SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-28774
_________________
WILLIS LEASE FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 68-0070656
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
2320 Marinship Way, Suite 300, Sausalito, CA 94965
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (415) 331-5281
_________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Title of Each Class Outstanding at October 31, 1998
------------------- -------------------------------
Common Stock, $0.01 Par Value 7,285,813
1
WILLIS LEASE FINANCE CORPORATION
INDEX
Page No.
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PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
As of September 30, 1998 and December 31, 1997 3
Consolidated Statements of Income 4
Three and nine months ended September 30, 1998 and 1997
Consolidated Statements of Shareholders' Equity 5
Year ended December 31, 1997 and
nine months ended September 30, 1998
Consolidated Statements of Cash Flows 6
Nine months ended September 30, 1998 and 1997
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition 9
and Results of Operations
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 17
2
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(Unaudited)
ASSETS
Cash and cash equivalents $2,926,597 $13,095,303
Deposits 16,701,061 18,461,456
Equipment held for operating lease, less accumulated depreciation
of $14,197,951 at September 30, 1998 and $15,267,683 at December 31, 1997 246,312,602 138,535,643
Net investment in direct finance lease 9,391,351 9,821,854
Property, equipment and furnishings, less accumulated depreciation
of $436,585 at September 30, 1998 and $275,109 at December 31, 1997 2,274,450 540,856
Spare parts inventory 29,150,797 10,334,113
Maintenance billings receivable 888,898 1,547,765
Operating lease rentals receivable 642,645 520,466
Receivables from spare parts sales 4,865,594 2,908,175
Other receivables 331,721 375,878
Other assets 7,963,459 2,288,547
------------- -------------
Total assets $321,449,175 $198,430,056
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses $6,270,112 $4,010,976
Salaries and commissions payable 461,319 1,070,051
Deferred income taxes 11,525,590 8,476,040
Deferred gain 163,406 183,278
Notes payable and accrued interest 214,861,837 101,433,200
Capital lease obligation 2,690,852 2,802,119
Residual share payable 2,402,410 2,092,140
Maintenance reserves 14,360,602 20,018,195
Security deposits 4,176,006 2,435,987
Unearned lease revenue 2,497,213 1,306,613
------------- -------------
Total liabilities $259,409,347 $143,828,599
------------- -------------
Shareholders' equity:
Common stock, ($0.01 par value and no par value as of
September 30, 1998 and December 31, 1997, respectively.
20,000,000 shares authorized; 7,285,813 and 7,177,320
shares issued and outstanding as of September 30, 1998
and December 31,1997, respectively) 72,858 -
Paid-in capital in excess of par 41,100,934 40,117,223
Retained earnings 20,866,036 14,484,234
------------- -------------
Total shareholders' equity 62,039,828 54,601,457
------------- -------------
Total liabilities and shareholders' equity $321,449,175 $198,430,056
------------- -------------
------------- -------------
See accompanying notes to the consolidated financial statements
3
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
REVENUE
Lease revenue $9,077,536 $5,159,969 $22,642,709 $13,703,795
Gain on sale of leased equipment 3,639,707 936,069 9,178,785 1,333,448
Spare part sales 7,229,672 5,581,648 16,828,866 11,459,311
Sale of equipment acquired for resale - 2,600,000 4,093,641 12,747,840
Interest and other income 133,644 90,821 752,876 543,660
----------- ----------- ----------- -----------
Total revenue $20,080,559 $14,368,507 $53,496,877 $39,788,054
EXPENSES
Interest expense 4,214,800 2,068,997 10,416,850 5,225,603
Depreciation expense 2,179,989 1,140,692 5,325,324 2,995,121
Residual share 187,128 226,659 587,387 598,125
Cost of spare part sales 5,037,298 4,044,196 11,923,306 7,751,179
Cost of equipment acquired for resale - 2,033,687 3,573,499 10,671,668
General and administrative 4,325,601 2,434,013 10,693,763 6,358,000
----------- ----------- ----------- -----------
Total expenses $15,944,816 $11,948,244 $42,520,129 $33,599,696
----------- ----------- ----------- -----------
Income before income taxes and extraordinary item 4,135,743 2,420,263 10,976,748 6,188,358
Income taxes (1,651,834) (969,327) (4,394,462) (2,456,283)
----------- ----------- ----------- -----------
Income before extraordinary item 2,483,909 1,450,936 6,582,286 3,732,075
Extraordinary item less applicable income taxes - - (200,480) 2,007,929
----------- ----------- ----------- -----------
Net income $2,483,909 $1,450,936 $6,381,806 $5,740,004
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Basic earnings per common share:
Income before extraordinary item $0.34 $0.27 $0.91 $0.69
Extraordinary item - - (0.03) 0.37
----------- ----------- ----------- -----------
Net income $0.34 $0.27 $0.88 $1.05
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted earnings per common share:
Income before extraordinary item $0.33 $0.26 $0.88 $0.67
Extraordinary item - - (0.03) 0.36
----------- ----------- ----------- -----------
Net income $0.33 $0.26 $0.85 $1.03
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Average common shares outstanding 7,280,130 5,447,117 7,245,404 5,441,292
