Aircastle LTD 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks, uncertainties and assumptions. You should read the following discussion in conjunction with our historical consolidated financial statements and the notes thereto appearing elsewhere in this Annual Report. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those described under Item 1A. — “Risk Factors” and elsewhere in this Annual Report. Please see “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995” for a discussion of the uncertainties, risks and assumptions associated with these statements. Our 25 consolidated financial statements are prepared in accordance with U.S. GAAP and, unless otherwise indicated, the other financial information contained in this Annual Report has also been prepared in accordance with U.S. GAAP. Unless otherwise indicated, all references to “dollars” and “$” in this Annual Report are to, and all monetary amounts in this Annual Report are presented in, U.S. dollars. OVERVIEW Aircastle acquires, leases, and sells commercial jet aircraft to airlines throughout the world. As of February 28, 2021, we owned and managed on behalf of our joint venture 261 aircraft leased to 75 lessees located in 43 countries. Our aircraft are managed by an experienced team based in the United States, Ireland and Singapore. Our aircraft are subject to net leases whereby the lessee is generally responsible for maintaining the aircraft and paying operational, maintenance and insurance costs. However, in many cases we are obligated to pay a specified portion of maintenance or modification costs. As of February 28, 2021, the net book value of our flight equipment (including flight equipment held for lease and net investment in direct financing and sales-type leases, or “net book value”) was $6.69 billion compared to $7.79 billion for the year ended December 31, 2019. Our revenues, net income (loss) and Adjusted EBITDA were $832.3 million, $(333.2) million, and $774.4 million for the year ended February 28, 2021, and were $917.9 million, $156.6 million and $862.2 million for the year ended December 31, 2019. Merger with MM Air Limited On March 27, 2020, the Company successfully completed its merger (the “Merger”) and is now controlled by affiliates of Marubeni Corporation and Mizuho Leasing Company, Limited (“Mizuho Leasing”). The Merger has not resulted in any change of the Company’s business strategy, and we believe the Company will benefit by having stable investors with a long-term investment horizon. We also may benefit by being affiliated with Mizuho Leasing, part of the Mizuho Financial Group, one of the largest Japanese financial institutions. As previously disclosed, on September 30, 2020, the Company’s Board of Directors unanimously agreed to change the Company’s fiscal year end to the twelve-month period ended the last day in February. This change better aligns the Company’s financial reporting period with the financial reporting cycle of its shareholders, Marubeni Corporation and Mizuho Leasing. 26 Acquisitions and Sales During the year ended February 28, 2021, we acquired five aircraft for $154.3 million. As of April 15, 2021, we have acquired no additional aircraft. At February 28, 2021, we had commitments to acquire 25 new E-Jet E2 aircraft from Embraer S.A. for $825.1 million, with delivery beginning in March 2021. These amounts include estimated amounts for pre-delivery deposits, contractual price escalations and other adjustments. As of April 15, 2021, we have commitments to acquire 25 aircraft for $825.1 million. During the year ended February 28, 2021, we sold twelve aircraft and other flight equipment for $180.3 million, which resulted in a net gain of $33.5 million. As of April 15, 2021, we have sold two additional aircraft. The following table sets forth certain information with respect to the aircraft owned and managed on behalf of our joint ventures by us as of February 28, 2021, February 29, 2020 and December 31, 2019: AIRCASTLE AIRCRAFT INFORMATION (dollars in millions) Owned Aircraft As of February 28, 2021 (1) As of February 29, 2020 (1) As of December 31, 2019 (1) Net Book Value of Flight Equipment $ 6,688 $ 7,569 $ 7,794 Net Book Value of Unencumbered Flight Equipment $ 5,432 $ 5,829 $ 5,979 Number of Aircraft 252 272 278 Number of Unencumbered Aircraft 219 232 237 Number of Lessees 75 85 84 Number of Countries 43 47 48 Weighted Average Age (years) (2) 10.6 10.0 9.9 Weighted Average Remaining Lease Term (years) (2) 4.2 4.7 4.8 Weighted Average Fleet Utilization during the Fourth Quarter (3)(5) 93.7 % N/A 99.2 % Weighted Average Fleet Utilization for the Year Ended (3) 94.5 % 99.1 % 96.4 % Portfolio Yield for the Fourth Quarter (4) 8.5 % 11.1 % 11.2 % Portfolio Yield for the Year Ended (4) 9.2 % 11.0 % 10.9 % Managed Aircraft on behalf of Joint Ventures Flight Equipment $ 312 $ 326 $ 328 Number of Aircraft 9 9 9 ____________ (1) Calculated using net book value at period end. (2) Weighted by net book value. (3) Aircraft on-lease days as a percent of total days in period weighted by net book value. The decrease from our historical utilization rate was primarily due to early terminations. Weighted Average Fleet Utilization for the Year Ended February 29, 2020 of 99.1% represents utilization for the two months ended February 29, 2020. (4) Lease rental revenue, interest income and cash collections on our net investment in direct financing and sales-type leases for the period as a percent of the average net book value for the period; quarterly information is annualized. The calculation of portfolio yield includes our net investment in direct financing and sales-type leases in the average net book value, and the interest income and cash collections from our net investment in direct financing and sales-type leases in lease rentals (5) N/A - not applicable. 27 PORTFOLIO DIVERSIFICATION Owned Aircraft as of February 28, 2021 Owned Aircraft as of February 29, 2020 Owned Aircraft as of December 31, 2019 Number of Aircraft % of Net Book Value (1) Number of Aircraft % of Net Book Value (1) Number of Aircraft % of Net Book Value (1) Aircraft Type Passenger: Narrow-body 226 78 % 244 75 % 250 75 % Wide-body 22 18 % 24 21 % 24 21 % Total Passenger 248 96 % 268 96 % 274 96 % Freighter 4 4 % 4 4 % 4 4 % Total 252 100 % 272 100 % 278 100 % Manufacturer Airbus 169 64 % 183 63 % 184 63 % Boeing 78 34 % 84 36 % 89 36 % Embraer 5 2 % 5 1 % 5 1 % Total 252 100 % 272 100 % 278 100 % Regional Diversification Asia and Pacific 79 37 % 90 38 % 94 38 % Europe 92 27 % 99 27 % 99 26 % Middle East and Africa 11 4 % 15 6 % 16 7 % North America 28 12 % 40 13 % 40 13 % South America 26 13 % 26 15 % 26 15 % Off-lease 16 (2) 7 % 2 (3) 1 % 3 (4) 1 % Total 252 100 % 272 100 % 278 100 % _______________ (1) Calculated using net book value at year end. (2) Consisted of one Airbus A320-200 and one Airbus A330-200 aircraft subject to executed leases with a customer in Europe, four Boeing 737-800 aircraft subject to executed leases or confirmed letters of intent with customers in Europe, one Boeing 737-800 aircraft consigned for sale and four Airbus A320-200, three Airbus A330-200, and two Boeing 737-800 aircraft which we are marketing for lease or sale. (3) Consisted of one Airbus A330-200 aircraft, which was delivered to a customer in Europe in August 2020, and one Boeing 737-800 aircraft, which is subject to a confirmed letter intent to lease with a customer in Europe. (4) Consisted of one Airbus A320-200 aircraft, which was delivered on lease to a customer in Europe in February 2020, one Airbus A330-200 aircraft, which was delivered to a customer in Europe in the second quarter of 2020, and one Boeing 737-800 aircraft, which was sold in February 2020. 