relative to their net book values, which aggregated to $9,900 and $14,390 at December 31, 2005 and 2006, respectively.
Two of our debt securities, with a fair value of $50,414 at December 31, 2006, have stated maturities in 2010. One of our debt securities with a fair value of $51,127 has a stated maturity in 2011. Our other three debt securities with an aggregate fair value of $19,732 have remaining terms to stated maturity in excess of 10 years after December 31, 2006. All of our debt securities provide for the periodic payment of both principal and interest and are subject to prepayment and/or acceleration depending on certain events, including the sale of the underlying collateral aircraft and events of default. Therefore, the actual maturity of our debt securities may be less than the stated maturities.
We used three separate credit facilities and our first securitization, as described below, to fund a portion of the purchase price of our acquisitions of flight equipment. These borrowings are secured by our interests in the leases on the flight equipment, including the rights to receive rents and other income from the flight equipment, funds on deposit in lockbox accounts and established to collect rents and any security deposits and/or maintenance payments received from lessees and certain other interests
On June 15, 2006, we completed our first securitization, a $560,000 transaction comprised of 40 aircraft, which we refer to as Securitization No. 1. In connection with Securitization No. 1, two of our subsidiaries, ACS Aircraft Finance Ireland plc (“ACS Ireland”) and ACS Aircraft Finance Bermuda Limited (“ACS Bermuda”), which we refer to together with their subsidiaries as the “ACS Group,” issued $560,000 of Class A-1 notes, or the “Notes,” to a newly formed trust, the ACS 2006-1 Pass Through Trust, or the “Trust.” The Trust simultaneously issued a single class of Class G-1 pass through trust certificates, or the “Certificates,” representing undivided fractional interests in the notes. Payments on the Notes will be passed through to holders of the certificates. The Notes are secured by ownership interests in aircraft-owning subsidiaries of ACS Bermuda and ACS Ireland and the aircraft leases, cash, rights under service agreements and any other assets they may hold. Each of ACS Bermuda and ACS Ireland has fully and unconditionally guaranteed the other’s obligations under the notes. However, the Notes are neither obligations of nor guaranteed by Aircastle Limited. The Notes mature on June 20, 2031.
The terms of Securitization No. 1 require the ACS Group to satisfy certain financial covenants, including the maintenance of debt service coverage ratios. The ACS Groups’ compliance with these covenants depends substantially upon the timely receipt of lease payments from their lessees. In particular, during the first five years from issuance, Securitization No. 1 has an amortization schedule that requires that lease payments be applied to reduce the outstanding principal balance of the indebtedness so that such balance remains at 54.8% of the assumed future depreciated value of the portfolio. If the debt service coverage ratio requirements are not met on two consecutive monthly payment dates in the fourth and fifth year following the closing date of Securitization No. 1, and in any month following the fifth anniversary of the closing date, all excess securitization cash flow is required to be used to reduce the principal balance of the indebtedness and will not be available to us for other purposes, including paying dividends to our shareholders.
The Notes provide for monthly payments of interest at a floating rate of one-month LIBOR plus 0.27%, which at December 31, 2006 was 5.62%, and scheduled payments of principal. Financial Guaranty Insurance Company issued a financial guaranty insurance policy to support the payment of interest when due on the Certificates and the payment, on the final distribution date, of the outstanding principal amount of the Certificates. The Certificates are rated Aaa and AAA by Moody’s Investors Service and Standard & Poor’s rating services, respectively. We have entered into a series of interest rate hedging contracts intended to hedge the interest rate exposure associated with issuing floating-rate obligations backed by primarily fixed-rate lease assets. These contracts, together with the guarantee premium, the spread referenced above and other costs of trust administration, result in a fixed rate cost of 6.60% per annum, after the amortization of issuance fees and expenses.
ACS Ireland, which had total assets of $146,990 at December 31, 2006, is a VIE which we consolidate. At December 31, 2006, the outstanding principal amount of ACS Ireland’s notes was $106,366.
Credit Facility No. 2
On February 28, 2006, we entered into a $500,000 revolving credit facility with a group of banks to finance the acquisition of aircraft and related improvements which we refer to as Credit Facility No. 2. The borrowing base is equal to 85% of the net book value of the aircraft. Borrowings under this credit facility incur interest at the one-month LIBOR rate plus 1.25%. Additionally, we are subject to a 0.12% fee on any unused portion of the total committed facility. Credit Facility No. 2 requires the monthly payment of interest and principal, to the extent of 85% of any decrease in the net book value of the assets. Prior to our initial public offering in August 2006, Credit Facility No. 2 limited our ability to pay dividends. After the initial public offering, Credit Facility No. 2 has no restrictions on the amount of dividends we can pay, provided that we are not in default. Effective June 15, 2006, Credit Facility No. 2 was amended to increase the maximum committed amount to $750,000 and to extend the maturity to November 15, 2007. On December 15, 2006, the $750,000 credit facility was amended to increase the maximum committed amount to $1,000,000 and to extend the maturity to December 15, 2008 (“Amended Credit Facility No. 2”). In addition, the borrowing base was revised to equal 65% of the purchase price of aircraft secured under the facility. The interest rate at December 31, 2006 was 6.60%. As of December 31, 2006, we had borrowed $369,328 under Amended Credit Facility No. 2.
