holders or treatment as ‘‘qualified dividend income’’ (which is taxable at the rates generally applicable to long-term capital gains) for U.S. holders taxed as individuals. U.S. holders that elect to treat us as a qualified electing fund (a ‘‘QEF election’’) will not be subject to U.S. federal income tax on dividends and will instead be taxed currently on their pro rata share of our ordinary earnings as ordinary income and a pro rata share of our net capital gain as long-term capital gain, and generally capital gain from the sale, exchange or other disposition of shares held more than one year will be long-term capital gain eligible for a maximum 15% rate of taxation for non-corporate holders. U.S. holders who make a QEF election may be required to include amounts in income for U.S. federal income tax purposes in excess of amounts distributed by us.
As a Bermuda company, our ability to pay dividends is subject to certain restrictions imposed by Bermuda law.
We operate in a capital-intensive industry. Our predecessor financed the purchase of aircraft and pre-delivery payments for aircraft with cash received from GE. We expect to fund our capital needs from retained cash flow and debt and equity financing, including borrowings under our $1 billion credit facility.
Our short-term liquidity needs include working capital for operations associated with our aircraft and cash to pay dividends to our shareholders. We expect that cash on hand, cash flow provided by operations and the availability of borrowings under our liquidity facility will satisfy our short-term liquidity needs with respect to our Initial Portfolio and dividend payments through at least the next 12 months.
Our sole source of operating cash flows is currently from distributions made to us by our subsidiary Genesis Funding, through which we hold all of the aircraft in our Initial Portfolio. Distributions of cash to us by Genesis Funding are subject to compliance with covenants contained in the agreements governing the securitization described below.
Our liquidity needs also include the financing of acquisitions of additional aircraft and other aviation assets that we expect will drive our growth. We plan to finance acquisitions through additional securitizations, borrowings under our credit facility and additional debt and equity offerings. Our ability to execute our business strategy to acquire these additional assets therefore depends to a significant degree on our ability to access debt and equity capital markets. We expect to refinance the notes issued in our securitization on or prior to the end of the fifth year after the issuance thereof. In the event that the notes are not repaid on or prior to such date, any excess cash flow provided by the leases in our Initial Portfolio will be used to repay the principal amount of the notes and will not be available to us to pay dividends to our shareholders.
Our access to debt and equity financing to fund acquisitions will depend on a number of factors, such as our historical and expected performance, compliance with the terms of our debt agreements, industry and market trends, the availability of capital and the relative attractiveness of alternative investments. We believe that funds will be available to support our growth strategy and that we will be able to pay dividends to our shareholders as contemplated by our dividend policy. However, deterioration in our performance or in the capital markets could limit our access to these sources of financing, increase our cost of capital, or both, which could negatively affect our ability to raise additional funds, grow our aircraft portfolio and pay dividends to our shareholders.
On April 20, 2007, we signed an agreement to purchase two new Airbus 320 aircraft from Air Deccan of India. The aircraft are expected to be delivered in July and September 2007 and will be leased back on long-term leases to Air Deccan.
In addition to acquisitions of additional aircraft and other aviation assets, we expect to make capital expenditures from time to time in connection with improvements to our aircraft. These
expenditures include the cost of major overhauls and modifications. As of March 31, 2007, the average weighted age of the aircraft in our Initial Portfolio was 6.0 years. In general, the costs of operating an aircraft, including capital expenditures, increase with the age of the aircraft.