Diluted average common shares outstanding 7,495,491 5,658,184 7,466,062 5,592,223
See accompanying notes to the consolidated financial statements
4
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1997 AND NINE MONTHS ENDED SEPTEMBER 30, 1998
Issued and
outstanding Paid-in Total
shares of Common Capital in Retained shareholders'
common stock Stock Excess of Par earnings equity
------------ ----------- ------------- ---------- ------------
Balances at December 31, 1996 5,426,793 $16,055,689 $ - $7,146,563 $23,202,252
Shares issued 25,527 221,244 - - 221,244
Common stock issued and
proceeds from secondary offering, net 1,725,000 23,840,290 - - 23,840,290
Net income - - - 7,337,667 7,337,667
--------- ----------- ----------- ----------- -----------
Balances at December 31, 1997 7,177,320 $40,117,223 $ - $14,484,230 $54,601,453
Shares issued 108,493 586,490 137,848 - 724,338
Tax benefit from disqualified
dispositions of qualified shares - - 332,231 - 332,231
Conversion to par value stock - (40,630,855) 40,630,855 - -
Net income - - - 6,381,806 6,381,806
--------- ----------- ----------- ----------- -----------
Balances at September 30, 1998 (unaudited) 7,285,813 $72,858 $41,100,934 $20,866,036 $62,039,828
--------- ----------- ----------- ----------- -----------
--------- ----------- ----------- ----------- -----------
See accompanying notes to the consolidated financial statements
5
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1998 1997
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,381,806 $ 5,740,004
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation of equipment held for lease 5,155,698 2,905,016
Depreciation of property, equipment and furnishings 169,626 90,105
Loss on sale of property, equipment and furnishings 15,536 (45,122)
Gain on sale of leased equipment (9,178,785) (1,333,448)
Increase in residual share payable 310,270 598,125
Changes in assets and liabilities:
Deposits 1,760,395 (620,199)
Spare parts inventory (18,816,684) (5,511,768)
Receivables (1,376,574) (1,414,577)
Other assets (2,300,171) (667,171)
Accounts payable and accrued expenses 2,259,136 (608,914)
Salaries and commission payable (608,732) 371,324
Deferred income taxes 3,049,550 3,030,693
Deferred gain (19,872) (19,872)
Accrued interest (172,694) (364,270)
Maintenance deposits (5,657,593) 6,244,630
Security deposits 1,740,019 501,887
Unearned lease revenue 1,190,600 90,410
------------ ------------
Net cash (used in) provided by operating activities (16,098,469) 8,986,853
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of equipment held for
operating lease (net of selling expenses) 28,676,239 12,083,807
Proceeds from sale of property,
equipment and furnishings 16,300 80,500
Purchase of equipment held for operating lease (132,430,111) (53,582,728)
Deposits made in connection with inventory purchases (3,374,741) -
Purchase of property, equipment and furnishings (1,935,060) (174,341)
Principal payments received on direct finance lease 430,503 133,967
------------ ------------
Net cash used in investing activities (108,616,870) (41,458,795)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable 157,685,170 104,038,706
Proceeds from issuance of common stock 1,056,569 221,244
Principal payments on notes payable (44,083,839) (71,635,450)
Principal payments on capital lease obligation (111,267) (122,754)
------------ ------------
Net cash provided by financing activities 114,546,633 32,501,746
(Decrease) increase in cash and cash equivalents (10,168,706) 29,804
Cash and cash equivalents at beginning of period 13,095,303 6,573,241
------------ ------------
Cash and cash equivalents at end of period $ 2,926,597 $ 6,603,045
------------- ------------
------------- ------------
Supplemental information:
Net cash paid for: Interest 10,589,544 5,589,873
------------- ------------
Income Taxes 3,013,122 188,600
------------- ------------
Non-cash financing activities:
Disqualified disposition of qualified shares
resulted in a $332,231 tax benefit.
See accompanying notes to the consolidated financial statements
6
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of Willis
Lease Finance Corporation and its subsidiaries (the "Company") have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission for reporting on Form 10-Q. Pursuant to such rules and regulations,
certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. The accompanying unaudited interim financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto, together with Management's Discussion and Analysis
of Financial Condition and Results of Operations, contained in the Company's
Annual Report to Shareholders incorporated by reference in the Company's Annual
Report on Forms 10-K and 10-KA for the fiscal year ended December 31, 1997.
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of only normal and
recurring adjustments) necessary to present fairly the financial position of the
Company as of September 30, 1998, and December 31, 1997, and the results of its
operations for the three and nine month periods ended September 30, 1998 and
1997 and its cash flows for the nine month periods ended September 30, 1998 and
1997. The results of operations and cash flows for the periods ended September
30, 1998, are not necessarily indicative of the results of operations or cash
flows which may be reported for the remainder of 1998.