28 Our largest customer represents approximately 8% of the net book value at February 28, 2021. The top ten customers for aircraft we owned at February 28, 2021, are as follows: Customer Percent of Net Book Value Country Number of Aircraft IndiGo 8.3% India 13 LATAM (1) 7.7% Chile 13 easyJet 4.6% United Kingdom 25 Iberia 3.9% Spain 15 Air Canada 3.7% Canada 5 Lion Air 3.5% Indonesia 7 Aerolineas Argentinas 3.0% Argentina 5 American Airlines 2.8% United States 7 AirBridge Cargo (2) 2.6% Russia 2 Jeju Air 2.5% South Korea 7 Total top ten customers 42.6% 99 All other customers 57.4% 153 Total all customers 100.0% 252 (1) LATAM filed for Chapter 11 in May 2020. (2) Guaranteed by Volga-Dnepr Airlines. We have one additional aircraft on lease with an affiliate. Finance We operate in a capital-intensive industry and have a demonstrated track record of raising substantial amounts of capital over the last sixteen years. Since our inception in late 2004, we raised $1.69 billion in equity capital from private and public investors. We also obtained $18.9 billion in debt capital from a variety of sources including export credit agency-backed debt, commercial bank debt, the aircraft securitization markets and the unsecured bond market. The diversity and global nature of our financing sources demonstrates our ability to adapt to changing market conditions and seize new growth opportunities. We intend to fund new investments through cash on hand, funds generated from operations, maintenance payments received from lessees, secured borrowings for aircraft, draws on our revolving credit facilities and proceeds from any future aircraft sales. We may repay all or a portion of such borrowings from time to time with the net proceeds from subsequent long-term debt financings, additional equity offerings or cash generated from operations and asset sales. Therefore, our ability to execute our business strategy, particularly the acquisition of additional commercial jet aircraft or other aviation assets, depends to a significant degree on our ability to obtain additional debt and equity capital on terms we deem attractive. See “Liquidity and Capital Resources — Secured Debt Financings” and “Liquidity and Capital Resources — Unsecured Debt Financings” below. 29 Comparison of the year ended February 28, 2021 to the year ended December 31, 2019: Year Ended, February 28, December 31, 2021 2019 (Dollars in thousands) Revenues: Lease rental revenue $ 611,421 $ 777,403 Direct financing and sales-type lease revenue 18,215 32,295 Amortization of lease premiums, discounts and incentives (22,842) (22,636) Maintenance revenue 172,668 74,987 Total lease revenue 779,462 862,049 Gain on sale of flight equipment 33,536 45,532 Other revenue 19,290 10,357 Total revenues 832,288 917,938 Operating expenses: Depreciation 347,517 356,021 Interest, net 235,338 258,070 Selling, general and administrative 93,671 77,034 Impairment of flight equipment 425,579 7,404 Maintenance and other costs 20,005 24,828 Total operating expenses 1,122,110 723,357 Other expense Loss on extinguishment of debt (2,640) (7,577) Merger expenses (32,605) (7,372) Other (191) (4,492) Total other expense (35,436) (19,441) Income (loss) from continuing operations before income taxes (325,258) 175,140 Income tax provision 10,236 22,667 Earnings of unconsolidated equity method investment, net of tax 2,326 4,102 Net income (loss) $ (333,168) $ 156,575 Revenues: Total revenues decreased by $85.7 million, for the year ended February 28, 2021 as compared to the year ended December 31, 2019: Lease rental revenue decreased by $166.0 million for the year ended February 28, 2021, as a result of: • a $121.6 million decrease due to early lease terminations and the recognition of lease rental revenue for certain customers using a cash basis of accounting rather than an accrual method – see Note 1 regarding our lease revenue recognition policy ; • a $58.2 million decrease due to the sale of 32 aircraft since January 1, 2019; and • a $38.4 million decrease due to lease extensions, amendments, transitions and other changes. This was partially offset by a $52.2 million increase in revenue reflecting the impact of 48 aircraft purchased since January 1, 2019. 30 Direct financing and sales-type lease revenue decreased $14.1 million, primarily attributable to the early lease terminations of eight aircraft during the year ended February 28, 2021 and the sales of three aircraft subject to direct financing and sales-type leases. Amortization of lease premiums, discounts and incentives. Year Ended February 28, December 31, 2021 2019 (Dollars in thousands) Amortization of lease premiums $ (15,652) $ (16,719) Amortization of lease discounts 1,070 4,406 Amortization of lease incentives (8,260) (10,323) Amortization of lease premiums, discounts and incentives $ (22,842) $ (22,636) The decrease in amortization of lease discounts of $3.3 million for the year ended February 28, 2021, as compared to the year ended December 31, 2019, was due to fully amortized lease discounts for aircraft that transitioned to new lessees or extended. The decrease in amortization of lease incentives of $2.1 million for the year ended February 28, 2021, as compared to the year ended December 31, 2019, was primarily due to scheduled lease expirations and early lease terminations, as well as the sales of six aircraft. Maintenance revenue. For the year ended February 28, 2021, we recorded $172.7 million of maintenance revenue, comprised primarily of $95.0 million related to the early lease terminations of seventeen narrow-body and one wide-body aircraft, as well as $57.3 million related to the scheduled lease expirations of ten narrow-body and one wide-body aircraft. In addition, we recorded $16.3 million of maintenance revenue related to three wide-body aircraft for which the customers are subject to judicial insolvency proceedings or similar protection. For the year ended December 31, 2019, we recorded $75.0 million of maintenance revenue, comprised of $45.8 million related to the scheduled lease expirations of nine narrow-body and four wide-body aircraft and $29.1 million related to the early lease terminations of nineteen narrow-body and one wide-body aircraft. Gain on sale of flight equipment decreased by $12.0 million to $33.5 million for the year ended February 28, 2021, as compared to gains of $45.5 million for the year ended December 31, 2019. During the year ended February 28, 2021, we sold twelve aircraft as compared to the sale of twenty aircraft during the year ended December 31, 2019. Gain on sale for each of these periods includes the receipt of insurance proceeds for one aircraft which was disposed. Other revenue increased $8.9 million to $19.3 million during the year ended February 28, 2021, as compared to $10.4 million for the year ended December 31, 2019, due to $18.7 million of security deposits and early lease termination fees recognized into revenue primarily related to ten narrow-body and one wide-body aircraft. This was partially offset by lower service fees of $8.8 million related to the liquidation of our joint venture with an affiliate of the Ontario Teachers’ Pension Plan. Operating Expenses: Total operating expenses increased by $398.8 million, for the year ended February 28, 2021 as compared to the year ended December 31, 2019: Depreciation expense decreased by $8.5 million for the year ended February 28, 2021 as compared to the year ended December 31, 2019. The decrease is primarily comprised of $40.0 million resulting from 33 aircraft sold since January 1, 2019 and lower depreciation for thirteen aircraft subject to impairments. This was partially offset by a $26.6 million increase in depreciation due to 53 aircraft acquired since January 1, 2019. 