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 March 31, 1999
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 April 30, 1999
------------------- -----------------------------
Common Stock, $0.01 Par Value 7,370,645
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 March 31, 1999 and December 31, 1998 3
Consolidated Statements of Income 4
Three months ended March 31, 1999 and 1998
Consolidated Statements of Shareholders' Equity 5
Year ended December 31, 1998 and
three months ended March 31, 1999
Consolidated Statements of Cash Flows 6
Three months ended March 31, 1999 and 1998
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition 11
and Results of Operations
Item 2A. Quantitative and Qualitative Disclosures About Market Risk 17
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
2
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
1999 1998
----------------- ---------------
(UNAUDITED)
ASSETS
Cash and cash equivalents $4,301 $10,305
Restricted cash 13,090 13,738
Equipment held for operating lease, less accumulated depreciation
of $16,696 at March 31, 1999 and $15,456 at December 31, 1998 280,654 274,618
Net investment in direct finance lease 9,114 9,249
Property, equipment and furnishings, less accumulated depreciation
of $739 at March 31, 1999 and $577 at December 31, 1998 3,333 2,480
Spare parts inventory 34,649 35,858
Operating lease related receivables 3,560 2,492
Trade receivables, net 7,404 5,310
Notes receivable 9,042 -
Other receivables 1,723 757
Other assets 4,890 5,198
----------------- ----------------
Total assets $371,760 $360,005
================= ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses $4,752 $9,619
Salaries and commissions payable 635 977
Deferred income taxes 12,227 11,684
Deferred gain 606 157
Notes payable and accrued interest 257,403 245,581
Capital lease obligation 2,613 2,652
Residual shares payable 2,830 2,618
Maintenance reserves 14,315 13,273
Security deposits 4,533 4,561
Unearned lease revenue 3,091 3,041
----------------- ----------------
Total liabilities $303,005 $294,163
----------------- ----------------
Shareholders' equity:
Preferred stock ($0.01 par value, 5,000,000 shares authorized; none
outstanding) - -
Common stock, ($0.01 par value, 20,000,000 shares authorized,
7,370,645 and 7,360,813 shares issued and outstanding
as of March 31, 1999 and December 31, 1998, respectively) 74 74
Paid-in capital in excess of par 42,161 42,033
Retained earnings 26,520 23,735
----------------- ----------------
Total shareholders' equity 68,755 65,842
----------------- ----------------
Total liabilities and shareholders' equity $371,760 $360,005
================= ================
See accompanying notes to the consolidated financial statements
3
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
1999 1998
------------------ ----------------
REVENUE
Lease revenue $10,569 $6,436
Gain on sale of leased equipment 3,411 3,108
Spare part sales 8,971 3,016
Sale of equipment acquired for resale 5,775 -
Interest and other income 220 185
------------------ ----------------
Total revenue $28,946 $12,745
EXPENSES
Interest expense 4,893 2,602
Depreciation expense 3,115 1,417
Residual share 211 233
Cost of spare part sales 6,630 2,055
Cost of equipment acquired for resale 4,784 -
General and administrative 4,668 3,184
------------------ ----------------
Total expenses $24,301 $9,491
------------------ ----------------
Income before income taxes and extraordinary item 4,645 3,254
Income taxes (1,860) (1,305)
------------------ ----------------
Income before extraordinary item 2,785 1,949
Extraordinary item less applicable income taxes - (200)
------------------ ----------------
Net income $2,785 $1,749
================== ================
Basic earnings per common share:
Income before extraordinary item $0.38 $0.27
Extraordinary item - (0.03)
------------------ ----------------
Net income $0.38 $0.24
================== ================
Diluted earnings per common share:
Income before extraordinary item $0.37 $0.26
Extraordinary item - (0.03)
------------------ ----------------
Net income $0.37 $0.23
================== ================
Average common shares outstanding 7,363 7,192
Diluted average common shares outstanding 7,450 7,440
See accompanying notes to the consolidated financial statements
4
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1998 AND THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS, EXCEPT SHARE DATA)
