate amount of such claims and the timing and amount of maintenance incurred in connection with preparation of off-lease assets for re-lease to new customers. The Company's maintenance payments typically constitute a large portion of its cash needs, and the Company may from time to time borrow additional funds under the Credit Facility to provide funding for such payments.

Management believes that the Company will have adequate cash flow to meet its ongoing operational needs, including any required repayments under the Credit Facility due to borrowing base limitations, based upon its estimates of future revenues and expenditures, which include assumptions regarding (i) revenues for assets to be re-leased, (ii) required debt payments, (iii) interest rates, (iv) the cost and anticipated timing of maintenance to be performed and (v) timely use of proceeds of unused debt capacity toward additional acquisitions of income producing assets.

Although the Company believes that the assumptions it has made in forecasting its cash flow are reasonable in light of experience, actual results could deviate from such assumptions. Among the more significant factors that could have an impact on the accuracy of cash flow assumptions are (i) lessee non-compliance with lease obligations, (ii) inability to locate new lessees for returned equipment within a reasonable remarketing period, or at a rent level consistent with projected rates for the asset, (iii) lessee performance of maintenance, and payment of related maintenance claims, earlier than anticipated, (iv) inability to locate and acquire a sufficient volume of additional assets at prices that will produce acceptable net returns, (v) increases in interest rates, (vi) inability to timely dispose of off-lease assets at prices commensurate with their market value, and (vii) any one or a combination of the above factors that causes the Company to violate covenants under the Credit Facility agreement, which may in turn require repayment of some or all of the amounts outstanding.

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(i)Operating activities

The Company's cash flow from operations was approximately the same in the first six months of 2014 compared to the same period in 2013. As discussed below, the change in cash flow was primarily a result of increases in payments received for operating lease revenue and security deposits as well as a decrease in payments for aircraft insurance, the effects of which were partially offset by increases in payments for maintenance, interest and management fees.

Payments for operating lease revenue and maintenance reserves

Payments received from lessees for rent increased by $2.8 million in the first half of 2014 compared to the first half of 2013, primarily due to rent from assets purchased during late 2013 and early 2014. Payments received for maintenance reserves decreased by $1.1 million in the first half of 2014 compared to the same period in 2013, primarily as a result of payment delinquencies and lower utilization of some assets for which the Company collects maintenance reserves.

The Company is receiving no lease revenue for its assets that are currently off lease, which assets are comprised of six Fokker 100 aircraft, six Saab 340B Plus aircraft, two Fokker 50 aircraft, one Dash-8-311 aircraft, two General Electric CF34-8E5 engines, two General Electric CT7-9B engines and one Tay 650-15 engine. The Tay 650-15 engine, which was acquired during the first quarter of 2013, is being held as a spare and used in connection with required maintenance on the Company's Fokker 100 aircraft.

Payments for security deposits

Payments for security deposits increased by $0.6 million in the first half of 2014 compared to the first half of 2013 primarily as a result of a 100% deposit received in the 2014 period for the sale of an aircraft in July 2014.

Payments for maintenance

Payments for maintenance increased by $1.4 million in the first half of 2014 compared to the first half of 2013, primarily as a result of an increase in maintenance costs for off-lease aircraft. The amount of payments for maintenance in future periods will depend on the amount and timing of maintenance paid as reimbursement to lessees for maintenance reserves claims, which are dependent upon utilization and required maintenance intervals, and maintenance paid for off-lease assets.

Payment for interest and management fees

Payments for interest and management fees increased by $0.7 million and $0.9 million, respectively, in the first half of 2014 compared to the same period of 2013 as a result of a higher Credit Facility balance and asset purchases.

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Payment for professional fees, general and administrative and other expenses

Payments for professional fees, general and administrative and other expenses increased by $0.5 million in the first half of 2014 compared to the same period in 2013 primarily as a result of pilot, fuel, insurance and other expenses incurred in connection with the return of six aircraft and two engines by one of the Company's customers in the 2014 period when it ceased operations.