31 Interest, net consisted of the following: Year Ended February 28, December 31, 2021 2019 (Dollars in thousands) Interest on borrowings, net settlements on interest rate derivatives, and other liabilities $ 221,246 $ 245,673 Amortization of deferred losses related to interest rate derivatives — 184 Amortization of deferred financing fees and debt discount 14,791 14,578 Interest expense 236,037 260,435 Less: Interest income (523) (2,365) Less: Capitalized interest (176) — Interest, net $ 235,338 $ 258,070 Interest, net decreased by $22.7 million as compared to the year ended December 31, 2019, primarily due to lower weighted average interest rates, partially offset by higher weighted average debt outstanding. Selling, general and administrative expense s for year ended February 28, 2021 increased $16.6 million as compared to the year ended December 31, 2019, primarily attributable to an increase in share-based compensation expense of $12.2 million as a result of the Merger and a provision for credit losses of $5.3 million related to the change in our allowance for credit losses. Impairment of aircraft. We recorded impairment charges of $425.6 million for the year ended February 28, 2021, which primarily related to seventeen narrow-body and nine wide-body aircraft. The Company recognized $157.0 million of maintenance revenue and security deposits into revenue related to these 26 aircraft during the year ended February 28, 2021. During the year ended December 31, 2019, we recorded impairment charges of $7.4 million related to two narrow-body aircraft. See “Summary of Recoverability Assessment and Other Impairments” below for a detailed discussion of impairment charges related to certain aircraft. Maintenance and other costs were $20.0 million for the twelve months ended February 28, 2021, a decrease of $4.8 million as compared to the year ended December 31, 2019. The year ended December 31, 2019 included higher than projected lessor contributions towards the cost of maintenance events for aircraft acquired with attached leases, as well as higher costs for unscheduled transitions. Other Expense : Total other expense increased by $16.0 million to $35.4 million for the year ended February 28, 2021, as compared to $19.4 million for the year ended December 31, 2019. During the year ended February 28, 2021, we incurred $32.6 million of legal and banking expenses related to the Merger. In addition, we recorded losses on extinguishment of debt totaling $2.6 million related to the early repayments of our Senior Notes due 2021 and secured debt obligations for three wide-body aircraft. During the year ended December 31, 2019, we incurred a loss on extinguishment of debt of $7.6 million due to the early repayment of our Senior Notes due 2019, $7.4 million of legal and banking expenses related to the Merger, and unfavorable mark-to-market adjustments on our interest rate caps of $4.8 million. Income Tax Provision : Our provision for income taxes for the years ended February 28, 2021 and December 31, 2019, was $10.2 million and $22.7 million, respectively. Income taxes have been provided based on the applicable tax laws and rates of those countries in which operations are conducted and income is earned, primarily Ireland and the United States. The decrease in our income tax provision of $12.5 million for the year ended February 28, 2021, as compared to the year ended December 31, 2019, was primarily attributable to changes in operating income subject to tax in Ireland, the United States and other jurisdictions. The year ended February 28, 2021, includes a reversal of prior period tax charges of $2.7 million related to the limitation in deductible compensation. The year ended December 31, 2019, included tax charges of $4.1 million related to the limitation in deductible compensation and $0.4 million related to the vesting of stock. 32 Earnings (Loss) of Unconsolidated Equity Method Investment, net of Tax: Earnings from unconsolidated equity method investment, net of tax, was $2.3 million during the twelve months ended February 28, 2021, as compared to $4.1 million in December 31, 2019. See Note 5 “Unconsolidated Equity Method Investment.” Summary of Recoverability Assessment and Other Impairments Impairment of Flight Equipment During the year ended February 28, 2021, the Company recorded impairment charges totaling $425.6 million, of which $378.2 million were transactional impairments, which primarily related to seventeen narrow-body and eight wide-body aircraft. The Company recognized $157.0 million of maintenance revenue and security deposits into revenue related to these 25 aircraft during the year ended February 28, 2021. The impairment charges were attributable to early lease terminations, scheduled lease expirations, lessee defaults and/or judicial insolvency proceedings, or as a result of our annual recoverability assessment – refer to the section below for additional details. During the year ended December 31, 2019, the Company recognized net maintenance revenue of $17.6 million related to the early lease terminations of seven narrow-body aircraft due to lessee default. We recorded impairment charges of $7.4 million related to two of these seven narrow-body aircraft. Annual Recoverability Assessment We completed our annual recoverability assessment of our aircraft in the second quarter. Of the $425.6 million impairment charges recorded for the year ended February 28, 2021, we recorded $43.0 million related to one narrow-body and one wide-body aircraft as a result our annual recoverability assessment. Although we have completed our annual recoverability assessment, we continue to monitor the developments of COVID-19. We are closely monitoring the impact of COVID-19 on our customers, air traffic, lease rental rates, and aircraft valuations, and will perform additional customer and aircraft specific reviews should changes in facts and circumstances arise that may impact the recoverability of our aircraft. We have and will focus on our customers that have entered judicial insolvency proceedings and any additional customers that may become subject to similar-type proceedings, aircraft with near-term lease expirations, and certain aircraft variants that are more susceptible to the impact of COVID-19 and value deterioration. The recoverability assessment is a comparison of the carrying value of each aircraft to its undiscounted expected future cash flows. We develop the assumptions used in the recoverability assessment, including those relating to current and future demand for each aircraft type, based on management’s experience in the aircraft leasing industry, as well as information received from