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, 1997 7,177,320 $40,117 $ - $14,484 $54,601
Shares issued 183,493 587 737 - 1,324
Tax benefit from disqualified
dispositions of qualified shares - - 666 - 666
Conversion to par value stock - (40,630) 40,630 - -
Net income - - - 9,251 9,251
---------------- -------------- -------------- ------------- -------------
Balances at December 31, 1998 7,360,813 74 42,033 23,735 65,842
Shares issued 9,832 - 98 - 98
Tax benefit from disqualified
dispositions of qualified shares - - 30 - 30
Net income - - - 2,785 2,785
---------------- -------------- -------------- ------------- -------------
Balances at March 31, 1999 (unaudited) 7,370,645 $74 $42,161 $26,520 $68,755
================ ============== ============== ============= =============
See accompanying notes to the consolidated financial statements
5
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
---------------------------------------
1999 1998
------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,785 $1,749
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation of equipment held for lease 2,932 1,382
Depreciation of property, equipment and furnishings 183 35
Gain on sale of property, equipment and furnishings (1) (9)
Gain on sale of leased equipment (3,411) (3,108)
Increase (decrease) in residual share payable 212 (45)
Changes in assets and liabilities:
Restricted Cash 648 (790)
Spare parts inventory 1,209 (1,410)
Receivables (4,128) 1,321
Other assets (173) 181
Accounts payable and accrued expenses (4,867) (1,785)
Salaries and commission payable (342) (571)
Deferred income taxes (543) 442
Deferred gain 449 (7)
Accrued interest 1,304 130
Maintenance reserves 1,042 1,052
Security deposits (28) 753
Unearned lease revenue 50 (137)
----------------- -----------------
Net cash (used in) provided by operating activities (1,593) (817)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of equipment held for operating lease (net
of selling expenses) 8,318 6,456
Proceeds from sale of property, equipment and furnishings 1 15
Purchase of equipment held for operating lease (22,917) (50,342)
Deposits made in connection with inventory purchases 481 (6,560)
Purchase of property, equipment and furnishings (1,037) (18)
Principal payments received on direct finance lease 135 142
----------------- -----------------
Net cash used in investing activities (15,019) (50,307)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under notes payable 30,907 49,395
Proceeds from issuance of common stock 128 73
Principal payments on notes payable (20,388) (8,007)
Principal payments on capital lease obligation (39) (36)
----------------- -----------------
Net cash provided by financing activities 10,608 41,425
(Decrease) in cash and cash equivalents (6,004) (9,697)
Cash and cash equivalents at beginning of period 10,305 13,095
----------------- -----------------
Cash and cash equivalents at end of period $4,301 $3,398
================= =================
Supplemental information:
Net cash paid for: Interest $3,590 $2,472
----------------- -----------------
Income Taxes $ 3 $2,249
----------------- -----------------
Non-cash investing activity:
Short-term loans related to sale of equipment
held for operating lease $7,000 $ -
----------------- -----------------
Installment loan related to sale of equipment held for
operating lease $2,042 $ -
----------------- -----------------
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 Form 10-K for the fiscal year ended December 31, 1998.
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 March 31, 1999, and December 31, 1998, and the results of its
operations for the three month periods ended March 31, 1999 and 1998 and its
cash flows for the three month periods ended March 31, 1999 and 1998. The
results of operations and cash flows for the period ended March 31, 1999 are not
necessarily indicative of the results of operations or cash flows which may be
reported for the remainder of 1999.
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
Authorized capital shares of the Company include 5,000,000 shares of
preferred stock and 20,000,000 shares of common stock with a par value of $0.01
per share. As of March 31, 1999 and December 31, 1998, 7,370,645 and 7,360,813
shares, respectively, of common stock were issued and outstanding. No preferred
stock was issued or outstanding as of March 31, 1999 or December 31, 1998.