(ii)Investing activities

During the six months ended June 30, 2014 and 2013, the Company received cash of $9.5 million and $5.1 million, respectively, from the sale of assets. During the same time periods, the Company used cash of $32.2 million and $4.1 million, respectively, for purchases and capital improvement of aircraft.

(iii)Financing activities

The Company borrowed $32.1 million and $2.0 million under the Credit Facility during the first six months of 2014 and 2013, respectively. In these same time periods, the Company repaid $8.2 million and $0.3 million, respectively, of its total outstanding debt under the Credit Facility. Such repayments were funded by excess cash flow. During the first six months of 2014 and 2013, the Company paid $2.4 million and $2.1 million of fees related to the extension and administration of the Company's Credit Facility. Such fees are amortized over the term of the Credit Facility.

Outlook

(a)General

While certain areas of the world air carrier industry are now beginning to experience growth after a period of contraction following the global downturn of recent years, other areas of the world continue to experience slow recovery and shakeouts of weaker air carrier competitors that were unable to survive the aftermath of the global downturn. Overall, the Company continues to experience a reduction in the number of aircraft and aircraft engines needed for operation by carriers in nearly all geographic areas, especially in Western Europe, as compared to periods before the global downturn. The overall low-growth environment, combined with the unanticipated cessation of operations by a regional Thai carrier and return to the Company of six leased aircraft and two aircraft engines, and continuing delays in re-leasing certain of the Company's older off-lease aircraft will present an ongoing and challenging environment for the Company in four respects:

Lessees who are located in low- or no- growth areas of the world carry heightened risk of an unanticipated lessee default. A lessee's default and the unscheduled return of an asset to the Company for remarketing could result not only in reduced operating lease revenue but also in unanticipated, unrecoverable expenses arising from the lessee's default on its maintenance and return condition obligations. The Company monitors the performance of all of its customers and has noted that several of the Company's customers continue to experience weakened operating results and have not yet achieved financial stability. The current environment heightens the possibility that the Company's existing lessees will choose to return leased assets at lease expiration rather than renew the existing leases, notwithstanding that any such lessee may incur significant expenses to satisfy return conditions. Due to the flat demand for aircraft capacity, it is likely that the Company will experience lower on-lease utilization rates and longer lead times for remarketing of returned assets, as well as lower rental rates for remarketed assets, as was the case with several lease extensions and re-leases since 2011. This trend is expected to continue to affect the Company's operating revenue through 2014. The lack of significant growth in the pool of customers requiring aircraft for lease creates a challenge for the Company in maintaining a high utilization rate for its aircraft portfolio. It could also cause the Company's overall credit risk profile to increase as the Company considers leasing its off-lease assets to start-up air carriers that have higher credit risk profiles than the Company's current lessees. Failure to bring new lessees into the portfolio could increase the Company's reliance on a small number of lessees, which increases the Company's risk of financial covenant compliance (see "Factors That May Affect Future Results - Concentration of Lessees and Aircraft Type," below). The inability to timely remarket the Company's off-lease aircraft could affect the Company's collateral base and impact its ability to access acquisition funds, and, if it continues over the medium term, could affect the Company's compliance with its collateral base financial covenants. - 19 -



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(b)Operating Segments

The Company operates in one business segment, the leasing of regional aircraft to foreign and domestic regional airlines, and therefore does not present separate segment information for lines of business.

At July 31, 2014, the dominant types of aircraft in the Company's portfolio were as follows: Number % of net Model owned book value Bombardier Dash-8-300 9 21 % Bombardier CRJ-700 3 18 % Bombardier Dash-8-Q400 3 15 % Fokker 100 7 13 % Bombardier CRJ-705 1 11 %



For the month ended July 31, 2014, the Company's sources of operating lease revenue were from the following regions:

% of Number operating Region of lessees lease revenue North America 2 34 % Africa 2 28 % Caribbean 1 15 % Europe 2 11 % Asia 3 10 % South America 1 2 % (c)Remarketing Efforts



In July 2014, the Company sold a Fokker 50 aircraft. The Company has a signed letter of intent for the lease of two Saab 340B Plus aircraft and a deposit for one of the aircraft. The Company expects to deliver the aircraft during the third quarter of 2014. The Company also has a signed purchase agreement and non-refundable deposit for the sale of a Fokker 50 aircraft.

