WILLIS LEASE FINANCE CORP - Quarter Report: 2013 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

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, 2013
	OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 001-15369

 

 

WILLIS LEASE FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code (415) 408-4700

 

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o		Accelerated filer x
Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

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 November 5, 2013
Common Stock, $0.01 par value per share		8,429,993

 

 

Table of Contents

 

WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES

 

INDEX

 

PART I.		FINANCIAL INFORMATION
Item 1.		Consolidated Financial Statements (Unaudited)		3
		Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012		3
		Consolidated Statements of Income for the three and nine months ended September 30, 2013 and 2012		4
		Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012		5
		Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2013 and 2012		6
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012		7
		Notes to Unaudited Consolidated Financial Statements		8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		25
Item 4.		Controls and Procedures		25
PART II.		OTHER INFORMATION		27
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		27
Item 5.		Exhibits		27

 

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PART I — FINANCIAL INFORMATION

 

Item 1.                                 Consolidated Financial Statements (Unaudited)

 

WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share data, unaudited)

 

		September 30, 2013			December 31, 2012
ASSETS
Cash and cash equivalents		$	4,028		$	5,379
Restricted cash		38,003			24,591
Equipment held for operating lease, less accumulated depreciation of $250,938 and $242,529 at September 30, 2013 and December 31, 2012, respectively		1,015,588			961,459
Equipment held for sale		31,506			23,607
Operating lease related receivable, net of allowances of $427 and $980 at September 30, 2013 and December 31, 2012, respectively		5,082			12,916
Investments		18,072			21,831
Property, equipment & furnishings, less accumulated depreciation of $8,523 and $7,087 at September 30, 2013 and December 31, 2012, respectively		4,994			5,989
Equipment purchase deposits		1,369			1,369
Other assets		20,779			21,574
Total assets		$	1,139,421		$	1,078,715
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Accounts payable and accrued expenses		$	12,877		$	15,374
Liabilities under derivative instruments		301			1,690
Deferred income taxes		82,608			90,248
Notes payable		744,300			696,988
Maintenance reserves		76,579			63,313
Security deposits		12,535			6,956
Unearned lease revenue		3,740			4,593
Total liabilities		932,940			879,162
Shareholders’ equity:
Common stock ($0.01 par value, 20,000,000 shares authorized; 8,492,948 and 8,715,580 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively)		85			87
Paid-in capital in excess of par		44,950			47,785
Retained earnings		161,984			152,911
Accumulated other comprehensive loss, net of income tax benefit of $251 and $651 at September 30, 2013 and December 31, 2012, respectively		(538		)	(1,230		)
Total shareholders’ equity		206,481			199,553
Total liabilities and shareholders’ equity		$	1,139,421		$	1,078,715

 

See accompanying notes to the unaudited consolidated financial statements.

 

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WILLIS LEASE FINANCE CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Income (Loss)

(In thousands, except share data, unaudited)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2013			2012			2013			2012
REVENUE
Lease rent revenue		$	25,779		$	23,022		$	75,016		$	70,917
Maintenance reserve revenue		8,891			10,653			29,908			28,668
Gain on sale of leased equipment		2,022			561			3,556			4,557
Other revenue		1,260			3,270			2,729			4,256
Total revenue		37,952			37,506			111,209			108,398
EXPENSES
Depreciation expense		15,762			13,885			43,563			38,881
Write-down of equipment		4,283			2,474			6,268			2,756
General and administrative		6,792			7,298			24,265			25,339
Technical expense		4,533			1,961			10,423			4,715
Net finance costs:
Interest expense		9,905			7,529			28,984			22,595
Interest income		—			(21		)	—			(81		)
Loss on debt extinguishment and derivatives termination		—			15,412			—			15,412
Total net finance costs		9,905			22,920			28,984			37,926
Total expenses		41,275			48,538			113,503			109,617
Loss from operations		(3,323		)	(11,032		)	(2,294		)	(1,219		)
Earnings (loss) from joint ventures		(289		)	352			3,186			948
Income (loss) before income taxes		(3,612		)	(10,680		)	892			(271		)
Income tax benefit (expense)		1,383			3,486			8,181			(405		)
Net income (loss)		$	(2,229	)	$	(7,194	)	$	9,073		$	(676	)
Preferred stock dividends		—			782			—			2,346
Net income (loss) attributable to common shareholders		$	(2,229	)	$	(7,976	)	$	9,073		$	(3,022	)
Basic earnings (loss) per common share:		$	(0.27	)	$	(0.92	)	$	1.12		$	(0.35	)
Diluted earnings (loss) per common share:		$	(0.27	)	$	(0.90	)	$	1.09		$	(0.34	)
Average common shares outstanding		8,126			8,667			8,091			8,553
Diluted average common shares outstanding		8,329			8,889			8,332			8,846

 

See accompanying notes to the unaudited consolidated financial statements.