Securitization
Concurrently with the completion of our IPO, our subsidiary Genesis Funding completed a securitization transaction that generated net proceeds of approximately $794.3 million after deducting initial purchasers’ discounts and fees. Genesis Funding is a special purpose exempted company that was organized under the laws of the Bermuda to purchase our Initial Portfolio. Although Genesis Funding is organized under the laws of the Bermuda, it is a resident in Ireland for Irish tax purposes and thus subject to Irish corporation tax on its income in the same way, and to the same extent, as if it were organized under the laws of Ireland. The authorized business of Genesis Funding is limited to acquiring, buying, leasing, maintaining, operating and selling aircraft and entering into hedge agreements and credit facilities related to such activities. We own 100% of the Class A Shares of Genesis Funding, through which we are the beneficiary of more than 99.99% of the equity interest in the property of Genesis Funding. A charitable trust established for the benefit of identified charities, which we refer to as the Charitable Trust, indirectly owns 100% of the Class B Shares of Genesis Funding entitling it to a nominal equity interest in the property of Genesis Funding. Holders of the Class A Shares are entitled to vote on all matters on which shareholders of Genesis Funding are entitled to vote. Holders of the Class B Shares are entitled to vote solely on matters relating to a winding-up, a dissolution, merger, consolidation, transfer of assets and certain limitations on the issuance, transfer and sale of ownership interests, and certain matters with respect to bankruptcy and corporate governance of Genesis Funding.
The notes have the benefit of a financial guaranty insurance policy issued by the policy provider identified below to support the payment of interest when due on the notes and the payment of the outstanding principal balance of the notes on the final maturity date of the notes and, under certain other circumstances, prior thereto.
The notes are rated Aaa and AAA by Moody’s Investors Service, Inc., or Moody’s, and Standard & Poor’s Rating Services, a division of The McGraw-Hill Companies, Inc., respectively.
The notes were issued pursuant to the terms of a trust indenture, dated December 19, 2006, the date of the completion of our IPO, which we refer to as the indenture, among Genesis Funding, a cash manager, a trustee, an operating bank, a liquidity facility provider and a policy provider.
We acquired the title or beneficial interest in all the aircraft in our Initial Portfolio through Genesis Funding and its subsidiaries. As a result, our rights to these aircraft are structurally subordinated to the rights of the creditors of Genesis Funding. This means that the creditors of Genesis Funding will be paid from its assets before we would have any claims to those assets. The obligations of Genesis Funding in connection with the securitization are without recourse to us or our other subsidiaries. In addition, the terms of the indenture impose restrictions on the ability to lease or sell the aircraft in the Initial Portfolio and require Genesis Funding to apply its cash flow in accordance with the priorities established in the indenture as described below.
Interest Rate
The notes bear interest at an adjustable interest rate equal to the then current one-month LIBOR plus 0.24%. Interest expense for the securitization also includes amounts payable to the policy provider and the liquidity facility provider thereunder. Genesis Funding has also entered into an interest rate swap agreement intended to hedge the interest rate exposure associated with issuing the floating-rate obligations of the notes, to the extent backed by fixed rate lease assets.
Maturity Date
The final maturity date of the notes is December 19, 2032.
Payment Terms
Principal payments during the fourth and fifth years following the closing date of the securitization and interest on the notes are due and payable on a monthly basis. During the first three
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years, there are no scheduled principal payments on the notes and for each month during the fourth and fifth years following the closing date of securitization, there are be scheduled principal payments in fixed amounts, in each case subject to satisfying certain debt service coverage ratios and other covenants. Thereafter, cash flow generally will not be available to us for the payment of dividends since principal payments are not fixed in amount but rather are determined monthly based on revenues collected and costs and other liabilities incurred prior to the relevant payment date. Effectively, after the fifth anniversary of the closing date of the securitization, all revenues collected during each monthly period will be applied to repay the outstanding principal balance of the notes, after the payment of certain expenses and other liabilities, including the fees of the service providers (including GECAS as servicer and us in our role as manager), the liquidity facility provider and the policy provider, in terest on the notes and interest rate swap payments, all in accordance with the priority of payments set forth in the indenture.
For each month during the fourth and fifth years following the closing date of the securitization, subject to satisfying a debt service coverage ratio and other covenants, the minimum scheduled payments of principal will be $1 million per month.