Revolving Credit Facility
On December 15, 2006, the Company entered into a $250,000 revolving credit facility (the “Revolving Credit Facility”) with a group of banks. The Revolving Credit Facility provides loans for working capital and other general corporate purposes and also provides for issuance of letters of credit for the account of any borrower up to $250,000 and matures on December 15, 2007. Borrowings under the Revolving Credit Facility bear interest (a) in the case of loans with an interest rate based on the applicable base rate (the “ABR”) plus 0.50% per annum or (b) in the case of loans with an interest rate based on the eurodollar rate (the “EDR”), the EDR plus 1.50% per annum. Additionally, we are subject to a per annum fee on any unused portion of the total committed facility of 0.25%, during periods when the average outstanding loans under the Revolving Credit Facility are less than $125.0 million, and 0.125% per annum when the average outstanding loans are equal to or greater than $125.0 million. Fees on any outstanding letters of credit will equal 1.625% per annum on the stated amount thereof. We are also required to pay customary agency fees. Additionally, we are required to maintain a net worth determined in accordance with GAAP of not less that $550,000. As of December 31, 2006, there were no borrowings under the Revolving Credit Facility. We are not permitted to pay dividends on our common shares to the extent a default or an event of default exists under our Revolving Credit Facility.
Credit Facility No. 1
In February 2005, we entered into a $300,000 revolving credit facility with a group of banks to finance the acquisition of flight equipment and related improvements, which we refer to as Credit Facility No. 1. The interest rate on Credit Facility No. 1 was the one month LIBOR plus 1.50%. In August 2005, the terms of Credit Facility No. 1 were amended to increase the amount of the facility to $600,000. On February 24, 2006, the revolving period of our $600,000 Credit Facility No. 1, was extended to April 28, 2006 and the maximum amount of this credit facility was reduced to $525,000. The other terms of Credit Facility No. 1 remained the same. Monthly payments of interest only continued through repayment of Credit Facility No. 1. Credit Facility No. 1 was repaid in full and terminated on August 4, 2006. In addition, we wrote off the remaining balance of deferred financing fees of $1,840 upon the termination of Credit Facility No. 1.
Credit Facility No. 3
In October 2005, the Company entered into a credit facility for $109,998 with a bank to finance the acquisition of three aircraft which we refer to as Credit Facility No. 3. The interest rate on this facility is one-month LIBOR plus 1.50%. On March 30, 2006, $36,666 of Credit Facility No. 3 was repaid using a portion of the proceeds from the disposition of flight equipment held for sale which had been financed
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under this facility. Credit Facility No. 3 was amended on July 18, 2006, to increase the maximum committed amount by approximately $25,116 and to extend the maturity date to March 31, 2007. The increase in the maximum committed amount was reduced by $25,116 with the closing of the initial public offering. As of December 31, 2006, we had borrowed $73,332 under Credit Facility No. 3 and the interest rate was 6.85%.
The weighted average interest of these credit facilities at December 31, 2004, 2005 and 2006 were 0%, 5.87%,and 6.64%, respectively.
Maturities of the securitization and credit facilities over the next five years and thereafter are as follows:
2007 | | $ | 102,380 | |
2008 | | | 385,387 | |
2009 | | | 24,239 | |
2010 | | | 25,410 | |
2011 | | | 65,668 | |
Thereafter | | | 388,976 | |
| | $ | 992,060 | |
Note 7. Repurchase Agreements
We entered into repurchase agreements to fund a portion of the purchase price of certain of our debt securities. At December 31, 2005 and 2006 the repurchase agreements are secured by liens on the debt securities with a fair value of $11,107 and $105,550, respectively. The repurchase agreements provide for the payment of interest at LIBOR based rates plus spreads ranging from 0.50% to 0.75%. At December 31, 2006 the rate for LIBOR plus 0.50% was 5.85% and the rate for LIBOR plus 0.75% was 6.10%. The repurchase agreements are substantially all with parties other than those from whom we originally purchased the debt investments. At December 31, 2006, the repurchase agreements are scheduled to mature through June 2007. Upon maturity, we plan to refinance the repurchase agreements on similar terms and conditions. The weighted average interest rate of these repurchase agreements was 0%, 5.09% and 5.88% in 2004, 2005 and 2006, respectively.
Note 8. Shareholders’ Equity and Share Based Payment
In August 2006, the Company completed its initial public offering (“IPO”) of 10,454,535 common shares at a price of $23.00 per share, raising $240,454 before offering costs. The net proceeds of the initial public offering, after our payment of $16,832 in underwriting discounts and commissions, and $4,027 in offering expenses were $219,595. $205,470 of the net proceeds was used to repay a portion of Credit Facility No. 2. The remainder of the proceeds was used for working capital requirements and to fund additional aircraft acquisitions.
On February 8, 2006, Fortress purchased an additional 3,693,200 common shares at $10 per share for a total amount of $36,932. On July 21, 2006, the Company returned $36,932 of cash to Fortress in exchange for the cancellation of 3,693,200 of our common shares at $10 per share.
In January 2006, the board of directors (the “Board”) and the Fortress Shareholders adopted the Aircastle Investment Limited 2005 Equity and Incentive Plan, and the Board and the Fortress Shareholders approved an amendment to and restatement thereof on July 20, 2006 (as so amended and restated, the “2005 Plan”). The purpose of the 2005 Plan is to provide additional incentive to selected management employees. The 2005 Plan provides that the Company may grant (a) share options, (b) share appreciation rights, (c) awards of restricted shares, deferred shares, performance shares, unrestricted shares or other share-based awards, or (d) any combination of the foregoing. Four million shares were reserved under the 2005 Plan, increasing by 100,000 each year beginning in 2007 through and including 2016. The 2005 Plan provides that grantees of restricted shares will have all of the rights of shareholders, including the right to
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receive dividends, other than the right to sell, transfer, assign or otherwise dispose of the shares until the lapse of the restricted period. Generally, the restricted shares vest over three or five year periods based on continued service and are being expensed on a straight line basis over the requisite service period of the awards. The terms of the grants provide for accelerated vesting under certain circumstances, including termination without cause following a change of control.
In February and March of 2006, the Board ratified the initial grants under the 2005 Plan of 347,500 restricted shares in the first half of 2005 and 25,000 restricted shares on July 5, 2005 which were provided for in certain employment contracts, and approved new grants of 412,500 restricted shares. The grants also imposed lock-up restrictions on restricted shares from the date of grant through 120 days after the date of any initial public offering, and provide for certain further restrictions and notice periods thereafter.