 

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WILLIS LEASE FINANCE CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(In thousands, unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2013			2012			2013			2012
Net income (loss)		$	(2,229	)	$	(7,194	)	$	9,073		$	(676	)
Other comprehensive income (loss):
Derivative instruments
Unrealized loss on derivative instruments		(8		)	(1,213		)	(56		)	(4,266		)
Reclassification adjustment for losses included in termination of derivative instruments		—			10,143			—			10,143
Reclassification adjustment for losses included in net income		390			1,810			1,149			6,026
Net gain recognized in other comprehensive income		382			10,740			1,093			11,903
Tax expense related to items of other comprehensive income (loss)		(140		)	(3,952		)	(401		)	(4,377		)
Other comprehensive income		242			6,788			692			7,526
Total comprehensive income (loss)		$	(1,987	)	$	(406	)	$	9,765		$	6,850

 

See accompanying notes to the unaudited consolidated financial statements.

 

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WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

Nine Months Ended September 30, 2013 and 2012

(In thousands, unaudited)

 

		Preferred Stock			Issued and Outstanding Shares of Common  Stock		Common Stock			Paid-in Capital in Excess of par			Accumulated Other Comprehensive Income/(Loss)			Retained Earnings			Total Shareholders’ Equity
Balances at December 31, 2011		$	31,915		9,110		$	91		$	56,842		$	(8,891	)	$	156,704		$	236,661
Net loss		—			—		—			—			—			(676		)	(676		)
Unrealized gain from derivative instruments, net of tax expense of $644		—			—		—			—			1,116			—			1,116
Reclassification adjustment for losses included in net income, net of tax expense of $3,733		—			—		—			—			6,410			—			6,410
Preferred stock dividends paid		—			—		—			—			—			(2,346		)	(2,346		)
Shares repurchased		—			(156	)	(2		)	(1,974		)	—			—			(1,976		)
Shares issued under stock compensation plans		—			440		4			1,308			—			—			1,312
Cancellation of restricted stock units in satisfaction of withholding tax		—			(71	)	—			(884		)	—			—			(884		)
Stock-based compensation, net of forfeitures		—			—		—			2,346			—			—			2,346
Excess tax benefit from stock-based compensation		—			—		—			607			—			—			607
Balances at September 30, 2012		$	31,915		9,323		$	93		$	58,245		$	(1,365	)	$	153,682		242,570
Balances at December 31, 2012		$	—		8,716		$	87		$	47,785		$	(1,230	)	$	152,911		$	199,553
Net income		—			—		—			—			—			9,073			9,073
Unrealized gain from derivative instruments, net of tax expense of $401		—			—		—			—			692			—			692
Shares repurchased		—			(354	)	(3		)	(5,255		)	—			—			(5,258		)
Shares issued under stock compensation plans		—			182		2			584			—			—			586
Cancellation of restricted stock units in satisfaction of withholding tax		—			(51	)	(1		)	(737		)	—			—			(738		)
Stock-based compensation, net of forfeitures		—			—		—			2,573			—			—			2,573
Balances at September 30, 2013		$	—		8,493		$	85		$	44,950		$	(538	)	$	161,984		$	206,481

 

See accompanying notes to the unaudited consolidated financial statements.