third-party sources. Estimates of the undiscounted cash flows for each aircraft type are impacted by changes in contracted and future expected lease rates, residual values, expected scrap values, economic conditions and other factors. If our estimates or assumptions change, including those related to our customers that have entered judicial insolvency proceedings, we may revise our cash flow assumptions and record future impairment charges. While we believe that the estimates and related assumptions used in the annual recoverability assessment, and subsequent assessments, are appropriate, actual results could differ from those estimates. Comparison of the year ended December 31, 2019 to the year ended December 31, 2018: We have omitted discussion of the earliest two of the four periods covered by our consolidated financial statements presented in this Annual Report because that disclosure was already included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 13, 2020. You are encouraged to reference Part II, Item 7, within that report, for a discussion of our financial condition and result of operations for the year ended December 31, 2019 to the year ended December 31, 2018. 33 APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP, which requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying footnotes. Our estimates and assumptions are based on historical experiences and currently available information. Actual results may differ from such estimates under different conditions, sometimes materially. A summary of our significant accounting policies is presented in the notes to our consolidated financial statements included elsewhere in this Annual Report. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and results and require our most subjective judgments, estimates and assumptions. Our most critical accounting policies and estimates are described below. Lease Revenue Recognition We lease flight equipment under net operating leases with lease terms typically ranging from three to seven years. We generally do not offer renewal terms or purchase options in our leases, although certain of our operating leases allow the lessee the option to extend the lease for an additional term. Operating leases with fixed rentals and step rentals are recognized on a straight-line basis over the term of the initial lease, assuming no renewals. Operating lease rentals that adjust based on a London Interbank Offered Rate (“LIBOR”) index are recognized on a straight-line basis over the lease term using the prevailing rate at lease commencement. Changes to rate-based lease rentals are recognized in the statement of income (loss) in the period of change. In certain instances, we may provide lease concessions to customers, generally in the form of lease rental deferrals. While these deferral arrangements affect the timing of lease rental payments, the total amount of lease rental payments required over the lease term is generally the same as that which was required under the original lease agreement. We account for the deferrals as if no modifications to the lease agreements were made and record the deferred rentals as a receivable within Other assets in our Consolidated Balance Sheets. If we determine that the collectability of rental payments is no longer probable (including any deferral thereof), we recognize lease rental revenue using a cash basis of accounting rather than an accrual method. Estimating whether collectability is probable requires some level of subjectivity and judgment. Management determines whether customers should be placed back on accrual status when it becomes probable that payments will be received in a timely manner. The accrual/non-accrual status of a customer is maintained at a level deemed appropriate based on factors such as the customer’s credit rating, payment performance, financial condition and requests for modifications of lease terms and conditions. Events or circumstances outside of historical customer patterns can also result in changes to a customer’s accrual status. In the period we conclude that collection of lease payments is no longer probable, we recognize any difference between revenue amounts recognized to date under the accrual method and payments that have been collected from the lessee, including security deposit amounts held, as a current period adjustment to lease rental revenue. Maintenance Payments and Maintenance Revenue Under our leases, the lessee must pay operating expenses accrued or payable during the term of the lease, which would normally include maintenance, overhaul, fuel, crew, landing, airport and navigation charges; certain taxes, licenses, consents and approvals; aircraft registration; and insurance premiums. Typically, our aircraft are subject to net operating leases whereby the lessee pays lease rentals and is generally responsible for maintaining the aircraft and paying operational, maintenance and insurance costs, although in a majority of cases, we are obligated to pay a portion of specified maintenance or modification costs. Our aircraft lease agreements generally provide for the periodic payment of a fixed amount of rent over the life of the lease, and the amount of the contracted rent will depend upon the type, age, specification and condition of the aircraft and market conditions at the time the lease is committed. The amount of rent we receive will depend on a number of factors, including the creditworthiness of our lessees and the occurrence of delinquencies, restructurings and defaults. Our lease rental revenues are also affected by the extent to which aircraft are off-lease and our ability to remarket aircraft that are nearing the end of their leases in order to minimize their off-lease time. Our success in re-leasing aircraft is affected by market conditions relating to our aircraft and by general industry conditions and trends. An increase in the percentage of off-lease aircraft or a reduction in lease rates upon remarketing would negatively impact our revenues. 34 Under an operating lease, the lessee will be responsible for performing maintenance on the relevant aircraft and will typically be required to make payments to us for heavy maintenance, overhaul or replacement of certain high-value components of the aircraft. These maintenance payments are based on hours or cycles of utilization or on calendar time, depending upon the component, and would be made either monthly in arrears or at or near the end of the lease term. For maintenance payments made monthly in arrears during a lease term, we will typically be required to reimburse all or a portion of these payments to the lessee upon completion of the relevant heavy maintenance, overhaul or parts replacement. We record maintenance payments paid by the lessee during a lease as accrued maintenance liabilities in recognition of our obligation in the lease to refund such payments, and therefore we typically do not recognize maintenance revenue during the lease. Maintenance revenue recognition would occur at or near the end of a lease, when we are able to determine the amount, if any, by which reserve payments received exceed the amount we are required under the lease to reimburse to the lessee for heavy maintenance, overhaul or parts replacement. If a lease requires end of lease term maintenance payments, typically the lessee would be required to pay us for its