During the year ended December 31, 2005, a total of 372,500 restricted shares were granted at a fair value of $8.50. The fair value of the restricted shares granted in 2005 was determined based on a retrospective valuation performed by an unrelated valuation specialist. The valuation relied on observed equity investments made by the Fortress Shareholders, adjusted to reflect the lack of marketability of the shares granted to employees.
A summary of the fair value of nonvested shares for the year ended December 31, 2006 is as follows:
Nonvested Shares | | Shares
(in 000’s) | | Weighted
Average
Grant Date
Fair Value | | Fair Value of
Nonvested
Shares at
Grant Date | |
Nonvested at January 1, 2006 | | 372.5 | | $ | 8.50 | | $ | 3,166 | |
Granted | | 604.3 | | | 23.59 | | | 14,258 | |
Cancelled | | (4.5) | | | 22.00 | | | (99) | |
Vested | | (71.0) | | | 14.92 | | | (1,059) | |
Forfeited | | — | | | — | | | — | |
Nonvested at December 31, 2006 | | 901.3 | | $ | 18.05 | | $ | 16,266 | |
The fair value of the restricted shares granted in 2006 prior to the IPO was determined based on an estimate of the offering range per share from the anticipated initial public offering. The fair value of restricted shares granted in 2006 subsequent to the date of the initial public offering was determined based upon the market price of the shares at the grant date. We anticipate that the current requisite service periods will be obtained for employees with awards. The total unrecognized compensation cost as of December 31, 2005 and 2006 in the amount of $2,757 and $12,667, respectively is expected to be recognized over a weighted average period of four years.
In May 2006, 200,000 of the Company’s common shares were purchased by a family trust of an individual who was appointed to the Board on July 20, 2006, for cash consideration of $5 per share. In addition, certain members of our management purchased 77,000 of the Company’s common shares in exchange for cash consideration in the amount of $10 per share. The respective purchase prices of these shares were below the fair value of $22 per share for the Company’s common shares. Accordingly, the Company recorded non-cash share based payment expense of approximately $4,324 which is recorded as selling, general and administrative expense in the accompanying consolidated statement of operations for the year ended December 31, 2006. The fair value of the Company’s common shares was determined based on an estimate of the offering range per share from our initial public offering.
Note 9. Dividends
On July 20, 2006, the Board declared a dividend from cash on hand in the amount of $0.35 per common share, or an aggregate of $14,367 to shareholders of record on July 26, 2006, which was paid on July 31, 2006. In addition, on August 2, 2006, our Board declared a dividend of $0.156 per common share, or an aggregate of $6,403 to shareholders of record on August 1, 2006, which was paid on August 15, 2006.
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The Company paid these dividends so that holders of our common shares prior to the initial public offering would receive a distribution for the period prior to the initial public offering.
On October 9, 2006 the Board declared a partial third quarter dividend on its common shares of $0.194 per share, or $9,992 to holders of record of as of October 31, 2006. This dividend was paid on November 15, 2006.
On December 13, 2006 the Board declared a fourth quarter dividend of $0.4375 per common share, or an aggregate of $22,584 to shareholders of record as of December 29, 2006, which was paid on January 15, 2007.
Note 10. Earnings Per Share
Aircastle is required to present both basic and diluted earnings (loss) per share (“EPS”). Basic EPS is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during each period. The weighted average shares outstanding exclude our unvested shares for purposes of Basic EPS. Diluted EPS is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period while also giving effect to all potentially dilutive common shares that were outstanding during the period based on the treasury stock method. For the year ended December 31, 2005, based on the treasury stock method, we had 24,071 anti-dilutive common share equivalents resulting from restricted shares. There were no anti-dilutive common shares for the year ended December 31, 2006.
The calculations of both basic and diluted earnings (loss) per share for the period from October 29 (Commencement of Operations) to December 31, 2004, and for the years ended December 31, 2005 and 2006 are as follows:
| | For the Period
from October 29
(Commencement of
Operations) to
December 31,
2004 | | Year Ended
December 31 | |
| | | 2005 | | 2006 | |
Numerator | | | | | | | | | | |
Income (loss) from continuing operations | | $ | (1,143) | | $ | (803) | | $ | 45,920 | |
Earnings from discontinued operations, net of income taxes | | | (322) | | | 1,031 | | | 5,286 | |
Net income (loss) | | | (1,465) | | $ | 228 | | $ | 51,206 | |
Denominator | | | | | | | | | | |
Denominator for basic earnings per share | | | 40,000,000 | | | 40,000,000 | | | 45,758,242 | |
Effect of dilutive restricted shares | | | — | | | —(a) | | | 293,757 | |
Denominator for diluted earnings per share | | | 40,000,000 | | | 40,000,000 | | | 46,051,999 | |
Basic Earnings (loss) per share: | | | | | | | | | | |
Income (loss) from continuing operations | | $ | (0.03) | | $ | (0.02) | | $ | 1.00 | |
Earnings from discontinued operations, net of income taxes | | | (0.01) | | $ | 0.03 | | $ | 0.12 | |
Net income (loss) per share | | $ | (0.04) | | $ | 0.01 | | $ | 1.12 | |
Diluted Earnings (loss) per share: | | | | | | | | | | |
Income (loss) from continuing operations | | $ | (0.03) | | $ | (0.02) | | $ | 1.00 | |
Earnings from discontinued operations, net of income taxes | | | (0.01) | | $ | 0.03 | | $ | 0.11 | |
Net income (loss) per share | | $ | (0.04) | | $ | 0.01 | | $ | 1.11 | |
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Note 11. Income Taxes
Income taxes have been provided based upon the tax laws and rates in countries in which our operations are conducted and income is earned. The Company received an assurance from the Bermuda Minister of Finance that it would be exempted from local income, withholding and capital gains taxes until March 2016. Consequently, the provision for income taxes recorded relates to income earned by certain subsidiaries of the Company which are located in or earn income in jurisdictions that impose income taxes, primarily the United States and Ireland.