2. MANAGEMENT ESTIMATES
The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
3. SHAREHOLDERS' EQUITY
The Company changed its state of incorporation from California to Delaware
through a merger of Willis Lease Finance Corporation into its wholly-owned
Delaware subsidiary. The reincorporation, approved by the Company's
shareholders at the May 12, 1998 Annual Meeting of Shareholders, results in a
change only of the Company's legal domicile. It does not result in any change
in the Company's name, operations, locations, management, reporting obligations,
NASDAQ National Market trading symbol or assets and liabilities. In connection
with this reincorporation, the Company converted no par value common stock to
$0.01 par value common stock.
The Company has a 1996 Employee Stock Purchase Plan (the "Purchase Plan")
under which 75,000 shares of common stock have been reserved for issuance. This
plan became effective in September 1996. Eligible employees may designate not
more than 10% of their cash compensation to be deducted each pay period for the
purchase of common stock under the Purchase Plan, and participants may purchase
not more than $25,000 of common stock in any one calendar year. Each January 31
and July 31 shares of common stock are purchased with the employees' payroll
deductions over the immediately preceding six months at a price per share of 85%
of the lesser of the market price of the common stock on the purchase date or
the market price on the date of entry into an offering period. During the nine
month
7
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
period ended September 30, 1998, the Company issued 15,755 shares of Common
Stock as a result of employee stock purchases under the Purchase Plan.
Under the 1996 Stock Option/Stock Issuance Plan, as amended and restated
February 24, 1998, 1,025,000 shares of the Company's shares have been set aside
to provide eligible persons with the opportunity to acquire a proprietary
interest in the Company. The plan includes a Discretionary Option Grant
Program, a Stock Issuance Program, and an Automatic Option Grant Program for
eligible nonemployee Board Members. During the nine month period ended
September 30, 1998, 67,500 options were exercised. In connection with the
exercise of a portion of these options, the Company recognized a $332,231 tax
benefit.
In conjunction with its initial public offering, the Company sold five-year
purchase warrants for $.01 per warrant covering an aggregate of 100,000 shares
of common stock exercisable at a price equal to 130% of the initial public
offering price. The warrants are exercisable commencing 24 months after the
effective date of the initial public offering or earlier, but not earlier than
12 months after the initial public offering, if and when the Company files a
registration statement for the sale by the Company of shares of common stock or
securities exercisable for, convertible into or exchangeable for shares of
common stock (other than pursuant to a stock option or other employee benefit or
similar plan, or in connection with a merger or an acquisition). The common
stock offering in December 1997 constituted such a registration. The warrants'
exercise price and the number of shares of Common Stock are subject to
adjustment to protect the warrant holders against dilution in certain events.
In February 1998, a holder of 50,000 of the warrants exercised the warrants
under the net issuance rights of the warrants. Based on the closing price on
such date, the exercise resulted in the issuance of 25,238 shares to the holder
of the warrants.
4. FINANCING
In September 1998, the Company amended and restated its revolving credit
facility, increasing the facility to $150 million. This credit facility is
available to finance the acquisition of aircraft engines, aircraft and
high-value spare parts for sale or lease as well as for general working capital
purposes. At September 30, 1998, the interest rate on this facility was LIBOR
plus 1.75%. This facility has a two-year revolving period followed by a
four-year term-out period. The facility is renewable annually.
In March 1998, the Company repaid a loan that had residual sharing
provisions. The repayment resulted in an extraordinary expense of $0.2 million,
net of tax.
5. COMMITMENTS
In June 1998, the Company commenced a new lease of office space for its
Sausalito operations. The initial term of this lease is five years and the
annual rental commitments under the lease are approximately $0.3 million. In
April 1998, the Company commenced lease of a warehouse and office facility for
Willis Aeronautical Services, Inc. ("WASI") in San Diego, California. WASI
moved its South San Francisco operations into this facility in June 1998. The
initial term of this lease is six years and the annual rental commitments under
the lease are approximately $0.4 million.
The Company has committed to purchase, during 1998 and 1999, additional
used aircraft and engines for its operations. Certain deposits were made in
connection with these commitments. The Company's current, remaining commitment
to such purchases is not more than $28.6 million. A portion of these purchases
will take place in 1998 and the remainder in 1999.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company's core business is acquiring and leasing, primarily pursuant to
operating leases, commercial aircraft spare engines, aircraft and other aircraft
equipment. The Company, through WASI, also specializes in the purchase and
resale of aftermarket airframe and engine parts, engines, modules and rotable
components. In July 1998, the Company formed Pacific Gas Turbine Center,
Incorporated ("PGTC"). Currently, PGTC provides engine disassembly services to
WASI and third parties from the Company's San Diego location. In addition, the
Company engages in the selective purchase and resale of commercial aircraft
engines.
The Company changed its state of incorporation from California to Delaware
through a merger of Willis Lease Finance Corporation into its wholly-owned
Delaware subsidiary. The reincorporation, approved by the Company's
shareholders at the May 12, 1998 Annual Meeting of Shareholders, resulted in a
change only of the Company's legal domicile. It did not result in any change in
the Company's name, operations, locations, management, reporting obligations,
NASDAQ National Market trading symbol or assets and liabilities.