utilization of the aircraft during the lease; however, in some cases, we may owe a net payment to the lessee in the event heavy maintenance is performed and paid for by the lessee during the lease term and the aircraft is returned to us in better condition than at lease inception. End of lease term maintenance payments made to us are recognized as maintenance revenue, and end of lease term maintenance payments we make to a lessee are recorded as contra maintenance revenue. The amount of maintenance revenue or contra maintenance revenue we recognize in any reporting period is inherently volatile and is dependent upon a number of factors, including the timing of lease expiries, including scheduled and unscheduled expiries, the timing of maintenance events and the utilization of the aircraft by the lessee. Lease Incentives and Amortization Many of our leases contain provisions which may require us to pay a portion of the lessee’s costs for heavy maintenance, overhaul or replacement of certain high-value components. We account for these expected payments as lease incentives, which are amortized as a reduction of revenue over the life of the lease. We estimate the amount of our portion for such costs, typically for the first major maintenance event for the airframe, engines, landing gear and auxiliary power units, expected to be paid to the lessee based on assumed utilization of the related aircraft by the lessee, the anticipated cost of the maintenance event and the estimated amounts the lessee is responsible to pay. The assumptions supporting these estimates are re-evaluated annually. This estimated lease incentive is not recognized as a lease incentive liability at the inception of the lease. We recognize the lease incentive as a reduction of lease revenue on a straight-line basis over the life of the lease, with the offset being recorded as a lease incentive liability, which is included in maintenance payments on the balance sheet. The payment to the lessee for the lease incentive liability is first recorded against the lease incentive liability, and any excess above the lease incentive liability is recorded as a prepaid lease incentive asset, which is included in other assets on the balance sheet and continues to amortize over the remaining life of the lease. Flight Equipment Held for Lease and Depreciation Flight equipment held for lease is stated at cost and depreciated using the straight-line method, typically over a 25-year life from the date of manufacture for passenger aircraft and over a 30 to 35-year life for freighter aircraft, depending on whether the aircraft is a converted or purpose-built freighter, to estimated residual values. Estimated residual values are generally determined to be approximately 15% of the manufacturer’s estimated realized price for passenger aircraft when new and 5% to 10% for freighter aircraft when new. Management may make exceptions to this policy on a case-by-case basis when, in its judgment, the residual value calculated pursuant to this policy does not appear to reflect current expectations of value. Examples of situations where exceptions may arise include but are not limited to: • flight equipment where estimates of the manufacturers’ realized sales prices are not relevant (e.g., freighter conversions); • flight equipment where estimates of the manufacturers’ realized sales prices are not readily available; and • flight equipment which may have a shorter useful life due to obsolescence. In accounting for flight equipment held for lease, we make estimates about the expected useful lives, the fair value of attached leases, acquired maintenance assets or liabilities and the estimated residual values. In making these estimates, we rely upon actual industry experience with the same or similar aircraft types and our anticipated utilization of the aircraft. As part of our due diligence review of each aircraft we purchase, we prepare an estimate of the expected 35 maintenance payments and any excess costs which may become payable by us, taking into consideration the then-current maintenance status of the aircraft and the relevant provisions of any existing lease. For planned major maintenance activities for aircraft off-lease, the Company capitalizes the actual maintenance costs by applying the deferral method. Under the deferral method, we capitalize the actual cost of major maintenance events, which are depreciated on a straight-line basis over the period until the next maintenance event is required. For purchase and lease back transactions, we account for the transaction as a single arrangement. We allocate the consideration paid based on the fair value of the aircraft and lease. The fair value of the lease may include a maintenance premium and a lease premium or discount. When we acquire an aircraft with a lease, determining the fair value of the attached lease requires us to make assumptions regarding the current fair values of leases for specific aircraft. We estimate a range of current lease rates of like aircraft in order to determine if the attached lease is within a fair value range. If a lease is below or above the range of current lease rates, we present value the estimated amount below or above fair value range over the remaining term of the lease. The resulting lease discount or premium is amortized into lease rental income over the remaining term of the lease. Impairment of Flight Equipment We perform a recoverability assessment of all aircraft in our fleet, on an aircraft-by-aircraft basis, at least annually. In addition, a recoverability assessment is performed whenever events or changes in circumstances, or indicators, indicate that the carrying amount or net book value of an asset may not be recoverable. Indicators may include, but are not limited to, a significant lease restructuring or early lease termination, significant air traffic decline, the introduction of newer technology aircraft or engines, an aircraft type is no longer in production or a significant airworthiness directive is issued. When we perform a recoverability assessment, we measure whether the estimated future undiscounted net cash flows expected to be generated by the aircraft exceed its net book value. The undiscounted cash flows consist of cash flows from currently contracted leases, future projected lease rates, transition costs, estimated down time and estimated residual or scrap values for an aircraft. In the event that an aircraft does not meet the recoverability test, the aircraft will be adjusted to fair value, resulting in an impairment charge. Management develops the assumptions used in the recoverability analysis based on current and future expectations of the global demand for a particular aircraft type and historical experience in the aircraft leasing market and aviation industry, as well as information received from third party industry sources. The factors considered in estimating the undiscounted cash flows are impacted by changes in future periods due to changes in contracted lease rates, residual values, economic conditions, technology, airline demand for a particular aircraft type and other risk factors discussed in Item 1A. “Risk Factors.” See further discussion of our aircraft more susceptible to failing our recoverability assessment under “Summary of Recoverability Assessment and Other Impairments” above and “Fair Value Measurements” below. Net