The Company is seeking remarketing opportunities for four Saab 340B Plus aircraft, a Fokker 50 aircraft, two General Electric CF34-8E5 engines and two General Electric CT7-9B engines.

Six of the Company's Fokker 100 aircraft are off lease. The Company also has a signed lease and deposit for the lease of a Fokker 100 aircraft, as well as a signed letter of intent and deposit for the lease of a second Fokker 100 aircraft to the same customer. The Company expects to deliver both aircraft during the third quarter of 2014. The Company is seeking remarketing opportunities for its other off-lease Fokker 100 aircraft.

Leases for four of the Company's assets will expire during the remainder of 2014 and the Company believes that is likely that they will be returned at lease end.

The Company is considering selling some or all of its off-lease aircraft. The Company is analyzing the amount and timing of maintenance required to remarket the aircraft, the amount of which may differ significantly if the aircraft are sold rather than re-leased.

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(d)Credit Facility

As of June 30, 2014, the Company was out of compliance with a profitability covenant. The non-compliance resulted primarily from the Company recognizing aircraft impairment charges totaling $6.8 million at June 30, 2014. Based on its current projections, the Company believes that it may be out of compliance with this covenant, which is calculated on a trailing 12 months basis, at subsequent calculation dates. The Company is in discussions with the agent bank to amend the credit facility agreement to exclude impairment charges from the profitability covenant calculation, effective as of the June 30, 2014 and subsequent calculation dates. The Company believes that the Credit Facility banks will agree to such an amendment during the third quarter of 2014; however, there is no assurance that such agreement will eventually be reached. Furthermore, if such an amendment is agreed to, it could result in an increase in cost of the Credit Facility and/or a change in terms of the Credit Facility less favorable to the Company than the current agreement.

The Company was in compliance with all other covenants at June 30, 2014.

The Company believes that available borrowings under the Credit Facility, considering possible lessee arrearages or off-lease periods, will be sufficient to meet its continuing obligations and to fund anticipated acquisitions. However, there can be no assurance the Company's beliefs will prove to be correct and that the Company will have sufficient cash to make any required Credit Facility repayments.

Factors that May Affect Future Results

Noncompliance with Credit Facility Financial Covenant. The Company's use of debt as the primary form of acquisition financing subjects the Company to increased risks associated with leveraging. In addition to payment obligations, the Credit Facility agreement includes financial covenants, including some requiring the Company to have positive earnings, meet minimum net worth standards and be in compliance with certain other financial ratios.

As discussed above in "Outlook - Credit Facility," as of June 30, 2014, the Company was out of compliance with a profitability covenant. The Company is in discussions with the agent bank to amend the covenant to exclude impairment charges from the profitability covenant calculation and retroactively cure the covenant default on the June 30, 2014 and subsequent calculation dates. The Company believes that the Credit Facility banks will agree to such an amendment during the third quarter of 2014; however, there is no assurance that the Company and the Credit Facility banks will reach an agreement to such an amendment. Furthermore, if such an amendment is agreed to, the Credit Facility banks could require terms and conditions that increase the cost of the Credit Facility to the Company and/or that are less favorable to the Company than the current agreement. If the Company and the Credit Facility banks cannot agree to such an amendment, the Credit Facility banks would have the right to declare a default under the Credit Facility based on the noncompliance and exercise their default remedies, including, declaring the Credit Facility immediately due and payable. The Company's assets secure its debt financing, and any default in payment obligations or other covenants under the Credit Facility could result in foreclosure upon any or all of the assets of the Company.