 

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WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands, unaudited)

 

		Nine Months Ended Setpember 30,
		2013			2012
Cash flows from operating activities:
Net income (loss)		$	9,073		$	(676	)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense		43,563			38,881
Write-down of equipment		6,268			2,756
Stock-based compensation expenses		2,573			2,346
Amortization of deferred costs		3,068			2,874
Amortization of loan discount		—			341
Amortization of interest rate derivative cost		(297		)	(167		)
Allowances and provisions		(553		)	(154		)
Gain on sale of leased equipment		(3,556		)	(4,557		)
Gain on non-monetary exchange		—			(1,961		)
Income from joint ventures, net of distributions		(3,186		)	(471		)
Gain on insurance settlement		(351		)	(173		)
Non cash portion of loss of debt extinguishment and derivatives termination		—			7,114
Deferred income taxes		(8,181		)	405
Changes in assets and liabilities:
Receivables		8,620			(289		)
Notes receivable		—			542
Other assets		(1,517		)	912
Accounts payable and accrued expenses		(1,225		)	(5,651		)
Restricted cash		(7,127		)	2,064
Maintenance reserves		13,266			8,588
Security deposits		(492		)	815
Unearned lease revenue		(874		)	359
Net cash provided by operating activities		59,072			53,898
Cash flows from investing activities:
Proceeds from sale of equipment (net of selling expenses)		28,482			31,971
Restricted cash for investing activities		(6,285		)	1,754
Capital contribution to joint ventures		(6,145		)	(3,830		)
Investment in joint venture, net of cash acquired		2,020			—
Purchase of equipment held for operating lease and for sale		(93,936		)	(46,941		)
Purchase of property, equipment and furnishings		(441		)	(1,196		)
Net cash used in investing activities		(76,305		)	(18,242		)
Cash flows from financing activities:
Proceeds from issuance of notes payable		72,000			537,693
Debt issuance cost		(591		)	(9,660		)
Interest bearing security deposits		6,071			—
Preferred stock dividends		—			(2,346		)
Proceeds from shares issued under stock compensation plans		586			1,312
Cancellation of restricted stock units in satisfaction of withholding tax		(738		)	(884		)
Excess tax benefit from stock-based compensation		—			607
Decrease in restricted cash		—			18,208
Repurchase of common stock		(5,258		)	(1,976		)
Principal payments on notes payable		(56,188		)	(567,871		)
Net cash provided by (used in) financing activities		15,882			(24,917		)
Increase (decrease) in cash and cash equivalents		(1,351		)	10,739
Cash and cash equivalents at beginning of period		5,379			6,440
Cash and cash equivalents at end of period		$	4,028		$	17,179
Supplemental disclosures of cash flow information:
Net cash paid for:
Interest		25,607			14,552
Income Taxes		$	16		$	101
Supplemental disclosures of non-cash investing activities:
During the nine months ended September 30, 2013 and 2012, engines and equipment totalling $9,493 and $4,900, respectively, were transferred from Held for Operating Lease to Held for Sale but not settled.

 

See accompanying notes to the unaudited consolidated financial statements.

 

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Notes to Unaudited Consolidated Financial Statements

 

1.  Summary of Significant Accounting Policies

 

(a) Basis of Presentation: Our unaudited consolidated financial statements include the accounts of Willis Lease Finance Corporation and its subsidiaries (“we” or the “Company”) and 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 note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The accompanying unaudited interim consolidated 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 our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2012.

 

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 our financial position as of September 30, 2013  and December 31, 2012, and the results of our operations for the three and nine months ended September 30, 2013 and 2012, and our cash flows for the nine months ended September 30, 2013 and 2012. The results of operations and cash flows for the period ended September 30, 2013 are not necessarily indicative of the results of operations or cash flows which may be reported for the remainder of 2013.

 

Management considers the continuing operations of our company to operate in one reportable segment.

 

(b) Fair Value Measurements:

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs, to the extent possible. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

 

We hold interest rate derivative instruments to mitigate exposure to changes in interest rates, in particular one-month LIBOR, with $343.5 million and $282.0 million of our borrowings at September 30, 2013 and December 31, 2012, respectively, at variable rates. We measure the fair value of our interest rate swaps of $100.0 million (notional amount) based on Level 2 inputs, due to the usage of inputs that can be corroborated by observable market data. The Company estimates the fair value of derivative instruments using a discounted cash flow technique and, at September 30, 2013, has used creditworthiness inputs that corroborate observable market data evaluating the Company’s and counterparties’ risk of non-performance. We have interest rate swap agreements which have a net liability fair value of $0.3 million and $1.7 million as of September 30, 2013 and December 31, 2012, respectively. For the nine months ended September 30, 2013 and September 30, 2012, $1.1 million and $6.0 million, respectively, were realized as interest expense on the Consolidated Statements of Income.