The rights and preferences of preferred stock are established by the
Company's Board of Directors upon issuance.
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
7
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 three month period ended March 31, 1999, the Company
issued 4,382 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 three month period
ended March 31, 1999, 7,500 options were exercised. In connection with the
exercise of a portion of these options, the Company recognized a tax benefit
of approximately $30,000.
In conjunction with its initial public offering, the Company sold
five-year purchase warrants for $0.01 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 became exercisable in December
1997. 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 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
The Company has three leases for its office and warehouse space. The
annual lease rental commitments are $309,481, $420,000, and $25,814 and the
leases expire on May 31, 2003, December 31, 2010 and July 31, 1999,
respectively.
The Company has committed to purchase during 1999, additional used
aircraft and new and used 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 $31.1 million.
6. OPERATING SEGMENTS
The Company operates in two business segments: (i) Leasing and Related
Operations which involves acquiring and leasing, primarily pursuant to
operating leases, commercial aircraft, aircraft spare engines and other
aircraft equipment and the selective purchase and resale of commercial
aircraft engines and other aircraft equipment and (ii) Spare Parts Sales
which involves the purchase and resale of after-market engine and airframe
parts, whole engines, engine modules and rotable aircraft components and
leasing of engines destined for disassembly and sale of parts.
In 1998, the Company formed Pacific Gas Turbine Center, Incorporated
("PGTC") to engage in engine disassembly and maintenance, repair and overhaul
services. During the three months ended March 31, 1999, the majority of
PGTC's revenue was derived from services provided to WASI. Revenue from third
parties during this period was not material. Accordingly, for the three
months ended March 31, 1999, the operations of PGTC are included in the Spare
Parts Sales segment. PGTC was not in operation during the three months ended
March 31, 1998.
8
The Company evaluates the performance of each of the segments based on
profit or loss after general and administrative expenses and inter-company
allocation of interest expense. While the Company believes there are synergies
between the two business segments, the segments are managed separately because
each requires different business strategies.
The following tables present a summary of the operating segments (in
thousands):
Spare
Parts
For the quarter ended March 31, 1999 Leasing Sales Total
- ------------------------------------ ------------------------------------------
Revenue
Lease revenue $10,065 $504 $10,569
Gain on sale of leased equipment 3,411 - 3,411
Spare parts sales - 8,971 8,971
Sale of equipment acquired for resale 5,775 - 5,775
Other 219 1 220
----------------------------------------
Total revenue 19,470 9,476 28,946
Expenses
Interest expense 4,216 677 4,893
Depreciation expense 2,836 279 3,115
Residual share 211 - 211
Cost of spare parts - 6,630 6,630
Cost of equipment acquired for resale 4,784 - 4,784
General and administrative 2,557 2,111 4,668
----------------------------------------
Total expenses 14,604 9,697 24,301
----------------------------------------
Income (loss) before income tax and
extraordinary item $4,866 ($221)(1) $4,645
========================================
Total assets as of March 31, 1999 $321,812 $49,948 $371,760
========================================
- ------------------------------------------------
(1) The Company estimates that income before income tax and extraordinary
item would have been $0.4 million if the effect of PGTC's operations,
after intercompany eliminations, were eliminated from the results of the
Spare Parts Sales segment.
9
Spare
Parts
For the quarter ended March 31, 1998 Leasing Sales Total
- ------------------------------------ ------------------------------------------
Revenue
Lease revenue $6,436 $ - $6,436
Gain on sale of leased equipment 3,108 - 3,108
Spare parts sales - 3,016 3,016
Sale of equipment acquired for resale - - -
Other 177 8 185
----------------------------------------
Total revenue 9,721 3,024 12,745
Expenses
Interest expense 2,484 118 2,602
Depreciation expense 1,402 15 1,417
Residual share 233 - 233
Cost of spare parts - 2,055 2,055
Cost of equipment acquired for resale - - -
General and administrative 2,379 805 3,184
----------------------------------------
Total expenses 6,498 2,993 9,491
----------------------------------------
Income before income tax and
extraordinary item $3,223 $31 $3,254
========================================
Total assets as of March 31, 1998 $234,245 $7,193 $241,438
========================================
10
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"). PGTC provides engine disassembly and
maintenance, repair and overhaul 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.