The sources of income (loss) from continuing operations before income taxes for the years ended December 31, 2005 and 2006 were as follows:
| | Year Ended
December 31, | |
| | 2005 | | 2006 | |
U.S. operations | | $ | 676 | | $ | 1,566 | |
Non-U.S. operations | | | (539) | | | 49,199 | |
Total | | $ | 137 | | $ | 50,765 | |
The components of the income tax provision from continuing operations for the year ended December 31, 2005 and 2006 consisted of the following:
| | Year Ended
December 31, | |
| | 2005 | | 2006 | |
Current: | | | | | | | |
United States: | | | | | | | |
Federal | | $ | 373 | | $ | 1,924 | |
State | | | 184 | | | 463 | |
Non-U.S | | | 50 | | | 118 | |
Current income tax provision | | | 607 | | | 2,505 | |
Deferred: | | | | | | | |
United States: | | | | | | | |
Federal | | | 96 | | | (331) | |
State | | | (26) | | | (66) | |
Non-U.S | | | 263 | | | 2,737 | |
Deferred income tax provision | | | 333 | | | 2,340 | |
Total | | $ | 940 | | $ | 4,845 | |
All of our aircraft owning subsidiaries are non U.S. corporations that, depending upon the flight activities of the leased aircraft, generally earn income from sources outside the United States and therefore are exempt from U.S. federal, state and local income taxes. Income earned by our non-U.S. subsidiaries that is attributable to leased aircraft used for flights to or from places within the United States are subject to U.S. federal income tax. In addition, certain of our non-U.S. subsidiaries are subject to state and local income taxes on a portion of their income as a result of aircraft used for flights to or from particular states or localities. The Company has a U.S. based subsidiary which provides management services to our non-U.S. subsidiaries and is subject to U.S. federal, state and local income taxes.
For the period from October 29, 2004 (commencement of operations) through December 31, 2004, the Bermuda companies sustained operating losses for which no benefit was recorded.
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Significant components of the Company’s deferred tax assets and liabilities at December 31, 2005 and 2006 consisted of the following:
| | December 31,
2005 | | December 31,
2006 | |
Deferred tax assets: | | | | | | | |
Non-cash share based payments | | $ | 152 | | $ | 1,051 | |
Net operating loss carry forwards | | | 49 | | | 1,176 | |
Other | | | 6 | | | 246 | |
Total deferred tax assets | | | 207 | | | 2,473 | |
Deferred tax liabilities | | | | | | | |
Accelerated depreciation | | | (333) | | | (4,971) | |
Other | | | — | | | (176) | |
U.S. federal withholding tax on unremitted earnings | | | (207) | | | — | |
Total deferred tax liabilities | | | (540) | | | (5,147) | |
Net deferred tax liabilities | | $ | (333) | | $ | (2,674) | |
The Company had approximately $2,836 of net operating loss carry forwards available at December 31, 2006 to offset future taxable income subject to U.S. graduated tax rates. If not utilized, these loss carryforwards expire in 2027. The company also had net operating loss carryforwards of $723 with no expiration date to offset future Irish taxable income. Deferred tax assets and liabilities are included in other assets and accounts payable and accrued liabilities, respectively, in the accompanying consolidated balance sheets.
We do not expect to incur income taxes on future distributions of undistributed earnings of non-U.S. subsidiaries, and, accordingly, no deferred income taxes have been provided for the distributions of such earnings. As of December 31, 2006 we have elected to permanently reinvest our accumulated undistributed U.S. earnings of $2,548. Accordingly no U.S. withholding taxes have been provided. Withholding tax of $764 would be due if such earnings were remitted.
Differences between statutory income tax rates and our effective income tax rates applied to pre-tax income consisted of the following:
| | December 31,
2005 | | December 31,
2006 | |
Notional U.S. federal income tax expense at the statutory rate: | | $ | 21 | | $ | 17,768 | |
U.S. state and local income tax, net | | | 103 | | | 186 | |
Non-U.S. operations | | | 558 | | | (13,641) | |
Non-deductible expenses in the U.S. | | | 13 | | | 644 | |
Other | | | 245 | | | (112) | |
Provision for income taxes | | $ | 940 | | $ | 4,845 | |
Note 12. Accumulated Comprehensive Income
Accumulated comprehensive income includes net income (loss), the changes in the fair value of derivatives, reclassification into earnings of amounts previously deferred relating to our derivative financial instruments and the change in unrealized appreciation of debt securities.
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The components of accumulated other comprehensive income was as follows:
| | Fair Value of
Derivatives | | Unrealized
Appreciation
Debt
Securities | | Accumulated
Other
Comprehensive
Income | |
January 1, 2005 | | $ | — | | $ | — | | $ | — | |
Net change in fair value of derivatives | | | 1,864 | | | — | | | 1,864 | |
Net change in unrealized appreciation of debt securities | | | — | | | 9,900 | | | 9,900 | |
December 31, 2005 | | | 1,864 | | | 9,900 | | | 11,764 | |
Net change in fair value of derivatives | | | (4,132) | | | — | | | (4,132) | |
Derivative gain reclassified into earnings | | | (2,213) | | | — | | | (2,213) | |
Net change in unrealized appreciation of debt securities | | | — | | | 4,490 | | | 4,490 | |
December 31, 2006 | | $ | (4,481) | | | 14,390 | | | 9,909 | |
Note 13. Commitments and Contingencies
Rent expense, primarily for the corporate office and sales and marketing facilities, was approximately $293 and $777 for the years ended December 31, 2005 and 2006, respectively. Amounts in 2005 include $43 of rent expense paid to Fortress for occupancy of shared space.