In connection with the offering of the notes we determined an expected final payment date of December 19, 2011, which will be five years after the date of issuance of the notes and assumes the refinancing of the notes. We also determined a base case final payment date of September 19, 2018, which was arrived at based on assumptions with respect to possible revenue scenarios designed to illustrate some of the payment characteristics of the notes and were not intended to be projections, estimates, forecasts or forward-looking statements. The final maturity date of the notes is December 19, 2032.
Available Cash
Genesis Funding is required to maintain as of each monthly payment date cash in an amount sufficient to cover its operating expenses for a period of one month or, in the case of maintenance expenditures, three months, following such payment date. In addition, during the three years after completion of our IPO, additional rent is deposited in a separate account to be used for major airframe overhauls, engine overhauls, engine life limited parts replacements, auxiliary power unit overhauls and landing gear overhauls. All cash flows attributable to the underlying aircraft after the payment of amounts due and owing in respect of, among other things, maintenance and repair expenditures with respect to the aircraft, insurance costs and taxes and all repossession and remarketing costs, certain amounts due to any credit support providers, swap providers, the policy provider, trustees, directors and various service providers (including GECAS as servicer and us as manager ) will be distributed in accordance with the priority of payments set forth in the indenture. Genesis Funding, however, is required to use the amount of excess securitization cash flows to repay principal under the notes instead of paying dividends upon the occurrence of certain events, including failure to maintain a specified debt service coverage ratio, certain events of bankruptcy or liquidation and any acceleration of the notes after the occurrence of other events of default.
Otherwise, we intend to use the excess securitization cash flow to pay dividends and to purchase additional aircraft and other aviation assets.
We expect to refinance the notes on or prior to the fifth anniversary of the completion of our IPO. In the event that the notes are not refinanced on or prior to that month, any excess securitization cash flow will be used to repay the principal amount of the notes and will not be available to us to pay dividends to our shareholders.
Collateral
The notes are secured by first priority, perfected security interests in and pledges or assignments of equity ownership and beneficial interests in the subsidiaries of Genesis Funding, their interests in the leases of the aircraft they own, cash held by or for them and by their rights under agreements with GECAS, the initial liquidity facility provider, hedge counterparties and the policy provider. Rentals
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paid under leases are placed in the collections account and paid out according to a priority of payments set forth in the indenture. The notes are also secured by a lien or similar interest in any of the aircraft in the Initial Portfolio that are registered in the United States or Ireland and in any additional aircraft of Genesis Funding so registered at any time prior to the second anniversary of the closing date of the securitization. Genesis Funding agreed not to encumber the aircraft in our Initial Portfolio with any other liens except the leases and liens created or permitted thereunder, under the indenture or under the security trust agreement. Genesis Funding also agreed not to incur any indebtedness, except as permitted under the indenture, other than the notes, any permitted credit and liquidity enhancement facilities and the obligations related to the policy.
Certain Covenants
Genesis Funding is subject to certain operating covenants including relating to the maintenance, registration and insurance of the aircraft as set forth in the indenture. The indenture also contains certain conditions and constraints which relate to the servicing and management of the Initial Portfolio including covenants relating to the disposition of aircraft, lease concentration limits, restrictions on the acquisition of additional aircraft and restrictions on the modification of aircraft and capital expenditures as described below. GECAS has agreed to use commercially reasonable efforts to perform its services pursuant to the Initial Portfolio Servicing Agreement, subject to certain provisions of the indenture as they relate to the services provided by GECAS thereunder.