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 MARCH 31, 1999 COMPARED TO THE THREE MONTHS ENDED MARCH
31, 1998:
Revenue is summarized as follows:
Three Months Ended March 31,
----------------------------------------------------
1999 1998
------- -------
Amount % Amount %
------------ ------------- ------------ ------------
(dollars in thousands)
Lease revenue $10,569 36% $ 6,436 51%
Gain on sale of leased equipment 3,411 12 3,108 24
Spare parts sales 8,971 31 3,016 24
Sale of equipment acquired for resale 5,775 20 -- --
Interest and other income 220 1 185 1
------- ------- ------- -------
Total $28,946 100% $12,745 100%
======= ======= ======= =======
LEASING RELATED ACTIVITIES. Lease related revenue for the quarter ended
March 31, 1999, increased 64% to $10.6 million from $6.4 million for the
comparable period in 1998. This increase reflects lease related revenues from
additional engines, aircraft and spare parts packages. The aggregate of net
book value of leased equipment and net investment in direct finance lease at
March 31, 1999 and 1998 was $289.8 million and $193.8 million, respectively,
an increase of 50%.
During the quarter ended March 31, 1999, 6 engines were added to the
Company's lease portfolio at a total cost of $20.1 million. Eight engines
from the lease portfolio were sold or transferred to inventory for sale. The
engines sold from the lease portfolio had a total net book value of $11.2
million and were sold for a gain of $3.4 million.
During the quarter ended March 31, 1998, the Company sold one engine from
the lease portfolio. The engine had a net book value of $2.2 million and was
sold for a gain of $3.1 million.
During the quarter ended March 31, 1999, the Company sold two engines
acquired for resale for $5.8 million which resulted in a gain of $1.0
million. The Company had no such sales during the comparable 1998 period.
SPARE PARTS SALES. Revenues from spare parts sales increased 197% to $9.0
million as compared to $3.0 million in the quarter ended March 31, 1998. The
gross margin decreased to 26% from 32% in the corresponding period in 1998.
This decrease was due to a change in the mix of parts being sold during the
past twelve months.
11
INTEREST AND OTHER INCOME. Interest and other income for the quarters
ended March 31, 1999 and 1998, were $0.2 million. This is a result of
interest earned on cash and deposits held.
INTEREST EXPENSE AND RESIDUAL SHARING Interest expense related to all
activities increased 88% to $4.9 million for the quarter ended March 31,
1999, from the comparable period in 1998, due to an increase in average debt
outstanding during the period. This increase in debt was primarily related to
debt associated with the increase in lease portfolio assets and to a lesser
extent an increase in spare parts inventories. Residual sharing expense
decreased 10% to $211,560 for the quarter ended March 31, 1999 from $232,512
for the comparable period in 1998. The decline was due to the repayment, in
March 1998, of one of the Company's loans which had residual sharing
provisions. Residual sharing arrangements apply to three of the Company's
engines as of March 31, 1999. The Company accrues for its residual sharing
obligations using net book value as a proxy for residual proceeds.
DEPRECIATION EXPENSE. Depreciation expense increased 120% to $3.1 million
for the quarter ended March 31, 1999, from the comparable period in 1998, due
primarily to the increase in lease portfolio assets.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 47% to $4.7 million for the quarter ended March 31, 1999, from the
comparable period in 1998. This increase reflects expenses, in all business
segments, associated with staff additions, increased rent due to the
expansion of the facilities, as well as an increase in professional fees and
insurance expense.