As of December 31, 2006 Aircastle is obligated under non-cancelable operating leases relating principally to office facilities, for future minimum lease payments are as follows:
December 31, | | Amount |
2007 | | $ | 658 |
2008 | | | 666 |
2009 | | | 673 |
2010 | | | 680 |
2011 | | | 686 |
Thereafter | | | 1,320 |
| | $ | 4,683 |
At December 31, 2006, Aircastle had letters of intent to acquire six aircraft for an estimated purchase price of $230,850. Three acquisitions were completed during first quarter of 2007, one acquisition is anticipated to be completed in during the first half of 2007, and two of the letters of intent were subsequently cancelled during the first quarter of 2007. The purchase price of the aircraft under these letters of intent is subject to variable price provisions that typically reduce the final purchase price if the actual closing occurs beyond an initially agreed upon date.
Note 14. Related Party Transactions
During 2004 and 2005, Fortress provided certain support services to Aircastle. These support services were primarily for payroll, benefits and administrative services and rent. Fortress requires Aircastle to reimburse it for costs incurred on behalf of Aircastle. These costs consist primarily of professional services and office supplies purchased from third parties. These expenses are charged to Aircastle at cost and are included in selling, general and administrative expenses in our consolidated statements of operations. Total costs of direct operating services were $1,098 in 2004; $311 in 2005 and $228 in 2006.
Through December 31, 2006, Aircastle employees participated in various benefit plans sponsored by Fortress including a voluntary savings plan (“401(k) Plan”) and other health and benefit plans. Aircastle reimbursed Fortress $13, $155 and $627 in 2004, 2005 and 2006, respectively, for its costs under the 401(k)
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Plan and the health and benefit plans. Aircastle also reimburses Fortress for matching contributions up to 3% of eligible earnings. At December 31, 2006, Aircastle accrued $113 in annual contributions for the 2006 plan year for our employees’ participation in the 401(k) Plan sponsored by Fortress.
As of December 31, 2005 and 2006, $105 and $132, respectively, were payable to Fortress.
In May 2006, two of our operating subsidiaries entered into service agreements to provide certain leasing, remarketing, administrative and technical services to a Fortress entity, with respect to four aircraft owned by the Fortress entity and leased to third parties. Our responsibilities include remarketing the aircraft for lease or sale, invoicing the lessees for expenses and rental payments, reviewing maintenance reserves, reviewing the credit of lessees, arranging for the periodic inspection of the aircraft, securing the return of the aircraft when necessary. The agreements also provide that the Fortress entity will pay us 3.0% of the collected rentals with respect to leases of the aircraft, plus expenses incurred during the service period and will pay us 2.5% of the gross sales proceeds from the sale of any of the aircraft plus expenses incurred during the service period. As of December 31, 2006, we had accrued $209 in fees due from the Fortress entity. The service agreements have an initial term which expires on December 31, 2008, but will continue thereafter unless one party terminates the agreement by providing the other with advance written notice.
On August 10, 2006 we acquired an aircraft from an affiliate of one of the Fortress Shareholders for a purchase price of $11,063 which we believe represented fair value at the acquisition date.
For the years ended December 31, 2005 and 2006, Aircastle paid $235 and $1,124, respectively for legal fees related to the establishment and financing activities of our Bermuda subsidiaries, and, for the years ended December 31, 2005 and 2006, Aircastle paid $155 and $120 for Bermuda corporate services related to our Bermuda companies to a law firm and a corporate secretarial services provider affiliated with a Bermuda resident director serving on certain of our subsidiaries” board of directors. The Bermuda resident director serves as an outside director of these subsidiaries.
Note 15. Derivatives
The objective of our hedging policy is to adopt a risk averse position with respect to changes in interest rates. Accordingly, we have entered into a number of interest rate swaps and interest rate forward contracts to hedge the current and expected future interest rate payments on our variable rate debt. Interest rate swaps are agreements in which a series of interest rate flows are exchanged with a third party over a prescribed period. An interest rate forward contract is an agreement to make or receive a payment at the end of the period covered by the contract, with reference to a change in interest rates. The notional amount on a swap or forward contract is not exchanged. Our swap transactions typically provide that we make fixed rate payments and receive floating rate payments to convert our floating rate borrowings to fixed rate obligations to better match the largely fixed rate cash flows from our investments in flight equipment and debt securities. Similarly, our interest rate forward contracts typically provide for us to receive payment if interest rates increase and make a payment if they decrease. We held the following interest rate derivative contracts as of December 31, 2006:
Hedged Item | | Notional
Amount | | Effective
Date | | Maturity
Date | | Floating
Rate | | Fixed
Rate | | Fair Value of
Derivative
Asset or
(Liability) | |
| | (Dollars in thousands) | |
Securitization No. 1 | | $ | 549,400 | | Jun-06 | | Jun-16 | | 1 Month LIBOR + 0.27% | | 5.78 | % | $ | (15,311) | |
Amended Credit Facility No. 2 and Credit Facility No. 3 | | | 500,000 | | Mar-06 | | Mar-11 | | 1 Month LIBOR | | 5.07 | % | | (2,007) | |
Amended Credit Facility No. 2 and Credit Facility No. 3 | | | 200,000 | | Jan-07 | | Aug-07 | | 1 Month LIBOR | | 5.06 | % | | (717) | |
Repurchase Agreement | | | 67,000 | | Feb-06 | | Jul-10 | | 1 Month LIBOR | | 5.02 | % | | 157 | |
Repurchase Agreement | | | 5,000 | | Dec-05 | | Sep-09 | | 3 Month LIBOR | | 4.94 | % | | 22 | |
Repurchase Agreement | | | 2,900 | | Jun-05 | | Mar-13 | | 1 Month LIBOR | | 4.21 | % | | 134 | |
Total | | $ | 1,324,300 | | | | | | | | | | $ | (17,722) | |
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The counterparties to these agreements are highly rated financial institutions. In the unlikely event that the counterparties fail to meet the terms of the interest rate swap contracts, our exposure is limited to the interest rate differential on the notional amount at each settlement period over the life of the agreements. We do not anticipate any non-performance by the counterparties.