Liquidity Facility
Upon the completion of the securitization, Genesis Funding, the manager and PK AirFinance US, Inc., an affiliate of GE, entered into a revolving credit facility, which we refer to as the liquidity facility. On March 19, 2007, PK AirFinance US, Inc. assigned its role as liquidity facility provider to Calyon. The aggregate amounts available under the liquidity facility is $75 million. Advances of up to $60 million may be drawn to cover certain expenses of Genesis Funding, including maintenance expenses, interest rate swap payments and interest on the notes issued under the indenture. The remaining $15 million of the liquidity facility is available for the three years from the completion of our IPO to cover any shortfalls in the separate account set aside for overhauls and certain parts replacements. Upon each drawing under the liquidity facility, Genesis Funding is required to reimburse the provider of the liquidity facility for the amount of such drawing plus accrued interest on such drawing in accordance with the order of priority specified in the indenture. In the event any amounts under the liquidity facility advanced for shortfalls for overhauls and replacements remains outstanding after such three-year period Genesis Funding will pay a principal amount equal to $625,000 per month to repay such advances. Upon the occurrence of certain events, including a downgrade of the provider of the liquidity facility below a certain ratings threshold, the liquidity facility will be drawn in full and the proceeds will be deposited in an account established under the indenture and will be available for the same purposes as drawings under the liquidity facility. Drawings under the initial liquidity facility bear interest at one-month LIBOR plus a spread of 120 basis points. Genesis Funding also is required to pay an upfront fee of $450,000 at closing and a commitment fee of 60 basis points on each payment date to the provider of the liquidity faci lity.
Credit Facility
On April 5, 2007, Genesis Acquisition entered into a $1 billion senior secured credit facility with Genesis Lease Limited, as Manager, the financial institutions party thereto as lenders, Citibank, N.A., as administrative agent, and Deutsche Bank Trust Company Americas, as security trustee and account bank. The credit facility permits initial loans in an aggregate principal amount of up to $250 million, with an option for Genesis Acquisition to increase the aggregate principal amount of available loans by an additional amount of up to $750 million during the first 18 months following the closing date of the credit facility, for a total commitment amount of up to $1 billion. The credit facility will provide funding for 65.0-72.5% (depending on aircraft type) of the agreed value of the aircraft that Genesis Acquisition may acquire.
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Revolving Facility, Conversion and Term. The commitments under the credit facility are available until April 2010, at which time Genesis Acquisition will have the option to convert any outstanding amount under the credit facility to a term loan with a two-year maturity. If Genesis Acquisition does not exercise this option, then the outstanding amount under the credit facility at such time will be due on such date. All borrowings under the credit facility are subject to the satisfaction of customary conditions, including the delivery of aircraft appraisals, lien perfection, absence of a default, the absence of a material adverse change in the financial condition or business of Genesis Lease or Genesis Acquisition, and the accuracy of customary representations and warranties.
Commitment Fees. The following commitment fees will be payable in connection with the commitment for the credit facility:
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| ▪ | 0.375% per year on the unused amount of the initial commitment of up to $250 million, payable quarterly by GAL in arrears from the closing date until October 2008; and |
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| ▪ | 0.375% per year on the unused amount of $750 million (1) for a period of 12 months from the signing date, which is payable by in advance by GE Commercial Aviation Services Limited (‘‘GECAS’’), (2) thereafter for a period of 6 months, payable quarterly by GAL in arrears, in each case of (1) and (2) whether or not the option to increase the commitment amount to $1 billion is exercised, and (3) thereafter, if GAL exercises the option to increase the commitment amount to $1 billion, payable quarterly by GAL in arrears. |
If Genesis Acquisition exercises its option to increase the commitment amount to $1 billion before the first anniversary of the signing date, then it will receive a credit equal to the amount of the commitment fee paid with respect to subclause (1) of the prior bullet, for the period of time from the date of such exercise to the first anniversary of the signing date, and Genesis Acquisition will refund such amount to GECAS.
Interest Rate. Borrowings under the credit facility will bear interest at one- or three-month LIBOR plus an applicable margin. The applicable margin will be between 1.50% and 1.75%, depending on Genesis Acquisition’s portfolio composition and the principal amount outstanding under the credit facility during the revolving period and 2.75% during the term period (if Genesis Acquisition exercises its option to convert the credit facility to a term loan).