Although the Company believes it will continue to be in compliance with all of the Credit Facility covenants through the term of the Credit Facility (assuming the profitability covenant is amended as expected), there can be no assurance of such compliance, and in the event of any non-compliance, the Company will need to seek further waivers or amendment of applicable covenants from its lenders if such compliance failure is not timely cured. Any default under the Credit Facility, if not cured in the time permitted under the facility or waived by the lenders, could result in foreclosure upon any or all of the assets of the Company.

Ownership Risks. The Company's leases are typically less than the entire anticipated remaining useful life of the leased assets. The Company's ability to recover its investment in an asset subject to such a lease is dependent upon the Company's ability to profitably re-lease or sell the asset after the expiration of the lease term. The Company's ability to re-lease or sell the asset is dependent on worldwide economic conditions, general aircraft market conditions, regulatory changes that may make an asset's use more expensive or preclude use due to the age of the aircraft or unless the asset is modified, changes in the supply or cost of aircraft equipment and technological developments that cause the asset to become obsolete. If the Company is unable to remarket its assets on favorable terms when the leases for such assets expire, the Company's financial condition, cash flow, ability to service debt and results of operations could be adversely affected.

The Company acquires used aircraft equipment. The market for used aircraft equipment has been cyclical, and generally reflects economic conditions and the strength of the travel and transportation industry. The demand for and value of many types of used aircraft in the recent past has been depressed by such factors as airline financial difficulties, the number of new aircraft on order and the number of aircraft coming off lease, as well as introduction of new aircraft models and types that may be more technologically advanced, more fuel efficient and/or less costly to maintain and operate. Values may also increase for certain aircraft types that become desirable based on market conditions and changing airline capacity.

In addition, a successful investment in an asset subject to a lease depends in part upon having the asset returned by the lessee in the condition as required under the lease. Each lease typically obligates a customer to return an asset to the Company in a specified condition, which generally requires it be returned in equal or better condition than at delivery to the lessee. If the lessee becomes insolvent during the term of its lease and the Company has to repossess the asset, it is unlikely that the lessee will have the financial ability to meet these return obligations and it is likely that the Company would be required to expend funds in excess of any maintenance reserves collected to return the asset to a remarketable condition. If the lessee files for bankruptcy and rejects the aircraft lease, although the lessee is required to return the aircraft, the lessee is relieved from all further obligations under the lease, including the obligation to return the aircraft in the condition required under the lease. In that case, it is also likely that the Company would be required to expend funds in excess of any maintenance reserves collected to return the asset to a remarketable condition.

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Several of the Company's leases do not require payment of monthly maintenance reserves, which serve as the lessee's advance payment for its future repair and maintenance obligations. If repossession due to lessee default or bankruptcy occurs under such a lease, the Company will be left with the costs of unperformed repair and maintenance under the applicable lease and the Company may incur an unanticipated expense in order to re-lease or sell the asset.

Furthermore, the occurrence of unexpected adverse changes that impact the Company's estimates of expected cash flows generated from an asset may result in an asset impairment charge against the Company's earnings. The Company periodically reviews long-term assets for impairment, 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 estimated to be not recoverable and exceeds its fair value. The Company recognized impairment charges for five of its Fokker 100 aircraft at June 30, 2014 and 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.

Lessee Credit Risk. The Company carefully evaluates the credit risk of each customer and attempts to obtain a third party guaranty, letters of credit or other credit enhancements, if it deems them necessary in addition to customary security deposits. There can be no assurance, however, that such enhancements will be available, or that, if obtained, will fully protect the Company from losses resulting from a lessee default or bankruptcy.

If a lessee that is a certified U.S. airline were in default under a lease and sought protection under Chapter 11 of the United States Bankruptcy Code, Section 1110 of the Bankruptcy Code would automatically prevent the Company from exercising any remedies against such lessee for a period of 60 days. After the 60-day period had passed, the lessee would have to agree to perform the lease obligations and cure any defaults, or the Company would have the right to repossess the equipment. However, this procedure under the Bankruptcy Code has been subject to significant litigation, and it is possible that the Company's enforcement rights may be further adversely affected by a bankruptcy filing by a defaulting lessee.