On June 1, 2006, we entered into a series of forward contracts to hedge the variable interest rate payments on Securitization No. 1. The notional amounts of the initial forward contracts in that series start at $560,000 with respect to the July 2006 forward contract and decrease monthly based on the projected principal payments on the certificates. The terms of the forward contracts provide for a comparison of, on average, a fixed rate of 5.78% per annum and of one-month LIBOR plus 0.27%. The aggregate fair value of the forward contracts at December 31, 2006 was a payable of $15,311. The interest rate forward contracts are treated as cash flow hedges for accounting purposes with fair value adjustments recorded as a component of other comprehensive income on our balance sheet.
On March 21, 2006 we entered into a series of interest rate forward contracts to hedge the variable interest rate payments on debt we expected to incur to finance aircraft acquisitions over the next year. The notional amounts of the forward contracts in that series started at $100,000 with respect to the March 2006 forward contract and increased to a maximum of $500,000 with respect to the December 2006 forward contract. The increase in notional amount over time reflected projected aircraft acquisitions and related borrowings through December 2006. To the extent that actual interest payments on borrowings do not match anticipated cash flows from forward contracts, we may be required to recognize additional income or expense on the forward contracts. The terms of the forward contracts provide for a comparison of, on average, a fixed rate of 5.07% per annum and of one-month LIBOR. The aggregate fair value of the forward contracts at December 31, 2006 was a payable of $2,007. The interest rate forward contracts are treated as cash flow hedges for accounting purposes with fair value adjustments recorded as a component of other comprehensive income on our balance sheet.
In November 2006 we entered into a $200,000 notional interest rate swap to hedge the variable interest payments we expect to incur to finance aircraft acquisitions over the next year. The terms of the swap provide for payment of a fixed rate of 5.06% and the receipt of one month LIBOR. The aggregate fair value of the swaps at December 31, 2006 was a payable of $717. This swap has a start date of January 15, 2007 and a mandatory termination date of August 15, 2007. We have designated this interest rate swap as a cash flow hedge for accounting purposes.
In March 2006 we designated an interest rate swap which we had entered into in February 2006 as a hedge of the future variable-rate interest payments on a repurchase agreement we executed to finance our acquisition of securities. The interest rate swap had an initial notional principal amount of $74,000 and decreases periodically based on estimated projected principal payments on the securities. The interest rate swap, which matures in July 2010, requires that we make semi-annual payments of a fixed rate of 5.02% per annum and receive monthly an amount based on the one-month LIBOR rate and the then current notional principal amount. At December 31, 2006 the fair value of the swap was a receivable of $157. The interest rate swap is treated as a cash flow hedge for accounting purposes with fair value adjustments recorded as a component of other comprehensive income on our balance sheet.
On December 5, 2005, we entered into a four-year interest rate swap with a notional amount of $5,000 to hedge a repurchase agreement we had entered into to finance our acquisition of securities. The swap requires that we make semi-annual fixed rate payments of 4.94% and receive quarterly floating rate payments equal to three-month LIBOR. The fair value of the swap was a (payable) receivable of ($17) and $22 at December 31, 2005 and 2006, respectively. The interest rate swap is treated as a cash flow hedge for accounting purposes with fair value adjustments recorded as a component of other comprehensive income on our balance sheet.
On June 28, 2005, we entered into a seven-year interest rate swap with a notional amount of $2.9 million to hedge a floating rate repurchase agreement we had entered into to finance our acquisition of
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securities. The swap requires that we make quarterly fixed rate payments at 4.21% per annum and receive monthly floating rate payments equal to one-month LIBOR. The fair value of the swap was a receivable of $116 and $134 at December 31, 2005 and 2006. The interest rate swap is treated as a cash flow hedge for accounting purposes with fair value adjustments recorded as a component of other comprehensive income on our balance sheet.
During 2005, we also entered into two forward starting interest rate swaps with a total notional amount of $600,000 to hedge the risk of interest rate fluctuations with respect to anticipated financings. The primary risk involved is that interest rates may increase between the date flight equipment is acquired and the closing of the anticipated financings. At December 31, 2005, the fair value of the $400,000 notional swap was a receivable of $3,492 and the fair value of the $200,000 notional swap was a payable of ($1,854). In June 2006, we terminated these two swaps resulting in a net deferred gain of $15,938 which will be amortized into income using the interest method over the life of Securitization No. 1 (the anticipated financing), which is expected to be five years. It is expected that approximately $3,967 of these existing gains will be reclassified into earnings in the next twelve months. This amount is included in interest expense on the consolidated statements of operations.
For the years ended December 31, 2005 and 2006, we recognized ineffectiveness gains (losses) of ($126) and $814 related to our cash flow hedges. These amounts are included in interest expense on the consolidated statements of operations. We did not have any derivatives for the period October 29, 2004 (commencement of operations) through December 31, 2004.
Note 16. Segment Reporting
We have two reportable segments: Aircraft Leasing and Debt Investments. We present our segment information on a contribution margin basis consistent with the information that our chief executive officer (the Chief Operating Decision Maker (“CODM”) reviews in assessing segment performance and allocating resources. Contribution margin includes revenue, depreciation, interest expense and other expenses that are directly connected to our business segments. We believe contribution margin is an appropriate measure of performance because it reflects the marginal profitability of our business segments excluding overhead.
Aircraft Leasing
The Aircraft Leasing segment consists of amounts earned from our commercial aircraft leasing operations. All of our aircraft are subject to net operating leases whereby the lessee is generally responsible for maintaining the aircraft and paying all operational and insurance costs. In many of our leases we are obligated to bear a portion of maintenance costs or costs associated with modifications required by manufacturers or regulators. We retain the benefit, and bear the risk, of re-leasing and the residual value of the aircraft upon expiration or early termination of the lease.