Investment in Direct Financing and Sales-Type Leases If a lease meets specific criteria at lease commencement or at the effective date of a lease modification, we recognize the lease as a direct financing or sales-type lease. The net investment in direct financing and sales-type leases consists of the lease receivable, estimated unguaranteed residual value of the leased flight equipment at lease-end and, for direct financing leases, deferred selling profit. For sales-type leases, we recognize the difference between the net book value of the aircraft and the net investment in the lease as a gain or loss on sale of fight equipment. Selling profit on a direct financing lease is deferred and amortized over the lease term, and a selling loss is recognized at lease commencement. Interest income on our net investment in leases is recognized as Direct financing and sales-type lease revenue over the lease term in a manner that produces a constant rate of return on the net investment in the lease. The net investment in leases is recorded in the consolidated financial statements net of an allowance for credit losses. The allowance for credit losses is recorded upon the initial recognition of the net investment in the lease based on the Company’s estimate of expected credit losses over the lease term. The allowance reflects the Company’s estimate of lessee default probabilities and loss given default percentages. When determining the credit loss allowance, we consider relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the net investment in the lease. The allowance also considers potential losses due to non-credit risk related to unguaranteed residual values. A provision for credit losses is recorded as a component of Selling, general, and 36 administrative expenses in our Consolidated Statements of Income (Loss) to adjust the allowance for changes to management’s estimate of expected credit losses. Fair Value Measurements We measure the fair value of certain assets and liabilities on a non-recurring basis, when U.S. GAAP requires the application of fair value, including events or changes in circumstances that indicate that the carrying amounts of assets may not be recoverable. Assets subject to these measurements include our aircraft and unconsolidated equity investments. We record aircraft at fair value when we determine the carrying value may not be recoverable. Fair value measurements for aircraft in impairment tests are based on the average of the market approach that uses Level 2 inputs, which include third party appraisal data and an income approach that uses Level 3 inputs, which include the Company’s assumptions and appraisal data as to future cash proceeds from leasing and selling aircraft discounted using the Company’s weighted average cost of capital. We account for our investments in unconsolidated joint ventures under the equity method of accounting. Investments are reviewed for impairment whenever events or changes in circumstances indicate the fair value is less than its carrying value and the decline is other-than-temporary Income Taxes The Company records an income tax provision in accordance with the various tax laws for those jurisdictions within which our transactions occur. Aircastle uses an asset and liability based approach in accounting for income taxes. Deferred income tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement and tax basis of existing assets and liabilities using enacted rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount estimated by us to be realizable. The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities. We did not have any unrecognized tax benefits. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS See Note 1 – Summary of Significant Accounting Policies - Organization and Basis of Presentation in the Notes to Consolidated Financial Statements below. RECENTLY PROPOSED ACCOUNTING PRONOUNCEMENTS See Note 1 – Summary of Significant Accounting Policies - Proposed Accounting Pronouncements in the Notes to Consolidated Financial Statements below. LIQUIDITY AND CAPITAL RESOURCES Our business is very capital intensive, requiring significant investments in order to expand our fleet and to maintain and improve our existing portfolio. Our operations generate a significant amount of cash, primarily from lease rentals and maintenance collections. We have also met our liquidity and capital resource needs by utilizing several sources over time, including: • various forms of borrowing secured by our aircraft, including bank term facilities, limited recourse securitization financings, and ECA-backed financings for new aircraft acquisitions; • unsecured indebtedness, including our current unsecured revolving credit facilities, term loan and senior notes; • asset sales; and • sales of common shares. Going forward, we expect to continue to seek liquidity from these sources and other sources, subject to pricing and conditions we consider satisfactory. 37 During the year ended February 28, 2021, we met our liquidity and capital resource needs with $175.0 million of cash flow from operations, $1.93 billion in gross proceeds from the issuance of our senior notes, bank debt and our revolving credit facilities and $180.3 million of cash from aircraft sales. As of February 28, 2021, the weighted average maturity of our secured and unsecured debt financings was 3.7 years and we are in compliance with all applicable covenants in our financings. We have also determined that as of February 28, 2021, our consolidated subsidiaries’ restricted net assets, as defined by Rule 4-08(e)(3) of Regulation S-X, are less than 25% of our consolidated net assets. We have agreed to defer some near-term lease payments with certain of our airline customers. As of April 15, 2021, we have agreed to defer approximately $108.4 million in near-term lease payments with 26 airlines, which these airline customers have agreed to repay over time. If air traffic remains depressed over an extended period and if our customers are unable to obtain sufficient funds from private, government or other sources, we may need to extend further deferrals to some of our other customers or to extend the deferrals we have already made. We may ultimately be unable to collect all the amounts we have deferred. As of February 28, 2021, we hold $80.7 million in security deposits, $519.2 million in maintenance payments and $151.5 million in letters of credit from our lessees. We believe we have sufficient liquidity to meet our contractual obligations over the next twelve months and as of April 1, 2021, total liquidity of $2.32 billion includes $1.25 billion of undrawn credit facilities, $609 million of unrestricted cash, $123 million of contracted asset sales and $340 million of projected operating cash flows through April 1, 2022. In addition, we believe payments received from lessees and other funds generated from operations, unsecured bond offerings, secured borrowings for aircraft, borrowings under our revolving credit facilities and other borrowings and proceeds from future aircraft sales will be sufficient to satisfy our liquidity and capital resource needs over the next twelve months. Our liquidity and capital resource needs include payments due under our aircraft purchase obligations, required principal and interest payments under our long-term debt facilities, expected capital expenditures, lessee maintenance payment reimbursements and lease incentive payments over the next twelve months. 