Several of the Company's customers have experienced significant financial difficulties, become insolvent, or have been declared or have filed for bankruptcy. Such an insolvency or bankruptcy usually discharges all unpaid obligations of the customer existing at the time of the filing, resulting in a total loss of those receivables. The Company closely monitors the performance of all of its lessees and its risk exposure to any lessee that may be facing financial difficulties, in order to guide decisions with respect to such lessee that would mitigate losses in the event the lessee is unable to meet or rejects its lease obligations. There can be no assurance that additional customers will not become insolvent or file for bankruptcy or that the Company will be able to mitigate any of the resultant losses.

Risks Related to Regional Air Carriers. The Company's continued focus on its customer base of regional air carriers subjects the Company to additional risks. Some of the lessees in the regional air carrier market are companies that are start-up, low-capital, and/or low-margin operators. Often, the success of such carriers depends on 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 on short notice. Regional carriers, even if financially strong, that are owned by, or are a sister corporation of, an established major carrier can also be swept into bankruptcy if the major carrier files for bankruptcy or becomes insolvent. Four of the Company's regional air carrier customers filed for bankruptcy in 2012-2013, and in May 2014, a Thai regional carrier that leased six aircraft and two engines from the Company ceased operations.

Credit Facility Debt Limitations. Under the Credit Facility, the amount available to be borrowed is limited to the total amount of asset-specific advance rates. Lessee arrearages or asset off-lease periods may reduce the advance rate for the related assets and, therefore, the permitted borrowing under the facility. Amounts subject to deferral agreements also reduce the borrowing base. The Company believes it will have sufficient cash funds to make any required principal repayment that arises due to any such borrowing base limitations.

Availability of Financing. The Company's continued growth will depend on its ability to continue to obtain capital, either through debt or equity financings. The financial markets have experienced significant setbacks that have continued to make access to capital and asset-based debt financing more costly and difficult to obtain. There can be no assurance that the Company's belief regarding the availability of financing under the current Credit Facility will prove to be correct, or that the Company will succeed in finding additional funding, and if such financing is found, it may be on terms less favorable than the Company's current debt financings.

General Economic Conditions and Lowered Demand for Travel. The Company's business is dependent upon general economic conditions and the strength of the travel and transportation industry. The industry is continuing to experience financial difficulty due to the slow recovery in the global economy. Passenger volume has fallen significantly for many carriers, and the loss of revenue has affected their financial condition. The current lending environment has made it difficult or impossible for many regional carriers to find the additional debt financing on which they have traditionally relied. The confluence of these economic factors increases the likelihood of failures among the Company's customers. The spread of a disease epidemic, the threat or execution of a terrorist attack against aviation, a worsening financial/bank crisis in Europe, a natural event that interrupts air traffic, political crises or other events that cause a prolonged spike in fuel prices, or other like events could exacerbate an already weakened condition and lead to widespread failures in the air carrier industry. If lessees experience financial difficulties and are unable to meet lease obligations, this will, in turn, negatively affect the Company's financial performance.

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Airline reductions in capacity in response to lower passenger loads have resulted in reduced demand for aircraft and aircraft engines and a corresponding decrease in market lease rental rates and aircraft values for many aircraft types. This reduced market value could affect the Company's results if the market value of an asset or assets in the Company's portfolio falls below carrying value, and the Company determines that a write-down of the value on its balance sheet is appropriate. Furthermore, if older, expiring leases are replaced with leases at decreased lease rates, the lease revenue from the Company's existing portfolio is likely to decline, with the magnitude of the decline dependent on the length of the downturn and the depth of the decline in market rents.