INCOME TAXES. Income taxes, exclusive of tax on extraordinary items, for
the quarter ended March 31, 1999, increased to $1.9 million from $1.3 million
for the comparable period in 1998. This increase reflects an increase in the
Company's pre-tax earnings. The effective tax rate for the quarters ended
March 31, 1999 and 1998 were 40%.
EXTRAORDINARY ITEM. In March 1998, the Company repaid a loan that had
residual sharing provisions and an interest rate of 10%. The repayment
resulted in an extraordinary expense of $0.2 million, net of tax. The Company
had no such transactions during the comparable 1999 period.
ACCOUNTING PRONOUNCEMENTS
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 $30.9 million
and $49.4 million, in the three month periods ended March 31, 1999 and 1998,
respectively, was derived from this activity. In these same time periods
$20.4 million and $8.0 million, respectively, was used to pay down related
debt. Cash flow from operating activities used approximately $1.6 million and
$0.8 million in the three month periods ended March 31, 1999 and 1998,
respectively. The deficit cash flow from operations was primarily
attributable to repayment of an account payable related to the purchase of an
engine and an increase in WASI's accounts receivable due to increased sales.
The Company's primary use of funds is for the purchase of equipment for
lease. Approximately $23.0 million and $50.3 million of funds were used for
this purpose in the three month periods ended March 31, 1999 and 1998,
respectively.
At March 31, 1999, 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. As
of March 31, 1999,
12
$9.3 million was available under this facility, subject to the Company
providing sufficient collateral. The facility has a two-year revolving period
followed by a four-year term-out period. The facility is renewable annually.
At March 31, 1999, the Company had an $80.0 million debt warehouse
facility, to a wholly-owned special purpose finance subsidiary of the
Company, WLFC Funding Corporation, 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. The Company has guaranteed the obligations under the facility
on a limited basis, up to an amount equal to the greater of (i) the lesser of
$5 million and 20% of the outstanding obligations or (ii) 10% of the
outstanding obligations. Assuming compliance with the facility's terms,
including sufficiency of collateral, as of March 31, 1999, $15.0 million was
available under this facility.
Approximately $10.1 million of the Company's debt is repayable during
1999. Such repayments consist of scheduled installments due under term loans.
The Company believes that its current equity base, internally generated
funds and existing and contemplated debt facilities are sufficient to fund
the Company's anticipated operations into the third quarter of 1999, at which
time additional capital will be required to fund projected growth. The
Company is currently discussing, with its commercial and investment banks,
additions to its debt and equity capital bases.
As of March 31, 1999, the Company had two 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 1999, additional used
aircraft and used and new engines for its operations. Certain deposits were
made, in 1998, in connection with a portion of these commitments. As of March
31, 1999, the Company's current commitment to such purchases is not more than
$31.1 million, which includes $1.4 million of deposits in other assets.
13
MANAGEMENT OF INTEREST RATE EXPOSURE
At March 31, 1999, $207.7 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. 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 March 31, 1999, 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. To further mitigate exposure to
interest rate changes, the Company entered into an interest rate swap
agreement in December 1998, which has a notional outstanding amount of $15.0
million, a duration of two years and a fixed rate of 4.95%. Under its
borrowing agreement, WLFC Funding Corporation is required to hedge a certain
portion of its $80 million warehouse facility against changes in interest
rates. WLFC has entered into interest rate swap agreements in order to meet
such hedging requirements and to manage the variable interest rate risk
related to its debt. As of March 31, 1999, such swap agreements had notional
outstanding amounts of $40 million, a weighted average remaining duration of
36 months and a weighted average fixed rate of 5.88%.
The Company will be exposed to 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 Form 10-K for the year ended
December 31, 1998. 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 businesses in which the Company is engaged are capital intensive
businesses. Accordingly, the Company's ability to successfully execute its
business strategy and to sustain its operations is dependent, in 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 is not successful in
obtaining sufficient capital, the Company's ability to: (i) add new aircraft
engines, aircraft and spare parts packages to its portfolio, (ii) add
inventory to support its spare parts sales, (iii) fund its working capital
needs, (iv) develop the business of PGTC, and (v) finance possible future
acquisitions, would be impaired. The Company's inability to obtain sufficient
capital would have a material adverse effect on the Company's business,
financial condition and/or results of operations.