38 Cash Flows Year Ended February 28, December 31, 2021 2019 (Dollars in thousands) Net cash flow provided by operating activities $ 175,022 $ 536,418 Net cash flow provided by (used in) investing activities 21,472 (784,029) Net cash flow provided by financing activities 212,667 235,201 Operating Activities: The COVID-19 pandemic has severely impacted the demand for air travel over the past twelve months, which has negatively impacted our customers’ financial performance. The impact of the COVID-19 pandemic, together with lease concessions given to many of our airline customers in the form of lease rental deferrals, has resulted in slower cash collections during the year ended February 28, 2021. Cash flow provided by operations was $175.0 million for the year ended February 28, 2021 compared to $536.4 million for the year ended December 31, 2019. The decrease in cash flow provided by operations of $361.4 million was primarily a result of: • a $121.6 million decrease in cash due to lower lease rental revenue resulting from early lease terminations and the recognition of lease rental revenue for certain customers using a cash basis of accounting rather than an accrual method; • a $113.0 million decrease in cash resulting from an increase in accounts receivable and other assets, primarily due to deferred lease rentals; • a $73.6 million decrease in cash resulting from advance lease rentals recognized into revenue, primarily due to lease terminations; and • a $32.6 million decrease in cash due to higher banking and legal costs resulting from the Merger. Investing Activities : Cash flow provided by investing activities was $21.5 million for the year ended February 28, 2021 as compared to cash flow used in investing activities of $784.0 million for the year ended December 31, 2019. The net decrease in cash flow provided by investing activities of $805.5 million for the year ended February 28, 2021 was primarily a result of a $1.03 billion decrease in the acquisition and improvement of flight equipment offset by a $181.4 million decrease in aircraft proceeds from the sale of flight equipment. Financing Activities : Cash flow provided by financing activities was $212.7 million and $235.2 million for the years ended February 28, 2021 and December 31, 2019, respectively. The decrease in cash flow provided by financing activities of $22.5 million for the year ended February 28, 2021 was primarily a result of a $183.9 million decrease in proceeds from secured and unsecured financings offset by a $119.9 million decrease in repayments of secured and unsecured financings and $11.2 million decrease in shares repurchased. Debt Obligations For complete information on our debt obligations, please refer to Note 7 – “Borrowings from Secured and Unsecured Debt” Financings in the Notes to Consolidated Financial Statements below. Contractual Obligations Our contractual obligations consist of principal and interest payments on debt financings, aircraft acquisitions and rent payments pursuant to our office leases. Total contractual obligations decreased to $6.82 billion at February 28, 2021 from $7.03 billion at December 31, 2019, due to a decrease in purchase obligations and principal payments for secured financings and borrowings under our revolving credit facilities, partially offset by an increase in principal payments for senior notes. 39 The following table presents our actual contractual obligations and their payment due dates as of February 28, 2021. Payments Due by Period as of February 28, 2021 Contractual Obligations Total 1 year or less 2-3 years 4-5 years More than 5 years (Dollars in thousands) Principal payments: Senior Notes due 2022-2027 $ 4,200,000 $ 500,000 $ 1,150,000 $ 1,150,000 $ 1,400,000 DBJ Term Loan 215,000 60,000 155,000 — — Revolving Credit Facilities — — — — — ECA Financings 36,423 14,847 15,517 6,059 — Bank Financings 738,353 72,096 293,791 372,466 — Total principal payments 5,189,776 646,943 1,614,308 1,528,525 1,400,000 Interest payments on debt obligations (1) 789,022 215,637 347,553 169,269 56,563 Office leases (2) 13,028 1,928 3,506 3,531 4,063 Purchase obligations (3) 825,119 199,990 473,804 151,325 — Total $ 6,816,945 $ 1,064,498 $ 2,439,171 $ 1,852,650 $ 1,460,626 _____________ (1) Future interest payments on variable rate, LIBOR-based debt obligations are estimated using the interest rate in effect at February 28, 2021. (2) Represents contractual payment obligations for our office leases in Stamford, Connecticut; Dublin, Ireland and Singapore. (3) At February 28, 2021, we had commitments to acquire 25 new E-Jet E2 aircraft from Embraer S.A for $825.1 million. These amounts include estimates for pre-delivery deposits, contractual price escalation and other adjustments. As of April 15, 2021, we have commitments to acquire 25 aircraft for $825.1 million. Capital Expenditures From time to time, we make capital expenditures to maintain or improve our aircraft. These expenditures include the cost of major overhauls necessary to place an aircraft in service and modifications made at the request of lessees. For the years ended February 28, 2021, and December 31, 2019 and 2018, we incurred a total of $26.6 million, $31.8 million and $9.3 million, respectively, of capital expenditures (including lease incentives) related to the acquisition and improvement of aircraft. As of February 28, 2021, the weighted average age (by net book value) of our aircraft was 10.6 years. In general, the costs of operating an aircraft, including maintenance expenditures, increase with the age of the aircraft. Our lease agreements call for the lessee to be primarily responsible for maintaining the aircraft. We may incur additional maintenance and modification costs in the future in the event we are required to remarket an aircraft or a lessee fails to meet its maintenance obligations under the lease agreement. These maintenance reserves are paid by the lessee to provide for future maintenance events. Provided a lessee performs scheduled maintenance of the aircraft, we are required to reimburse the lessee for scheduled maintenance payments. In certain cases, we are also required to make lessor contributions, in excess of amounts a lessee may have paid, towards the costs of maintenance events performed by or on behalf of the lessee. Actual maintenance payments to us by lessees in the future may be less than projected as a result of a number of factors, including defaults by the lessees. Maintenance reserves may not cover the entire amount of actual maintenance expenses incurred and, where these expenses are not otherwise covered by the lessees, there can be no assurance that our operational cash flow and maintenance reserves will be sufficient to fund maintenance requirements, particularly as our aircraft age. See Item 1A. “Risk Factors — Risks Related to Our Business — Risks related to our leases — If lessees are unable to fund their maintenance obligations on our aircraft, we may incur increased costs at the conclusion of the applicable lease .” Off-Balance Sheet Arrangements We entered into a joint venture arrangement in order to help expand our base of new business opportunities. This joint venture does not qualify for consolidated accounting treatment. The assets and liabilities of this entity are not included in our Consolidated Balance Sheets and we record our net investment under the equity method of accounting. 