Economic downturns can affect certain regions of the world more than others. As the Company's portfolio is not entirely globally diversified, a localized downturn in one of the key regions in which the Company leases assets could have a significant adverse impact on the Company. The Company's significant sources of operating lease revenue by region are summarized in "Outlook - Operating Segments," above.

Over the last few years, several of the Company's customers have experienced financial difficulties arising from a combination of the weakened air carrier market and their own unique financial circumstances and have requested and been granted deferral of certain overdue and/or future rental or reserve payment obligations. It is possible that the Company may enter into additional deferral agreements if the current weakened air carrier environment continues. When a customer requests a deferral of lease obligations, the Company evaluates the lessee's financial plan, the likelihood that the lessee can remain a viable carrier, and whether the deferral will be repaid according to the agreed schedule. The Company may elect to record the deferred rent and reserve payments from the lessee on a cash basis, which could have a material effect on the Company's financial results in the applicable periods.

International Risks. The Company leases assets primarily in overseas markets. Leases with foreign lessees, however, may present different risks than those with domestic lessees. Most of the Company's expected growth is outside of the United States.

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. An economic downturn in a particular country or region may impact a foreign lessee's ability to make lease payments, even if the U.S. and other foreign economies remain stable.

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. In addition, if the Company undertakes certain obligations under a lease to contribute to a repair or improvement and if the work is performed in a foreign jurisdiction and paid for in foreign currency, currency fluctuations resulting in a weaker dollar between the time such agreement is made and the time payment for the work is made may result in an unanticipated increase in U.S. dollar-denominated cost for the Company.

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 payments, increasing the risk of default of that lessee, particularly if its revenue is primarily derived in the local currency.

Foreign lessees that operate internationally may also face restrictions on repatriating foreign revenue to their home country. This could create a cash flow crisis for an otherwise profitable carrier, affecting its ability to meet its lease obligations.

Non-U.S. lessees are not subject to U.S. bankruptcy laws, although there may be debtor protection similar to U.S. bankruptcy laws available in some jurisdictions. Certain countries do not have a central registration or recording system 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. In any event, collection and enforcement may be more difficult and complicated in foreign countries.

Finally, ownership of a leased asset operating in a foreign country and/or by a foreign carrier may subject the Company to additional tax liabilities that are not present with aircraft operated in the United States. Depending on the jurisdiction, laws governing such tax liabilities may be complex, not well formed or not uniformly enforced. In such jurisdictions, the Company may decide to take an uncertain tax position based on the best advice of the local tax experts it engages, which position may be challenged by the taxing authority. If the taxing authority later assesses a liability, the Company may be required to pay penalties and interest on the assessed amount, which penalties and interest would not give rise to a corresponding foreign tax credit on the Company's U.S. tax return.

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Concentration of Lessees and Aircraft Type. For the month ended July 31, 2014, based on monthly operating lease revenue and interest income from finance leases, the Company's five largest customers accounted for a total of approximately 83% of the Company's monthly lease revenue. A lease default by or collection problem with one or a combination of any of these significant customers could have a disproportionate negative impact on the Company's financial results and borrowing base under the Credit Facility, and, therefore, the Company's operating results are especially sensitive to any negative developments with respect to these customers in terms of lease compliance or collection. In addition, if the Company's revenues become overly concentrated in a small number of lessees, the Company could fail to comply with certain financial covenants in its Credit Facility related to customer concentration. In the event of any such failure to be in compliance, the Company will need to seek waivers or amendment of the applicable covenants from its lenders if such compliance failure is not timely cured. Any default under the Credit Facility, if not cured in the time permitted under the Credit Facility or waived by the lenders, could result in foreclosure upon any or all of the assets of the Company.

The dominant types of aircraft in the Company's portfolio are summarized in "Outlook - Operating Segments," above. 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 significant impact on the Company's portfolio value. Such aircraft type concentration would 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.