 

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The following table shows by level, within the fair value hierarchy, the Company’s assets and liabilities at fair value as of September 30, 2013 and December 31, 2012:

 

		Assets and (Liabilities) at Fair Value
		September 30, 2013												December 31, 2012
		Total			Level 1			Level 2			Level 3			Total			Level 1			Level 2			Level 3
		(in thousands)
Liabilities under derivative instruments		$	(301	)	$	—		$	(301	)	$	—		$	(1,690	)	$	—		$	(1,690	)	$	—
Total		$	(301	)	$	—		$	(301	)	$	—		$	(1,690	)	$	—		$	(1,690	)	$	—

 

During the nine months ended September 30, 2013 and December 31, 2012, all hedges were effective and no ineffectiveness was recorded in earnings.

 

Assets Measured and Recorded at Fair Value on a Nonrecurring Basis

 

We determine the fair value of long-lived assets held and used, such as Equipment held for operating lease and Equipment held for sale, by reference to independent appraisals, quoted market prices (e.g. industry market data) and other factors. An impairment charge is recorded when the carrying value of the asset exceeds its fair value.

 

The following table shows by level, within the fair value hierarchy, the Company’s assets measured at fair value on a nonrecurring basis as of September 30, 2013 and December 31, 2012, and the gains (losses) recorded during the nine months ended September 30, 2013 and twelve months ended December 31, 2012 on those assets:

 

														Total Losses
		Assets at Fair Value (in thousands)												Nine Months Ended
		Total			Level 1			Level 2			Level 3			September 30, 2013
														(in thousands)
Balance at September 30, 2013
Equipment held for sale		$	31,506		$	—		$	29,839		$	1,667		$	(6,268	)
Total		$	31,506		$	—		$	29,839		$	1,667		$	(6,268	)

 

														Total Losses
		Assets at Fair Value (in thousands)												Twelve Months Ended
		Total			Level 1			Level 2			Level 3			December 31, 2012
														(in thousands)
Balance at December 31, 2012
Equipment held for sale		$	23,607		$	—		$	23,384		$	223		$	(5,874	)
Total		$	23,607		$	—		$	23,384		$	223		$	(5,874	)

 

At September 30, 2013, the Company used Level 2 inputs and, due to a portion of the valuations requiring management judgment due to the absence of quoted market prices, Level 3 inputs to measure the fair value of certain engines that were held as inventory not consigned to third parties. The fair values of the assets held for sale categorized as Level 3 were based on management’s estimate considering projected future sales proceeds at September 30, 2013 and December 31, 2012. An impairment charge is recorded when the carrying value of the asset exceeds its fair value. An asset write-down of $3.5 million was recorded in the nine months ended September 30, 2013 based on a comparison of the asset net book values with the proceeds expected from the sale of engines. A further asset write-down of $2.8 million was recorded in the nine months ended September 30, 2013, based upon a comparison of the asset net book values with the revised net proceeds expected from part sales arising from consignment of the engines. An asset write-down of $4.7 million was recorded in the twelve months ended December 31, 2012 based on a comparison of the asset net book values with the proceeds expected from the sale of engines. A further asset write-down of $1.2 million was recorded in the twelve months ended December 31, 2012, based upon a comparison of the asset net book values with the revised net proceeds expected from part sales arising from consignment of the engines.

 

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2.  Management Estimates

 

These consolidated financial statements have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States.

 

The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to residual values, estimated asset lives, impairments and bad debts. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Management believes that the accounting policies on revenue recognition, maintenance reserves and expenditures, useful life of equipment, asset residual values, asset impairment and allowance for doubtful accounts are critical to the results of operations.

 

If the useful lives or residual values are lower than those estimated by us, upon sale of the asset a loss may be realized. Significant management judgment is required in the forecasting of future operating results, which are used in the preparation of projected undiscounted cash-flows and should different conditions prevail, material impairment write-downs may occur.