Debt Investments
The Debt Investments segment consists of amounts earned from our investments in debt securities secured by commercial jet aircraft including enhanced equipment trust certificates, or EETCs, and other forms of collateralized debt.
Information on reportable segments for the period October 29, 2004 (commencement of operations) to December 31, 2004 is as follows:
| | Period October 29 to December 31, 2004 | |
| | Aircraft
Leasing | | Debt
Investments | | Total | |
Revenues | | | | | | | | | | |
Lease rentals | | $ | 78 | | $ | — | | $ | 78 | |
Interest income | | | — | | | — | | | — | |
Other revenue | | | — | | | — | | | — | |
Total revenues | | $ | 78 | | | — | | $ | 78 | |
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| | Period October 29 to December 31, 2004 | |
| | Aircraft
Leasing | | Debt
Investments | | Total | |
Expenses | | | | | | | | | | |
Depreciation | | | 102 | | | — | | | 102 | |
Interest | | | — | | | — | | | — | |
Other expenses | | | 11 | | | — | | | 11 | |
Total expenses | | | 113 | | | — | | | 113 | |
Contribution Margin | | $ | (35) | | $ | — | | $ | (35) | |
Segment Assets | | $ | 72,230 | | $ | — | | $ | 72,230 | |
Information on reportable segments for the years ended December 31, 2005 and 2006 is as follows:
| | Year Ended December 31, 2005 | | Year Ended December 31, 2006 | |
| | Aircraft
Leasing | | Debt
Investments | | Total | | Aircraft
Leasing | | Debt
Investments | | Total | |
Revenues | | | | | | | | | | | | | | | | | | | |
Lease rentals | | $ | 28,590 | | $ | — | | $ | 28,590 | | $ | 173,605 | | $ | — | | $ | 173,605 | |
Interest income | | | — | | | 2,942 | | | 2,942 | | | — | | | 9,038 | | | 9,038 | |
Other revenue | | | 2 | | | 104 | | | 106 | | | 209 | | | — | | | 209 | |
Total revenues | | | 28,592 | | | 3,046 | | | 31,638 | | | 173,814 | | | 9,038 | | | 182,852 | |
Expenses | | | | | | | | | | | | | | | | | | | |
Depreciation | | | 11,121 | | | — | | | 11,121 | | | 52,895 | | | — | | | 52,895 | |
Interest | | | 7,999 | | | 173 | | | 8,172 | | | 51,194 | | | 4,572 | | | 55,766 | |
Other expenses | | | 783 | | | — | | | 783 | | | 1,261 | | | — | | | 1,261 | |
Total expenses | | | 19,903 | | | 173 | | | 20,076 | | | 105,350 | | | 4,572 | | | 109,922 | |
Contribution Margin | | $ | 8,689 | | $ | 2,873 | | $ | 11,562 | | $ | 68,464 | | $ | 4,466 | | $ | 72,930 | |
Segment Assets | | $ | 768,934 | | $ | 27,447 | | $ | 796,381 | | $ | 1,694,485 | | $ | 129,087 | | $ | 1,823,572 | |
Total contribution margin reported as a segment profit for reportable business segments is reconciled to income (loss) from continuing operations before income taxes for the period October 29 (Commencement of Operations) to December 31, 2004 and for the years ended December 31, 2005 and 2006 as follows:
| | 2004 | | 2005 | | 2006 | |
Contribution Margin | | $ | (35) | | $ | 11,562 | | $ | 72,930 | |
Selling, general and administrative expenses | | | (1,117) | | | (12,493) | | | (27,836) | |
Depreciation and other expenses | | | — | | | (258) | | | (529) | |
Interest income on cash balances | | | 9 | | | 1,326 | | | 6,200 | |
Income (loss) from continuing operations before income taxes | | $ | (1,143) | | $ | 137 | | $ | 50,765 | |
The Company’s CODM does not consider selling, general and administrative expenses, depreciation from leasehold improvements and office equipment and other expenses in the evaluation of the operating segment’s results as such costs are recurring and do not bear a direct correlation to operating results. The Company’s CODM does not consider interest income on all cash balances in the evaluation of the operating segment’s results as such amounts do not bear a direct correlation to operating results.