Investment in New Aircraft Types and Engines. The Company intends to continue to focus solely on regional aircraft and engines. Although the Company has traditionally invested in a limited number of types of turboprop aircraft and engines, the Company has also acquired several types of regional jet aircraft, as well as regional jet aircraft engines, and may continue to seek acquisition opportunities for new types and models of aircraft and engines used in the Company's targeted customer base of regional air carriers. Acquisition of aircraft types and engines not previously acquired by the Company entails greater ownership risk due to the Company's lack of experience managing those assets. The Company believes, however, that the overall industry experience of JMC's personnel and its technical resources should permit the Company to effectively manage such new aircraft types and engines. Further, the broadening of the asset types in the aircraft portfolio may have a benefit of diversifying the Company's portfolio (see "Factors That May Affect Future Results - Concentration of Lessees and Aircraft Type," above).

Engine Leasing Risk. The Company currently has five engines in its portfolio, making up 5% of the Company's total net book value of aircraft and aircraft engines held for lease. The Company may from time to time lease one or more of these engines under industry standard short-term engine leases, which place the risk of an engine failure not caused by lessee negligence or foreign object damage upon the lessor. It is not economically practicable for an engine lessor to insure against that risk. If an engine failure occurs and is not covered by a manufacturer's warranty or is not otherwise caused by circumstances that the lessee is required to cover, the Company's investment in the engine could be a significant loss or the Company might incur a significant maintenance expense.

Interest Rate Risk. The Credit Facility carries a floating interest rate based upon short-term interest rate indices. Lease rates typically, but not always, move over time with interest rates, but market demand and numerous other asset-specific factors also affect lease rates. Because the Company's typical lease rates are fixed at lease origination, interest rate changes during the lease term have no effect on existing lease rental payments. Therefore, if interest rates rise significantly and there is relatively little lease origination by the Company following such rate increases, the Company could experience decreased net income as additional interest expense outpaces revenue growth. Further, even if significant lease origination occurs following such rate increases, other contemporaneous aircraft market forces may result in lower or flat rental rates, thereby decreasing net income.

Reliance on JMC. All management of the Company is performed by JMC under the twenty-year Management Agreement between the Company and JMC that expires in April of 2018 and provides for an asset-based management fee. JMC is not a fiduciary of the Company or its stockholders. The Company's Board of Directors (the "Board") 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, all of 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 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. Certain directors of the Company are also directors of JMC and, as discussed above, the officers of the Company are also officers of JMC and certain officers hold significant ownership positions in both the Company and JHC, the holding company for 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.

Management Fee Structure. All decisions regarding acquisitions and disposal of aircraft from the Company's portfolio are made by JMC. JMC is paid a management fee based on the net asset value of the Company's portfolio. It may also receive a one-time asset acquisition fee upon purchase of an asset by the Company, and a one-time remarketing fee in connection with the sale or re-lease of an asset. Optimization of the results of the Company depends on timing of the acquisition, lease yield on the acquired assets, and re-lease or sale of its portfolio assets. Under the current management fee structure, a larger volume of acquisitions generates acquisition fees and also increases the periodic management fee by increasing the size of the aircraft portfolio. Since the Company's current business strategy involves continued growth of its portfolio and a "buy and hold" strategy, a compensation structure that results in greater compensation with an increased portfolio size is consistent with that strategy.

The compensation structure does, nonetheless, create a situation where a decision by JMC for the Company to forego an asset transaction deemed to be an unacceptable business risk due to the lessee or the aircraft type is in conflict with JMC's own pecuniary interest. As a result, the compensation structure could act to incent greater risk-taking by JMC in asset acquisition decision-making. The Company has established objective target guidelines for yields on acquired assets. Further, the Company's Board, including a majority of the outside independent directors, must approve any acquisition that involves a new asset type. While the Company currently believes the foregoing are effective mitigating factors against undue compensation-incented risk-taking by JMC, there is no assurance that such mechanisms can entirely and effectively eliminate such risk.