Revenue consists primarily of lease revenue, income from the sale of spare
parts and components and income from the sale of engines and equipment.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1997:
Revenue is summarized as follows:
Nine Months Ended September 30,
-------------------------------------
1998 1997
---- -----
Amount % Amount %
-------------------------------------
(dollars in thousands)
Lease revenue. . . . . . . . . . . . . . . . 9,077 45% 5,160 36%
Gain on sale of leased equipment . . . . . . 3,640 18 936 6
Spare parts sales. . . . . . . . . . . . . . 7,230 36 5,582 39
Sale of equipment acquired for resale. . . . -- -- 2,600 18
Interest and other income. . . . . . . . . . 133 1 91 1
-------------------------------------
Total. . . . . . . . . . . . . . . . . . . . 20,080 100% 14,369 100%
-------------------------------------
-------------------------------------
LEASE PORTFOLIO. During the quarter ended September 30, 1998, seven
engines, and additional spare parts were added to the Company's lease portfolio
at a total cost of $31.0 million. Four engines were sold from the lease
portfolio.
LEASING ACTIVITIES. Lease revenue for the quarter ended September 30, 1998
increased 76% to $9.1 million from $5.2 million for the comparable period in
1997. This increase reflects lease revenues from additional engines, aircraft
and spare parts packages.
GAIN ON SALE OF LEASED EQUIPMENT. During the quarter ended September 30,
1998, the Company sold four engines from the lease portfolio which resulted in a
gain of $3.6 million. During the quarter ended September 30, 1997 the Company
sold two engines from the lease portfolio which resulted in a gain of $0.9
million.
9
SPARE PARTS SALES. Revenues from spare parts sales in the quarter ended
September 30, 1998 increased 29% to $7.2 million from $5.6 million in the
comparable 1997 period. The gross margin was 30% in the third quarter of 1998,
and 28% in the corresponding period in 1997.
SALE OF EQUIPMENT ACQUIRED FOR RESALE. During the quarter ended September
30, 1997, the Company sold five engines for $2.6 million resulting in a gain of
$0.6 million. The Company had no such sales during the comparable 1998 period.
INTEREST AND OTHER INCOME. Interest and other income for the quarter ended
September 30, 1998 was $0.1 million compared to $0.1 million for the quarter
ended September 30, 1997.
INTEREST EXPENSE AND RESIDUAL SHARING. Interest expense related to all
activities increased 104% to $4.2 million for the quarter ended September 30,
1998, from the comparable period in 1997, due to an increase in average debt
outstanding during the period. Residual sharing expense decreased 17% to
$187,128 for the quarter ended September 30, 1998 from $226,659 for the
comparable period in 1997. The decline was due to the repayment, in March 1998,
of one of the Company's loans which had residual sharing provisions. This
expense is calculated by comparing the net book value of the engines subject to
such agreements to their related debt balances and adjusting the residual share
payable to the appropriate amount representing the sharing percentage of any
excess of the net book value over the corresponding debt balance for such
engines.
DEPRECIATION EXPENSE. Depreciation expense increased 91% to $2.2 million
for the quarter ended September 30, 1998, from the comparable period in 1997,
due to the larger average asset base in the third quarter of 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 78% to $4.3 million for the quarter ended September 30, 1998 from $2.4
million in the comparable period in 1997. This increase reflects expenses
associated with staff additions, relocation of facilities, increased rent due to
the expansion of the Company's office and warehouse facilities, expenses
associated with Pacific Gas Turbine Center, as well as increases in professional
fees, insurance expense and expenses related to promotional and marketing
activities.
INCOME TAXES. Income taxes, exclusive of tax on extraordinary items, for
the quarter ended September 30, 1998, increased to $1.7 million from $1.0
million for the comparable period in 1997. This increase reflects an increase
in the Company's pre-tax earnings.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 1997:
Revenue is summarized as follows:
Nine Months Ended September 30,
------------------------------------
1998 1997
---- ----
Amount % Amount %
-------------------------------------
(dollars in thousands)
Lease revenue. . . . . . . . . . . . . . . . 22,643 42% 13,704 35%
Gain on sale of leased equipment . . . . . . 9,179 17 1,333 3
Spare parts sales. . . . . . . . . . . . . . 16,829 32 11,459 29
Sale of equipment acquired for resale. . . . 4,093 8 12,748 32
Interest and other income. . . . . . . . . . 753 1 544 1
-------------------------------------
Total. . . . . . . . . . . . . . . . . . . . 53,497 100% 39,788 100%
-------------------------------------
-------------------------------------
10
LEASE PORTFOLIO. During the period ended September 30, 1998, twenty-eight
engines, one spare parts package and two aircraft were added to the Company's
lease portfolio at a total cost of $132.5 million. Eight engines and one spare
parts package were sold or transferred from the lease portfolio.
LEASING ACTIVITIES. Lease revenue for the period ended September 30, 1998
increased 65% to $22.6 million from $13.7 million for the comparable period in
1997. This increase reflects lease revenues from additional engines, aircraft
and spare parts packages.
GAIN ON SALE OF LEASED EQUIPMENT. During the period ended September 30,
1998, the Company sold eight engines from the lease portfolio which resulted in
a gain of $9.2 million. This compares with gains in the period ended September
30, 1997 of $1.3 million from sales of three engines.