40 See Note 5 – “Unconsolidated Equity Method Investment” in the Notes to Unaudited Consolidated Financial Statements below. We hold a 25% equity interest in our joint venture with Mizuho Leasing and as of February 28, 2021, the net book value of its nine aircraft was $312.0 million. Foreign Currency Risk and Foreign Operations At February 28, 2021 all our leases are payable to us in U.S. dollars. However, we incur Euro- and Singapore dollar-denominated expenses in connection with our subsidiaries in Ireland and Singapore. For the year ended February 28, 2021, expenses, such as payroll and office costs, denominated in currencies other than the U.S. dollar aggregated $20.3 million in U.S. dollar equivalents and represented approximately 21.7% of total selling, general and administrative expenses (or 26.2% when excluding share-based compensation expense, of which a large portion relates to employees domiciled in the U.S.). Our international operations are a significant component of our business strategy and permit us to more effectively source new aircraft, service the aircraft we own and maintain contact with our lessees. Therefore, it is likely that our international operations and our exposure to foreign currency risk will increase over time. Although we have not yet entered into foreign currency hedges because our exposure to date has not been significant, if our foreign currency exposure increases we may enter into hedging transactions in the future to mitigate this risk. For the years ended February 28, 2021, and December 31, 2019 and 2018, we incurred insignificant net gains and losses on foreign currency transactions. Inflation Inflation affects our lease rentals, asset values and costs, including SG&A expenses and other expenses. We do not believe that our financial results have been, or will be, adversely affected by inflation in a material way. Management’s Use of EBITDA and Adjusted EBITDA We define EBITDA as income (loss) from continuing operations before income taxes, interest expense, and depreciation and amortization. We use EBITDA to assess our consolidated financial and operating performance, and we believe this non-U.S. GAAP measure is helpful in identifying trends in our performance. This measure provides an assessment of controllable expenses and affords management the ability to make decisions which are expected to facilitate meeting current financial goals, as well as achieving optimal financial performance. It provides an indicator for management to determine if adjustments to current spending decisions are needed. EBITDA provides us with a measure of operating performance because it assists us in comparing our operating performance on a consistent basis as it removes the impact of our capital structure (primarily interest charges on our outstanding debt) and asset base (primarily depreciation and amortization) from our operating results. Accordingly, this metric measures our financial performance based on operational factors that management can impact in the short-term, namely the cost structure, or expenses, of the organization. EBITDA is one of the metrics used by senior management and the Board of Directors to review the consolidated financial performance of our business. We define Adjusted EBITDA as EBITDA (as defined above) further adjusted to give effect to adjustments required in calculating covenant ratios and compliance as that term is defined in the indenture governing our senior unsecured notes. Adjusted EBITDA is a material component of these covenants. 41 The table below shows the reconciliation of net income to EBITDA for the year ended February 28, 2021, the two months ended February 29, 2020, and for the years ended December 31, 2019 and 2018, respectively. Year Ended February 28, Two Months Ended February 29, Year Ended December 31, 2021 2020 2019 2018 (Dollars in thousands) Net income (loss) $ (333,168) $ 3,659 $ 156,575 $ 247,919 Depreciation 347,517 59,853 356,021 310,850 Amortization of lease premiums, discounts and incentives 22,842 3,669 22,636 15,269 Interest, net 235,338 41,038 258,070 234,504 Income tax provision 10,236 1,675 22,667 5,642 EBITDA $ 282,765 $ 109,894 $ 815,969 $ 814,184 Adjustments: Impairment of flight equipment 425,579 62,657 7,404 — Equity share of joint venture impairment — — 2,724 15,791 Loss on extinguishment of debt 2,640 3,955 7,577 — Non-cash share-based payment expense 28,049 10,678 15,830 11,488 Merger related expenses (1) 35,165 321 7,886 — Loss (gain) on mark-to-market of interest rate derivative contracts 19 96 4,771 (1,632) Contract termination expense 172 — — — Adjusted EBITDA $ 774,389 $ 187,601 $ 862,161 $ 839,831 ______________ (1) Includes $32.6 million in Other expense and $2.6 million in Selling, general and administrative expenses. Limitations of EBITDA and Adjusted EBITDA An investor or potential investor may find EBITDA and Adjusted EBITDA important measures in evaluating our performance, results of operations and financial position. We use these non-U.S. GAAP measures to supplement our U.S. GAAP results in order to provide a more complete understanding of the factors and trends affecting our business. EBITDA and Adjusted EBITDA have limitations as analytical tools and should not be viewed in isolation or as substitutes for U.S. GAAP measures of earnings (loss). Material limitations in making the adjustments to our earnings (loss) to calculate EBITDA and Adjusted EBITDA, and using these non-U.S. GAAP measures as compared to U.S. GAAP net income (loss), income (loss) from continuing operations and cash flows provided by or used in operations, include: • depreciation and amortization, though not directly affecting our current cash position, represent the wear and tear and/or reduction in value of our aircraft, which affects the aircraft’s availability for use and may be indicative of future needs for capital expenditures; • the cash portion of income tax (benefit) provision generally represents charges (gains), which may significantly affect our financial results; • elements of our interest rate derivative accounting may be used to evaluate the effectiveness of our hedging policy; and • adjustments required in calculating covenant ratios and compliance as that term is defined in the indenture governing our senior unsecured notes which may not be comparable to similarly titled measures used by other companies. EBITDA and Adjusted EBITDA are not alternatives to net income (loss), income (loss) from operations or cash flows provided by or used in operations as calculated and presented in accordance with U.S. GAAP. You should not rely on these non-U.S. GAAP measures as a substitute for any such U.S. GAAP financial measure. We strongly urge you to 42 review the reconciliations to U.S. GAAP net income (loss), along with our consolidated financial statements included elsewhere in this report. We also strongly urge you to not rely on any single financial measure to evaluate our business. In addition, because EBITDA and Adjusted EBITDA are not measures of financial performance under U.S. GAAP and are susceptible to varying calculations, EBITDA and Adjusted EBITDA as presented in this report, may differ from and may not be comparable to similarly titled measures used by other companies.