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Total segment assets are reconciled to total assets as follows:
| | December 31,
2005 | | December 31
2006 | |
Segment Assets | | $ | 796,381 | | $ | 1,823,572 | |
Operating cash accounts | | | 79,943 | | | 58,118 | |
Flight equipment held for sale | | | 89,401 | | | 31,280 | |
All other | | | 1,807 | | | 5,733 | |
| | $ | 967,532 | | $ | 1,918,703 | |
Note 17. Quarterly Financial Data (Unaudited)
Quarterly results of our operations for the years ended December 31, 2005 and 2006 are summarized below (in thousands, except per share amounts):
| | First
Quarter | | Second
Quarter | | Third
Quarter | | Fourth
Quarter | |
2005 | | | | | | | | | | | | | |
Revenues | | $ | 2,187 | | $ | 4,140 | | $ | 6,238 | | $ | 19,073 | |
Income (loss) from continuing operations | | | (659) | | | (864) | | | (2,061) | | | 2,781 | |
Earnings from discontinued operations | | | (715) | | | (12) | | | 455 | | | 1,303 | |
Net Income (loss) | | $ | (1,374) | | $ | (876) | | $ | (1,606) | | $ | 4,084 | |
Basic earnings (loss) per share | | | | | | | | | | | | | |
Income (loss) from continuing operations | | $ | (0.01) | | $ | (0.02) | | $ | (0.05) | | $ | 0.07 | |
Discontinued operations | | | (0.02) | | | — | | | 0.01 | | | 0.03 | |
Net income | | $ | (0.03) | | $ | (0.02) | | $ | (0.04) | | $ | 0.10 | |
Diluted earnings (loss) per share | | | | | | | | | | | | | |
Income (loss) from continuing operations | | $ | (0.01) | | $ | (0.02) | | $ | (0.05) | | $ | 0.07 | |
Discontinued operations | | | (0.02) | | | — | | | 0.01 | | | 0.03 | |
Net income (loss) | | $ | (0.03) | | $ | (0.02) | | $ | (0.04) | | $ | 0.10 | |
2006(1) | | | | | | | | | | | | | |
Revenues | | $ | 31,393 | | $ | 40,469 | | $ | 51,436 | | $ | 59,554 | |
Income from continuing operations | | | 7,435 | | | 4,708 | | | 14,712 | | | 19,065 | |
Earnings from discontinued operations | | | 3,745 | | | 342 | | | 470 | | | 729 | |
Net Income | | $ | 11,180 | | $ | 5,050 | | $ | 15,182 | | | 19,794 | |
Basic earnings per share | | | | | | | | | | | | | |
Income from continuing operations | | $ | 0.18 | | $ | 0.11 | | $ | 0.31 | | $ | 0.38 | |
Discontinued operations | | | 0.09 | | | .01 | | | 0.01 | | | 0.01 | |
Net income | | $ | 0.27 | | $ | 0.12 | | $ | 0.32 | | $ | 0.39 | |
Diluted earnings per share | | | | | | | | | | | | | |
Income from continuing operations | | $ | 0.18 | | $ | 0.10 | | $ | 0.31 | | $ | 0.38 | |
Discontinued operations | | | 0.09 | | | 0.01 | | | 0.01 | | | 0.01 | |
Net income | | $ | 0.27 | | $ | 0.11 | | $ | 0.32 | | $ | 0.39 | |
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______________(1) | During the second quarter of 2006, we recorded compensation to a director and employees for a non-cash share based payment expense for the purchase of common shares below fair value in the amount of $4,324. During the second quarter of 2006, we wrote off the remaining deferred financing fees in the amount of $1,840 related to the termination of Credit Facility No 1. |
The sum of the quarterly earnings per share amounts does not equal the annual amount reported since per share amounts are computed independently for each period presented.
Note 18. Subsequent Events
Aviation Asset Acquisitions
From January 1, 2007 through March 15, 2007, we acquired additional aviation assets for an aggregate purchase price of approximately $438,387, including five aircraft associated with the Guggenheim Aviation Investment Fund LP (“GAIF”) transaction (see below). The acquisitions were funded with borrowings under our credit facilities. At March 15, 2007, all of the purchased aircraft are subject to operating leases.
As of March 15, 2007, Aircastle had binding letters of intent to additional aviation assets with an estimated purchase price of $107,450. In addition, on January 22, 2007 Aircastle entered into a definitive purchase agreement with GAIF to purchase 38 aircraft for an aggregate purchase price of approximately $1,594,950. As of March 15, 2007 Aircastle had acquired five of these aircraft, which are included in the eight total acquired aviation assets above, for a purchase price of approximately $258,751, leaving the remaining 33 to be acquired at an aggregate purchase price of approximately $1,336,199. The GAIF aircraft will be purchased in a series of closings scheduled to occur through February 2009. The closing of each purchase is contingent on the seller meeting certain conditions precedent. The Company expects that all of the non-GAIF aircraft will be acquired during the first and second quarters of 2007. The purchase price of certain of the aircraft is subject to variable price provisions that typically reduce the final purchase price if the actual closing occurs beyond an initially agreed upon date.
Shareholders’ Equity
On February 13, 2007, the Company completed a follow-on public offering of 15,525,000 common shares at a price of $33.00 per share, raising $512,325 before offering costs. Net proceeds of the offering, after our payment of $17,931 in underwriting discounts and commissions and $1,550 in offering expenses, were $492,844. $473,074 of the net proceeds was used to repay borrowings under Amended Credit Facility No. 2 and the Revolving Credit Facility as of January 31, 2007. The remainder of the net proceeds were used for other general corporate purposes.
On March 14, 2007, the Board declared a first quarter dividend of $0.50 per Common Share, or an aggregate of $33,634 payable on April 13, 2007 to the shareholders of record as of March 30, 2007.
Financing
On January 22, 2007, the $1,000,000 Amended Credit Facility No. 2 was amended to increase the maximum committed amount to $1,250,000; provided that such amount will reduce to $1,000,000 on the earlier of (1) the closing of our next securitization financing or (2) June 30, 2007 (or, if we pay a commitment fee to the lenders, December 31, 2007).
On January 22, 2007, the Revolving Credit Facility was amended to increase the maximum committed amount to $450,000. However, such amount was reduced back to $250,000 upon the closing of our follow-on offering in February 2007.
On January 23, 2007, we entered into three interest rate swaps with a combined notional amount of $920,000 to hedge the variable interest payments on debt we expect to incur to finance aircraft acquisitions over the next several years. The terms of the swap provide for payment of a fixed rate of 5.14%, 5.14% and 5.16%, respectively, and receipt of one-month LIBOR on the notional amount. These swaps have a start date of February 15, 2007, July 15, 2007 and January 15, 2008, respectively, a termination date of April 15, 2017, December 15, 2017 and February 15, 2019, respectively, and a mandatory early termination date of
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August 15, 2007, August 15, 2008 and February 15, 2009, respectively. We have designated these interest rate swaps as cash flow hedges for accounting purposes.
On January 26, 2007, Credit Facility No. 3 was amended to extend the maturity date from March 31, 2007 to the earlier of September 30, 2007 or the closing of the next securitization.
At December 31, 2006, two of the repurchase agreements totaling $75.0 million matured on March 1, 2007 and were subsequently extended to March 1, 2008; and one of the repurchase agreements for $5.9 million matured on March 12, 2007 and was subsequently extended to September 12, 2007.
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