The Company retains title to the aircraft engines, aircraft and parts
packages that it leases to third parties. Upon termination of a lease, the
Company will seek to re-lease or sell the aircraft equipment or will
dismantle the equipment and will sell the parts. The Company also engages in
the selective purchase and resale of commercial aircraft engines and engine
components. On occasion, the Company purchases engines or components without
having a firm commitment for their sale. Numerous factors, many of which are
beyond the Company's control, may have an impact on the Company's ability to
re-lease or sell aircraft equipment on a timely basis, including the
following: (i) general market conditions, (ii) the condition of the aircraft
equipment upon termination of the lease, (iii) the maintenance services
performed during the lease term and, as applicable, the number of hours
remaining until the next major maintenance is required, (iv) regulatory
changes (particularly those imposing environmental, maintenance and other
requirements on the operation of aircraft engines), (v) changes in the supply
or cost of aircraft engines, and (vi) technological developments. There is no
14
assurance that the Company will be able to re-lease or sell aircraft
equipment on a timely basis or on favorable terms. The failure to re-lease or
sell aircraft equipment on a timely basis or on favorable terms re-lease or
sell aircraft equipment on a timely basis or on favorable terms could have a
material adverse effect on the Company's business, financial condition and/or
results of operations.
The Company experiences fluctuations in its operating results. Such
fluctuations may be due to a number of factors, including: (i) general
economic conditions, (ii) the timing of sales of engines and spare parts,
(iii) financial difficulties experienced by airlines, (iv) interest rates,
(v) fuel costs, (vi) downturns in the air transportation industry, (vii)
increased fare competition, (viii) decreases in growth of air traffic, (ix)
unanticipated early lease termination or a default by a lessee, (x) the
timing of engine acquisitions, (xi) engine marketing activities, (xii)
fluctuations in market prices for the Company's assets. The Company
anticipates that fluctuations from period to period will continue in the
future. As a result, the Company believes that comparisons to results of
operations for preceding periods are not necessarily meaningful and that
results of prior periods should not be relied upon as an indication of future
performance.
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 and/or results of
operations. Various airlines have experienced financial difficulties in the
past, 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, creditors
are automatically stayed from enforcing their rights. In the case of United
States certified airlines, Section 1110 of the Bankruptcy Code provides
certain relief to lessors of aircraft equipment. The scope of Section 1110
has been the subject of significant litigation and there is 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. Leases of spare parts may involve additional risks. For example,
it is likely to be more difficult to recover parts in the event of a lessee
default and the residual value of parts may be less ascertainable than an
engine.
The Company's leases are generally structured at fixed rental rates for
specified terms while many of the Company's borrowings 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 the Company pays under its borrowings,
and have a material adverse effect on the Company's business, financial
condition and/or results of operations.
During the three month period ended March 31, 1999, 76% of the Company's
lease revenue was generated by leases to foreign customers, including 7% from
Asian customers and 18% from South American 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. 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. Furthermore, many foreign
countries have currency and exchange laws regulating the international
transfer of currencies.
The Company generates a portion of its revenue from sale of leased
assets. The inability to execute transactions for gain on sale or a change in
the accounting guidelines related to such sales could have a material impact
on the Company's business, financial condition and/or results of operations.
The Company has recently experienced significant growth in revenues. The
Company's growth has placed, and is expected to continue to place, a
significant strain on the Company's managerial, operational and financial
resources. There is 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,
in which event the Company's business, financial condition and/or results of
operations could be adversely affected. The Company may also acquire
businesses that would complement or expand the Company's existing businesses.