Prepayment. Genesis Acquisition has the right to prepay any amounts outstanding under the credit facility or to reduce the commitment thereunder. In addition, Genesis Acquisition will be required to make partial prepayments of borrowings under the credit facility upon the total loss, sale or other disposition of aircraft financed with borrowings under the credit facility, or if the aggregate amount of the loans outstanding under the credit facility exceeds the borrowing base (as defined in the credit facility), including as a result of a decrease in the value of an aircraft financed with borrowings thereunder as determined by mandatory periodic appraisals.
Collateral. Pursuant to a security trust agreement, dated as of April 5, 2007, among Genesis Acquisition, certain affiliates of Genesis Acquisition, Citibank, N.A., as administrative agent, and Deutsche Bank Trust Company Americas, as security trustee and account bank, borrowings under the credit facility will be secured by first priority, perfected security interests in and pledges or assignments of (1) the equity ownership and beneficial interests of each subsidiary of Genesis Acquisition, (2) leases of the aircraft financed under the credit facility, (3) rights under the casualty insurance on such aircraft, (4) accounts under the sole dominion and control of the administrative agent under the credit facility into which lease rentals, insurance proceeds, sale proceeds and other amounts will be paid, and (5) where possible, an intern ational interest under the Cape Town Convention in each eligible airframe, engine and lease.
Covenants. The credit facility contains customary covenants, including the following:
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| ▪ | a requirement that GAL deliver periodic financial and other reports to the administrative agent; |
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| ▪ | limitations on the incurrence of additional indebtedness; |
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| ▪ | limitations on consolidation, acquisition, merger and transfer of assets; |
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| | |
| ▪ | a requirement that the aircraft in GAL’s portfolio comply with lessee and geographic concentration limits; |
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| ▪ | a requirement that the weighted average age of GAL’s aircraft portfolio not exceed 10 years until the option to increase the commitment amount to up to $1 billion is exercised, and 8 years thereafter; and |
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| ▪ | a requirement that from the earlier of (1) six months after the signing date and (2) GAL having borrowed at least $100 million under the credit facility, the ratio of earnings before interest, taxes, depreciation and amortization (‘‘EBITDA’’) to interest expense for any trailing period of three consecutive months exceeds (i) 1.1 at all times and (ii) 1.5 for advances to be available under the credit facility. |
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Interest rate risk is the exposure to loss resulting from changes in the level of interest rates and the spread between different interest rates. Interest rate risk is highly sensitive to many factors, including U.S. monetary and tax policies, U.S. and international economic factors and other factors beyond our control. We are exposed to changes in the level of interest rates and to changes in the relationship or spread between interest rates. Our primary interest rate exposures relate to our lease agreements and our floating rate debt obligations such as the notes issued in the securitization and borrowings under our liquidity facility and our credit facility. Thirty-eight out of 41 of our lease agreements require the payment of a fixed amount of rent during the term of the lease, with rent under the remaining three leases adjusting bi-annually based on six-month LIBOR Our indebtedness require payments based on a variable interest rate index such as LIBOR. Howe ver, we have entered into an interest rate swap for a five year period to fix the cost associated with the notes issued in the securitization. Therefore, increases in interest rates may reduce our net income by increasing the cost of our debt without any corresponding proportional increase in rents or cash flow from our leases.
Sensitivity Analysis
The following discussion about the potential effects of changes in interest rates is based on a sensitivity analysis, which models the effects of hypothetical interest rate shifts on our financial condition and results of operations. Although we believe a sensitivity analysis provides the most meaningful analysis permitted by the rules and regulations of the SEC, it is constrained by several factors, including the necessity to conduct the analysis based on a single point in time and by the inability to include the extraordinarily complex market reactions that normally would arise from the market shifts modeled. Although the following results of a sensitivity analysis for changes in interest rates may have some limited use as a benchmark, they should not be viewed as a forecast. This forward-looking disclosure also is selective in nature and addresses only the potential impacts on our financial instruments and our three variable rate leases. It does not include a variety of other potential factors that could affect our business as a result of changes in interest rates.