SPARE PARTS SALES. Revenues from spare parts sales in the period ended
September 30, 1998 increased 47% to $16.8 million from $11.5 million in the
comparable 1997 period. The gross margin decreased to 29% in the first nine
months of 1998, from 32% in the corresponding period in 1997. The decrease in
margin was primarily the result of the Company's decision to sell, shortly after
their acquisition, certain of the engines acquired under its agreement with
United Airlines to acquire used aircraft. In doing so, the Company avoided
disassembly, inventory and financing costs that would have been incurred had the
Company disassembled, inventoried and sold, over a period of time, the engines
in a piece part matter.
SALE OF EQUIPMENT ACQUIRED FOR RESALE. During the period ended September
30, 1998, the Company sold one engine for $4.1 million resulting in a gain of
$0.5 million. During the period ended September 30, 1997, the Company sold ten
engines for $12.7 million which resulted in gains of $2.1 million.
INTEREST AND OTHER INCOME. Interest and other income for the period ended
September 30, 1998 was $0.7 million compared to $0.5 million for the period
ended September 30, 1997.
INTEREST EXPENSE AND RESIDUAL SHARING. Interest expense related to all
activities increased 99% to $10.4 million for the period ended September 30,
1998, from the comparable period in 1997, due to an increase in average debt
outstanding during the period. Residual sharing expense decreased 2% to
$587,387 for the period ended September 30, 1998 from the $598,125 for the
comparable period in 1997. This expense is calculated by comparing the net book
value of the engines subject to such agreements to their related debt balances
and adjusting the residual share payable to the appropriate amount representing
the sharing percentage of any excess of the net book value over the
corresponding debt balance for such engines. In March 1998, the Company repaid
one of its loans which had residual sharing provisions. (See "Extraordinary
Items" below).
DEPRECIATION EXPENSE. Depreciation expense increased 78% to $5.3 million
for the period ended September 30, 1998, from the comparable period in 1997, due
to the larger average asset base in the first nine months of 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 68% to $10.7 million for the period ended September 30, 1998 from $6.4
million in the comparable period in 1997. This increase reflects expenses
associated with staff additions, relocation of facilities, increased rent due to
the expansion of the Company's office and warehouse facilities, expenses
associated with Pacific Gas Turbine Center, as well as increases in professional
fees, insurance expense and expenses related to promotional and marketing
activities.
INCOME TAXES. Income taxes, exclusive of tax on extraordinary items, for
the period ended September 30, 1998, increased to $4.4 million from $2.5 million
for the comparable period in 1997. This increase reflects an increase in the
Company's pre-tax earnings.
EXTRAORDINARY ITEMS. In March 1998, the Company repaid a loan that had
residual sharing provisions. The repayment resulted in an extraordinary expense
of $0.2 million, net of tax. In February 1997, the Company obtained a new loan
agreement for $41.5 million to replace an existing loan of $44.2 million. The
transaction resulted in an extraordinary gain of $2.0 million, net of tax.
11
ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued a new
statement: SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," which establishes annual and interim reporting standards
for a public Company's operating segments and related disclosures about its
products, services, geographic areas, and major customers. This statement is
effective for the Company's fiscal year ended December 31, 1998, with earlier
application permitted. The effect of adoption of the statement will be limited
to the form and content of the Company's disclosures and will not impact the
Company's results of operations, cash flow, or financial position.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which
standardizes the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, by requiring that an entity
recognize those items as assets or liabilities in the statement of financial
position and measure them at fair value. This statement is effective for all
quarters of fiscal years beginning after June 15, 1999. The Company is reviewing
the effect this standard will have on the Company's consolidated financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has financed its growth through borrowings
secured by its equipment lease portfolio. Cash of approximately $157.7 million
and $104.0 million, in the nine month periods ended September 30, 1998 and 1997,
respectively, was derived from this activity. In these same time periods $44.1
million and $71.6 million, respectively, was used to pay down related debt or
the capital lease. In December 1997, net proceeds from a follow-on common stock
offering were approximately $23.8 million. In September 1996, net proceeds from
the initial public offering were approximately $15.9 million. Cash flow from
operating activities used approximately $16.1 million in the nine month period
ended September 30, 1998 and cash flows from operating activities generated $9.0
million in the nine month period ended September 30, 1997. The deficit cash
flow from operations was primarily attributable to the acquisition of used
aircraft for WASI's inventory and deposits made in connection with future,
committed inventory purchases. Such deposits are carried as other assets on the
Company's consolidated balance sheet.
The Company's primary use of funds is for the purchase of equipment for
lease. Approximately $132.4 million and $53.6 million of funds were used for
this purpose in the nine month periods ended September 30, 1998 and 1997,
respectively.
At September 30, 1998, the Company had a $150.0 million revolving credit
facility to finance the acquisition of aircraft engines, aircraft and spare
parts for sale or lease as well as for general working capital purposes.
Assuming compliance with the facility's terms, including sufficiency of
collateral, at September 30, 1998, $47.5 million was available under this
facility, respectively. The facility has a two-year revolving period followed by
a four-year term-out period. The facility is renewable annually.