Any acquisition or expansion made by the Company may result in one or more of
the following events: (i) the incurrence of additional debt, (ii) future
15
charges to earnings related to the amortization of goodwill and other
intangible assets, (iii) difficulties in the assimilation of operations,
services, products and personnel, (iv) an inability to sustain or improve
historical revenue levels, (v) diversion of management's attention from
ongoing business operations, and (vi) potential loss of key employees. Any of
the foregoing factors could have a material adverse effect on the Company's
business, financial condition and/or results of operations.
The markets for the Company's products and services are extremely
competitive, and the Company faces competition from a number of sources.
These include aircraft and aircraft part manufacturers, aircraft and aircraft
engine lessors, airline and aircraft service companies and aircraft spare
parts redistributors. 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,
equipment manufacturers, aircraft maintenance providers, FAA certified repair
facilities and other aviation aftermarket suppliers may vertically integrate
into the markets that the Company serves, thereby significantly increasing
industry competition. There can be no assurance that competitive pressures
will not materially and adversely affect the Company's business, financial
condition and/or results of operations.
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 or affect the Company's recognition of revenue or expense
would have a material impact on the Company's business, financial condition
and/or results of operations.
Before parts may be installed in an aircraft, they must meet certain
standards of condition established by the FAA and/or the equivalent
regulatory agencies in other countries. Specific regulations vary from
country to country, although regulatory requirements in other countries are
generally satisfied by compliance with FAA requirements. Parts must also be
traceable to sources deemed acceptable by the FAA or such equivalent
regulatory agencies. Such standards may change in the future, requiring
engine components already contained in the Company's inventory to be scrapped
or modified. In all such cases, to the extent the Company has such engine
components in its inventory, their value may be reduced and the Company's
business, financial condition and/or results of operations could be adversely
affected
The Company obtains a substantial portion of its inventories of
aircraft, engines and engine parts from airlines, overhaul facilities and
other suppliers. There is no organized market for aircraft, engines and
engine parts, and the Company must rely on field representatives and
personnel, advertisements and its reputation as a buyer of surplus inventory
in order to generate opportunities to purchase such equipment. The market for
bulk sales of surplus aircraft, engines and engine parts is highly
competitive, in some instances involving a bidding process. While the Company
has been able to purchase surplus inventory in this manner successfully in
the past, there is no assurance that surplus aircraft, engines and engine
parts of the type required by the Company's customers will be available on
acceptable terms when needed in the future or that the Company will continue
to compete effectively in the purchase of such surplus equipment.
A change in the market for aircraft and engine parts could result in the
Company's inventory being overvalued and could require the Company to
write-down its inventory valuations in order to bring them into line with the
revised fair market value. Furthermore, when the Company purchases and
dismantles used aircraft, engines and parts, the Company assigns a value to
the parts based on market price. Airline manufacturers may also develop new
parts to be used in lieu of parts already contained in the Company's
inventory. There is no assurance that a write-down would not adversely affect
the Company's business, operating results or financial condition.
The Company uses computer systems in many areas of its operations. In
addition, various third parties that are important to the Company's business
(including lessees, customers, vendors and financial institutions) use
computer systems in their areas of operations. Should the Company or certain
of such third parties not be "Year 2000 compliant," certain of the Company's
operations could be disrupted for an indeterminate period of time,
potentially having a material adverse impact on the Company's results,
business, financial condition and/or of operations. As is the case with most
companies, the Year 2000 computer problem creates risks for the Company.
16
The Company has assessed the Year 2000 computer problem as it affects
the Company's computer systems and information technology. As a result of the
Company's assessment, the Company does not expect any material interruption
of internal operations arising from the Company's computer systems and
information technology not being Year 2000 compliant. The mission critical
systems of the Company identified during the assessment are all off the shelf
software packages with unmodified source codes which have been certified by
the manufacturer as Year 2000 compliant. The Company is not aware of any
significant Year 2000 issues with respect to the airworthiness of the
Company's 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.