A hypothetical 100-basis point increase / decrease in our variable interest rates would increase / decrease the minimum contracted rentals on our Initial Portfolio in 2007 by $1.0 million and would have no impact on our net interest expense on the notes issued in the securitization because we have entered into a five-year interest swap agreement to fix the cost associated with the debt. This assumes no drawdowns on our liquidity facility or our credit facility.
Foreign Currency Exchange Risk
We currently receive all of our revenue in U.S. dollars, and we pay substantially all of our expenses in U.S. dollars. However, we incur some of our expenses in other currencies, primarily the euro, and we may enter into leases under which we receive revenue in other currencies, primarily the euro. During the past several years, the U.S. dollar has depreciated against the euro. Depreciation in
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the value of the U.S. dollar relative to other currencies increases the U.S. dollar cost to us of paying such expenses. The portion of our business conducted in other currencies could increase in the future, which could expand our exposure to losses arising from currency fluctuations. We have not engaged in any foreign currency hedging transactions. However, we may consider engaging in these transactions in the future. Because we currently receive all of our revenue in U.S. dollars and pay substantially all of our expenses in U.S. dollars, a change in foreign exchange rates would not have a material impact on our results of operations.
Item 4. Controls and Procedures
We conducted an evaluation of our disclosure controls and procedures under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2007 to ensure that information required to be disclosed in the reports we file or submit under the Securities and Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
In connection with our IPO and our acquisition of our Initial Portfolio, we assumed independent responsibility for our disclosure controls and internal controls over financial reporting. Prior to the IPO, GECAS and other affiliates of GE provided our predecessor with disclosure controls and internal controls over financial reporting. Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we are in the process of conducting further evaluation of our internal controls over financial reporting for compliance with the requirements of Section 404 under the Sarbanes-Oxley Act. In this regard, we have engaged an advisor to assist us in evaluating, designing, implementing and testing internal controls over financial reporting intended to comply with the requirements of Section 404. As we are still in the evaluation process, we may identify material weaknesses or significant deficienci es in the future. Should we discover such conditions, we intend to remediate them as soon as practicable. We are committed to taking appropriate steps for remediation, as needed.
Our Chief Executive Officer and Chief Financial Officer do not expect that our disclosure controls or internal controls will prevent all error and all fraud. Although our disclosure controls and procedures were designed to provide reasonable assurance of achieving their objectives, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based partly on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
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PART II — Other Information
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
There have been no material changes to the disclosure related to the risk factors described in our Annual Report on Form 20-F, filed with the SEC on April 3, 2007.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On January 16, 2007, we issued and sold 517,500 shares in the form of ADSs to an affiliate of GE at a price of $23.00 per ADS in a private placement pursuant to an exemption provided by Section 4(2) of the Securities Act of 1933. The private placement involved no public offering and was completed pursuant to a private placement agreement, dated November 26, 2006.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
The following exhibits are filed as part of this Report:
| | | | | | |
| 4 | .1* | | | | Credit Agreement, dated April 5, 2007, among the Genesis Acquisition Limited, Genesis Lease Limited, the financial institutions named thereinas lenders, Citibank, N.A., and Deutsche Bank Trust Company Americas. |
| 4 | .2* | | | | Security Trust Agreement, dated April 5, 2007, among Citibank, N.A., Deutsche Bank Trust Company Americas and Genesis Acquisition Limited. |
| 4 | .3* | | | | Servicing Agreement, dated April 5, 2006, among GE Commercial Aviation Services Limited, Financial Guaranty Insurance Company and Genesis Acquisition Limited. |
|
| * | Filed as an exhibit to the Report on Form 6-K, dated April 12, 2007, and incorporated by reference herein. |
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