The Company has an $80.0 million debt warehouse facility (the "WLFC
Funding Corp. Facility"), to a fully-owned special purpose finance subsidiary
of the Company, for the financing of jet aircraft engines transferred by the
Company to such finance subsidiary. This transaction's structure facilitates
future public or private securitized note issuances by the special purpose
finance subsidiary. The subsidiary is consolidated for financial statement
presentation purposes. The facility has an eight-year initial term and is
partially guaranteed by the Company. This facility requires the issuer to
hedge a certain portion of the facility against interest rate changes. In
May 1998, a three year $15 million interest rate swap was executed to hedge a
portion of the interest expense under this facility. Additionally, in August
1998, a five year $10.0 million interest rate swap was executed. Assuming
compliance with the facility's terms, including sufficiency of collateral, as
of September 30, 1998, $20.3 million was available under this facility.
Approximately $2.5 million of the Company's debt is repayable during the
remainder of 1998. Such repayments consist of scheduled installments due under
term loans.
12
The Company believes that its current equity base, internally generated
funds and debt facilities are sufficient to fund the Company's anticipated
operations for the remainder of 1998 and into early 1999, at which time
additional capital will be required to fund projected growth.
As of September 30, 1998, the Company had four engines and four spare parts
packages which had not been financed. The Company may seek financing for this
equipment, although no assurance can be given that such financing will be
available on favorable terms, if at all. In addition, certain of the Company's
engines have been financed under floating rate facilities. Until fixed rate
financing for these assets is in place, the Company is subject to interest rate
risk, since the underlying lease revenue is fixed. See "Management - Interest
Rate Exposure" below.
The Company has committed to purchase, during 1998 and 1999, additional
used aircraft and engines for its operations. Certain deposits were made in
connection with these commitments. The Company's current, remaining commitment
to such purchases is not more than $28.6 million. A portion of these purchases
will take place in 1998 and the remainder in 1999.
MANAGEMENT OF INTEREST RATE EXPOSURE
At September 30, 1998, $165.4 million of the Company's borrowings were on a
variable rate basis at various interest rates tied to either LIBOR or the prime
rate. The Company's equipment leases are generally structured at fixed rental
rates for specified terms. To date, this variable rate borrowing has resulted
in lower interest expense for the Company. Increases in interest rates could
narrow or eliminate the spread, or result in a negative spread, between the
rental revenue the Company realizes under its leases and the interest rate that
the Company pays under its borrowings.
In September 1996, the Company purchased an amortizing interest rate cap in
order to limit its exposure to increases in interest rates on a portion of its
variable rate borrowings. Pursuant to this cap, the counter party will make
payments to the Company, based on the notional amount of the cap, if the three
month LIBOR rate is in excess of 7.66%. As of September 30, 1998, the notional
principal amount of the cap was $34.3 million which will decline to $26.0
million at the end of its term. The cost of the cap is being amortized as an
expense over its remaining term. WLFC-Funding Corp. purchased a three year $15
million interest rate swap in May 1998 and purchased a five year $10 million
interest rate swap in August 1998. The weighted average fixed rate under these
swaps is 5.88%. The Company will be exposed to credit risk in the event of
non-performance of the interest rate hedge counter parties. The Company
anticipates that it will hedge additional amounts of its floating rate debt
during the next several months.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Except for historical information contained herein, the discussion in this
report contains forward-looking statements that involve risks and uncertainties,
such as statements of the Company's plans, objectives, expectations and
intentions. The Company's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include those discussed below as well as those discussed elsewhere herein and in
the Company's report on Forms 10-K and 10-KA for the year ended December 31,
1997. The cautionary statements made in this report should be read as being
applicable to all related forward-looking statements wherever they appear in
this report or in other written or oral statements by the Company.
The Company leases its portfolio of aircraft engines, aircraft and spare
parts packages primarily under operating leases as opposed to finance leases.
Operating leases require the Company to re-lease or sell aircraft equipment in
its portfolio in a timely manner upon termination of the lease in order to
minimize off-lease time and recover its investment in the aircraft equipment.
The Company also engages in the selective purchase and resale of commercial
aircraft engines and engine components in the aftermarket. On occasion, the
Company purchases engines or components without having a commitment for their
sale. Numerous factors, many of which are beyond the control of the Company,
may have an impact on the Company's ability to re-lease or sell aircraft
equipment on a timely basis. Among the factors are general market conditions,
regulatory changes (particularly those imposing environmental, maintenance and
other requirements on the operation of aircraft engines), changes in the supply
or cost of the aircraft equipment and technological developments. Further, the
value of a particular used aircraft engine or aircraft varies greatly depending
upon its condition, the number of hours remaining until the next major
maintenance of the aircraft equipment is required and
13
general conditions in the airline industry. In addition, the success of an
operating lease depends in part upon having the aircraft equipment returned
by the lessee in marketable condition as required by the lease.
Consequently, there can be no assurance that the Company's estimated residual
value for the aircraft equipment will be realized. If the Company is unable
to lease, re-lease or sell the aircraft equipment on favorable terms, its
business, financial condition, cash flow, ability to service debt and results
of operations could be adversely affected.