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Government Regulation. There are a number of areas in which government regulation may result in costs to the Company. These include aircraft registration safety requirements, required equipment modifications, maximum aircraft age, and aircraft noise requirements. Although it is contemplated that the burden and cost of complying with such requirements will fall primarily upon lessees 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 aircraft 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. Nevertheless, 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 in many cases customers that are private companies without well-established third party credit ratings, 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 competition from larger aircraft leasing companies will not increase significantly or that JMC's reputation 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. A "triple net lease" is a lease under which, in addition to monthly rental payments, the lessee is generally responsible for the taxes, insurance and maintenance and repair of the aircraft arising from the use and operation of the aircraft during the term of the lease. Although the United States Aviation Act may provide some protection with respect to the Company's aircraft assets, it is unclear to what extent such statutory protection would be available to the Company with respect to most of the Company's assets, which are operated in foreign countries where such provisions of the United States Aviation Act may not apply.

The Company's leases generally require a lessee to insure against likely risks of loss or damage to the leased asset, and liability to passengers and third parties pursuant to industry standard insurance policies and require lessees to provide insurance certificates documenting the policy periods and coverage amounts. The Company tracks receipt of the certificates and calendars their expiration dates. Prior to the expiration of an insurance certificate, if a replacement certificate has not been received, the Company reminds the lessee of its obligation to provide current insurance certificates to avoid a default under the lease.

Despite these requirements and procedures, there may be certain cases where the loss is not entirely covered by the lessee or its insurance. The possibility of such an event is remote, but any such uninsured loss with respect to the equipment or insured loss for which insurance proceeds are inadequate might result in a loss of invested capital in and any profits anticipated from, such equipment, as well as a potential claim directly against the Company.

Compliance with Future Environmental Regulations. Compliance with future environmental regulations may harm the Company's business. Many aspects of aircraft operations are subject to increasingly stringent environmental regulations, and growing concerns about climate change may result in the imposition by the U.S and foreign governments of additional regulation of carbon emissions, aimed at either requiring adoption of technology to reduce the amount of carbon emissions or putting in place a fee or tax system on carbon emitters. It is likely that any such regulation will be directed at the Company's customers, as operators of aircraft, or at the Company, as owners of aircraft. Under the Company's triple-net lease arrangements, the Company would likely shift responsibility for compliance to its lessees, but there might be some costs of regulation that the Company could not shift and would itself have to bear. Although it is not expected that the costs of complying with current environmental regulations will have a material adverse effect on the Company's financial position, results of operations, or cash flows, no assurance can be given that the costs of complying with environmental regulations adopted in the future will not have such an effect.

Cyber-Security Risks. The Company believes that it has sufficient cyber-security measures in place commensurate with the risks to the Company of a successful cyber-attack or breach of security. The Company's main vulnerability to a cyber-attack would be interruption of the Company's email communications internally and with third parties, and loss of document sharing between the Company's offices and remote workers. Such an attack could temporarily impede the efficiency of the Company's operations; however, the Company believes that sufficient replacement mechanisms exist in the event of such an interruption that there would not be a material adverse financial impact on the Company's business.

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Warrants. As part of a subordinated debt financing, which was fully repaid in December of 2011, the Company issued warrants to purchase up to 81,224 shares of the Company's common stock that are currently exercisable (and expire on December 31, 2015) and represent approximately 5% of the post-exercise fully diluted capitalization of the Company. The exercise price of the warrants is $8.75 per share. If the warrants to purchase shares are exercised at a time when the exercise price is less than the market price of the Company's common stock, there will be dilution to the existing holders of common stock. This dilution of the Company's common stock could depress its trading price.

Possible Volatility of Stock Price. The market price of the Company's common stock may be subject to fluctuations following developments relating 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, or arising from other investor sentiment unknown to the Company. Because the Company has a relatively small capitalization of approximately 1.5 million shares outstanding, there is a correspondingly limited amount of trading and float of the Company's shares. Consequently, the Company's stock price is more sensitive to a single large trade or a small number of simultaneous trades along the same trend than a company with larger capitalization and higher trading volume and float.


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Source: Edgar Glimpses


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