Significant uncertainties remain about the effect on the Company's
operations of third parties that may not be Year 2000 compliant and with whom
the Company does business (including lessees, customers, vendors and
financial institutions). The Company is in the process of assessing Year 2000
issues relating to such third parties and certain of the Company's officers
have oversight of these assessments. The Company has circulated to
significant third parties with whom the Company does business a written
request for their plans and progress in addressing the Year 2000 issue. The
Company intends to evaluate the responses and develop contingency plans to
address risks of non-compliance by such third parties. The Company expects to
complete this process by July 1999. The costs associated with assessing the
Year 2000 issue, including developing and implementing the above plan, are
expected to be nominal. 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.
A reasonable 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 will be 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. However, 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 third parties. The Company cannot assure you that it would be able
to re-lease such assets at favorable terms or at all. Similarly, the Company
would attempt to find compliant customers for the Company's spare parts
sales. If a significant number of leased assets could not be re-leased on
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/or results of operations would be adversely affected.
Providers of casualty and liability insurance to the aviation industry
have indicated that they may exclude coverage for Year 2000 related risks
and/or may require aviation equipment operators to answer, to the insurance
provider's satisfaction, a questionnaire regarding the Year 2000 preparedness
of aviation equipment operators, in order to provide coverage for Year 2000
risks. The inability of a lessee to obtain or maintain coverage for Year 2000
related losses and/or the Company's inability to obtain or maintain any
contingent insurance for Year 2000 related risks would expose the Company to
material risk of loss. The Company is in the process of informing its lessees
of Year 2000 related insurance issues and will be monitoring its lessees'
ability to obtain insurance coverage for Year 2000 related risks.
ITEM 2A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is that of interest rate
risk. A change in the U.S. prime interest rate, LIBOR rate, or cost of funds
based on commercial paper market rates, would affect the rate at which the
Company could borrow funds under its various borrowing facilities. Increases
in interest rates to the Company, which may cause the Company to raise the
implicit rates charged to its customers, could result in a reduction in
demand for the Company's leases. Certain of the Company's warehouse credit
facilities are variable rate debt. The Company estimates a one percent
increase or decrease in the Company's variable rate debt would result in an
increase or decrease, respectively, in interest expense of $1.4 million per
annum. The Company estimates a two percent increase or decrease in the
Company's variable rate debt would result in an increase or decrease,
respectively, in interest expense of $2.9 million per annum. The foregoing
effect of interest rate changes, net of interest rate hedges, on per annum
interest expense is estimated as constant due to the terms of the Company's
variable rate borrowings, which generally provide for the maintenance of
borrowing levels given adequacy of collateral and compliance with other loan
conditions.
17
The Company hedges a portion of its borrowings, effectively fixing the
rate of these borrowings. The Company is currently required to hedge a
portion of debt of the WLFC Funding Corporation Facility. Such hedging
activities may limit the Company's ability to participate in the benefits of
any decrease in interest rates, but may also protect the Company from
increases in interest rates. A portion of the Company's leases provide that
lease payments be adjusted based on changes in interest rates. Furthermore,
since lease rates tend to vary with interest rate levels, it is likely that
the Company can adjust lease rates for the effect of change in interest rates
at the termination of leases. Other financial assets and liabilities are at
fixed rates.
The Company is also exposed to currency devaluation risk. During the
three month period ended March 31, 1999, 76% of the Company's total lease
revenues came from non-United States domiciled lessees. All of the leases
require payment in United States (U.S.) currency. If these lessees' currency
devalues against the U.S. dollar, the lessees could potentially encounter
difficulty in making the U.S. dollar denominated lease payments.
18
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT DESCRIPTION
NUMBER
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 Note Purchase Agreement (Series 1997-1 Notes) dated February 11, 1999.
10.2* Amended and Restated Series 1997-1 Supplement dated February 11, 1999
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 and the redacted material has been filed separately
with the Commission.
(b) Reports on Form 8-K
None
19
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: May 17, 1999
Willis Lease Finance Corporation
By: /s/ James D. McBride
---------------------------------
James D. McBride
Chief Financial Officer
20