A lessee may default in performance of its lease obligations and the
Company may be unable to enforce its remedies under a lease. The Company's
inability to collect receivables due under a lease or to repossess aircraft
equipment in the event of a default by a lessee could have a material adverse
effect on the Company's business, financial condition or results of operations.
A number of airlines have experienced financial difficulties, certain airlines
have filed for bankruptcy and a number of such airlines have ceased operations.
In most cases where a debtor seeks protection under Chapter 11 of Title 11 of
the United States Code (the "Bankruptcy Code"), creditors are automatically
stayed from enforcing their rights. The scope of Section 1110 has been the
subject of significant litigation and there can be no assurance that the
provisions of Section 1110 will protect the Company's investment in an aircraft,
aircraft engines or parts in the event of a lessee's bankruptcy. In addition,
Section 1110 does not apply to lessees located outside of the United States and
applicable foreign laws may not provide comparable protection.
A substantial portion of the Company's lease revenue was generated by
leases to foreign customers worldwide, including but not limited to Asian
customers. Such international leases may present greater risks to the Company
because certain foreign laws, regulations and judicial procedures may not be as
protective of lessor rights as those which apply in the United States. In
addition, many foreign countries have currency and exchange laws regulating the
international transfer of currencies. The Company has experienced some
collection problems under certain leases with foreign airlines, and there can be
no assurance that the Company will not experience such collection problems in
the future. The Company may also experience collection problems related to the
enforcement of its lease agreements under foreign local laws and the attendant
remedies in such locales. Consequently, the Company is subject to the timing
and access to courts and the remedies local laws impose in order to collect its
lease payments and recover its assets. In addition, political instability
abroad and changes in international policy also present risk of expropriation of
the Company's leased engines.
The operating lease business is a capital intensive business.
Accordingly, the Company's ability to successfully execute its business
strategy and to sustain its operations is dependent, in a large part, on the
availability of debt and equity capital. There can be no assurance that the
necessary amount of such capital will continue to be available to the Company
on favorable terms, or at all. If the Company were unable to continue to
obtain required financing on favorable terms, the Company's ability to add
new aircraft engines, aircraft and spare parts packages to its portfolio, add
inventory to support its spare parts sales or to conduct profitable
operations with its existing asset base would be impaired, which would have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, a portion of the Company's debt
facilities are repayable during the current calendar year. Should the Company
be unable to meet the terms of repayment of these facilities, and/or
refinance or extend these facilities, it would have a material adverse effect
on the Company's financial condition and its ability to conduct business.
Factors that could cause equity or debt financing to be more expensive or
unavailable include changes in interest rates, financial conditions of the
lessee or the Company, prospects for the airline industry or the asset type
as well as general economic, equity market and debt market conditions.
The Company's equipment leases are generally structured at fixed rental
rates for specified terms while many of the Company's borrowing arrangements are
at a floating rate. Increases in interest rates could narrow or eliminate the
spread, or result in a negative spread between the rental revenue the Company
realizes under its leases and the interest rate that the Company pays under its
lines of credit or loans.
The Company, through WASI, acquires aviation equipment such as whole
aircraft engines and aircraft which can be dismantled and sold as parts. Before
parts may be installed in an aircraft, they must meet certain standards of
condition established by the Federal Aviation Administration. Parts must also
be traceable to sources deemed acceptable by the FAA. Parts owned by the
Company may not meet applicable standards or standards may change, causing parts
which are already in the Company's inventory to be scrapped or modified. Engine
manufacturers may also develop new parts to be used in lieu of parts already
contained in the Company's inventory. In all such cases, to the extent the
Company has such parts in its inventory, their value may be reduced. In
addition, if the Company does not sell airframe and engine
14
component parts that it purchases in the time frame contemplated at
acquisition, the Company may be subject to unanticipated inventory financing
costs as well as all the risks of ownership.
Certain of the Company's competitors have substantially greater resources
than the Company, including greater name recognition, larger inventories, a
broader range of material, complementary lines of business and greater
financial, marketing and other resources. In addition, original equipment
manufacturers ("OEMs"), aircraft maintenance providers, FAA certified repair
facilities and other aviation aftermarket suppliers may vertically integrate
into the aircraft engine/spare parts sales industry, thereby significantly
increasing industry competition. A variety of potential actions by any of the
Company's competitors, including a reduction of product prices or the
establishment by competitors of long-term relationships with new or existing
customers, could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will continue to compete effectively against present and future
competitors or the competitive pressures will not have a material adverse effect
on the Company's business, financial condition or results of operations.
The Company has recently experienced significant growth in assets and
revenues. Such growth has placed, and is expected to continue to place, a
significant strain on the Company's managerial, operational and financial
resources. There can be no assurance that the Company will be able to
effectively manage the expansion of its operations, or that the Company's
systems, procedures or controls will be adequate to support the Company's
operations. An inability to effectively manage growth could have a material
adverse effect on the Company's business, financial condition or results of
operations.
With the new millennium approaching, many institutions around the world
are reviewing and modifying their computer systems (IT systems) to ensure
that they are Year 2000 compliant. The issue, in general terms, is that many
existing computer systems and microprocessors with data functions, including
those in non-information technology equipment and systems (non-IT systems),
use only two digits to identify a year in the date field with the assumption
that the first two digits of the year are always "19". Consequently, on
January 2000, computers that are not Year 2000 compliant may read the year as
1900. This could result in a failure of IT systems and non-IT systems in
the year 2000, causing disruption of operation of the Company, its lessees,
customers, vendors, or business partners.
The Company has assessed the Year 2000 issue as it affects the Company's
internal IT and non-IT systems. As a result of its assessment, the Company
expects to have no interruption of operations as a result of internal IT and
non-IT systems. The Company is in the process of assessing Year 2000 issues
relating to third parties on which the Company's operations depend. Certain
of the Company's officers have oversight of these assessments. Significant
uncertainties remain about the affect of third parties who may not be Year
2000 compliant and on which the Company depends. The Company plans to
circulate to significant third parties on which the Company depends
(including lessees, customers, vendors and financial institutions) a written
request for their plans and progress in addressing the Year 2000 issue;
evaluate the responses; and develop contingency plans to address risks of
non-compliance by such third parties. The Company intends to complete this
process by June 1999. The costs associated with assessing the Year 2000
issue, including developing and implementing the above plan are expected to
be nominal. The Company has not and does not expect to incur any significant
costs relating to internal IT and non-IT systems as a result of the Year 2000
issue.
The Company is not aware of any significant Year 2000 systems issues with
respect to the airworthiness of its aircraft, aircraft engines or spare parts;
however, should such issues result in Airworthiness Directives or other
manufacturer recommended maintenance for leased assets, the implementation and
the majority of the cost of such implementation would generally be the
responsibility of the lessee. Any resulting costs to the Company cannot be
estimated at this time.
Non-compliance on the part of a third party could result in lost revenue
and an inability to make lease or other payments to the Company. Non-compliance
by the third party's financial institution could also affect the ability to
process payments. The Company will attempt to mitigate such risks by inquiring
of each third party about its Year 2000 plans, including whether they have
addressed the issue with their financial institution. A worst case scenario
would be that a large number of third parties (including lessees and spare parts
customers) will be unable to operate and generate revenues and as a result
unable to make lease payments or purchase parts. The Company is unable to
estimate the likelihood or the magnitude of the resulting lost revenue at this
time. Should this occur, the Company would attempt to repossess leased engines,
aircraft and spare parts from non-compliant third parties and place such assets
with compliant
15
third parties. No assurances can be given that the Company would be able to
re-lease such assets at favorable terms or at all. Similarly, the Company
would attempt to find compliant customers for its spare parts sales. If a
significant number of leased assets could not be released at favorable terms
or at all, or their re-lease is delayed, or if compliant customers for spare
parts sales were unavailable, the Company's business, financial condition and
results of operations would be adversely affected.
The Company's leasing activities generate significant depreciation
allowances that provide the Company with substantial tax benefits on an ongoing
basis. In addition, the Company's lessees currently enjoy favorable accounting
and tax treatment by entering into operating leases. Any change to current tax
laws or accounting principles that make operating lease financing less
attractive could adversely affect the Company's business, financial condition or
results of operations
The Company may experience fluctuations in its quarterly operating
results. Such fluctuations may be due to a number of factors, including the
timing of sales of engines and spare parts, fluctuation in aircraft equipment
marketing activities, fluctuation of margins on such activities,
unanticipated early lease terminations, the timing of aircraft equipment
acquisitions or a default by a lessee. Downturns in the air transportation
industry affect the Company's business. In particular, substantial increases
in fuel costs or interest rates, increased fare competition, slower growth in
air traffic, or any significant downturn in the general economy could
adversely affect the air transportation industry and may therefore negatively
impact the Company's business, financial condition and results of operations.
As a result, the Company believes that comparisons to the results of its
operations for preceding quarters are not necessarily meaningful and that
results for any prior quarter should not be relied upon as an indication of
future performance. In the event the Company's revenues or earnings for any
quarter are less than the level expected by securities analysts or the market
in general, such shortfall could have an immediate and significant adverse
impact on the market price of the Company's common stock.
16
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
3.1 Certificate of Incorporation, filed on March 12, 1998 together with
Certificate of Amendment of Certificate of Incorporation filed on
May 6, 1998. Incorporated by reference to Exhibits 4.01 and 4.02
of the Company's report on Form 8-K filed on June 23, 1998.
3.2 Bylaws. Incorporated by reference to Exhibit 4.03 of the Company's
report on Form 8-K filed on June 23, 1998.
4.1 Specimen of Common Stock Certificate. Incorporated by reference to
Exhibit 4.1 of the Company's report on form 10-Q for the quarter
ended June 30, 1998.
10.1* Amended and Restated Credit Agreement dated September 30, 1998.
11.1 Statement regarding computation of per share earnings.
27.1 Financial Data Schedule.
- -----------------------------------------
*Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.
(b) Reports on Form 8-K
None
17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: November 13, 1998
Willis Lease Finance Corporation
By: /s/ James D. McBride
----------------------------
James D. McBride
Chief Financial Officer
18