 

3.  Commitments, Contingencies, Guarantees and Indemnities

 

Our principal offices are located in Novato, California. We occupy space in Novato under a lease that covers approximately 20,534 square feet of office space and expires September 30, 2018. The remaining lease rental commitment is approximately $2.7 million. Equipment leasing, financing, sales and general administrative activities are conducted from the Novato location. We also sub-lease office and warehouse space for our operations at San Diego, California. This lease expires October 31, 2013 and the remaining lease commitment is approximately $12,000. We also lease office and warehouse space in Shanghai, China. The office lease expires December 31, 2013 and the warehouse lease expires July 31, 2017 and the remaining lease commitments are approximately $16,200 and $27,300, respectively. We also lease office space in London, United Kingdom. The lease expires December 21, 2015 and the remaining lease commitment is approximately $0.2 million. We also lease office space in Blagnac, France. The lease expires December 31, 2013 and the remaining lease commitment is approximately $4,400. We lease office space in Dublin, Ireland. The lease expires May 15, 2017 and the remaining lease commitment is approximately $0.2 million.

 

We have made purchase commitments to secure the purchase of four engines and related equipment for a gross purchase price of $39.3 million, for delivery in 2013 to 2015. As of September 30, 2013, non-refundable deposits paid related to these purchase commitments were $1.4 million. In October 2006, we entered into an agreement with CFM International (“CFM”) to purchase new spare aircraft engines. The agreement specifies that, subject to availability, we may purchase up to a total of 45 CFM56-7B and CFM56-5B spare engines over a five year period, with options to acquire up to an additional 30 engines. Our outstanding purchase orders with CFM for three engines represent deferral of engine deliveries originally scheduled for 2009 and are included in our commitments to purchase in 2013 to 2015.

 

4.  Investments

 

On May 25, 2011, we entered into an agreement with Mitsui & Co., Ltd. to participate in a joint venture formed as a Dublin-based Irish limited company, Willis Mitsui & Company Engine Support Limited (“WMES”) for the purpose of acquiring and leasing jet engines. Each partner holds a fifty percent interest in the joint venture. The initial capital contribution by the Company for its investment in WMES was $8.0 million. The Company provided the initial lease portfolio by transferring 7 engines to the joint venture in June 2011. In addition, the Company made $1.0 million, $5.6 million and $6.1 million capital contributions to WMES in the years ended December 31, 2011, 2012 and the nine months ended September 30, 2013, respectively, for the purchase of 16 engines from third parties, increasing the number of engines in the lease portfolio to 23. Mitsui & Co., Ltd. contributed equally the capital contribution to support all of these purchases. The $20.7 million of capital contributions has been partially offset by $3.6 million, resulting in a net investment of $17.1 million, which has increased to $18.1 million as a result of the Company’s share of WMES reported earnings to date. The $3.6 million reduction in investment represents 50% of the $7.2 million gain related to the sale by the Company of the 7 engines to WMES.

 

WMES has a loan agreement with JA Mitsui Leasing, Ltd. which provides a credit facility of up to $180.0 million to support the funding of future engine acquisitions. Funds are available under the loan agreement have been extended through March 31, 2014. WMES also established a separate credit facility for $8.0 million to fund the purchase of an engine, which is repayable over the 7 year term of the facility. Our investment in the joint venture is $18.1 million and $11.8 million as of September 30, 2013 and December 31, 2012, respectively.

 

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Prior to September 18, 2013, we held a fifty percent membership interest in a joint venture, WOLF A340, LLC, a Delaware limited liability company, (“WOLF”). On December 30, 2005, WOLF completed the purchase of two Airbus A340-313 aircraft from Boeing Aircraft Holding Company for a purchase price of $96.0 million. The purchase was funded by four term notes with one financial institution totaling $76.8 million, with interest payable at one-month LIBOR plus 1.0% to 2.5% and matured in May 2013. Two of the term notes were paid off in May 2013 and the remaining two term notes totaling $36.0 million were amended and extended, with a maturity date of  May 2017 and interest payable at one-month LIBOR plus 4.0%. At June 30, 2013, the return of both aircraft from the prior lessee, Emirates, had been completed. As part of the lease return process, upon termination of the aircraft leases, Emirates made maintenance reserve payments totaling $9.0 million, which was recorded by WOLF as maintenance reserve revenue in the period ended June 30, 2013. The airframes are being disassembled and parted out and the eight engines are being marketed for lease separately to airline customers.

 

On September 18, 2013,  we completed the acquisition of the fifty percent membership interest held by the other joint venture partner in WOLF for a purchase price of $1.0 million, with the purchase price representing a $12.7 million discount from the JV partner’s equity interest. The transaction is being accounted for as an asset acquisition. We recorded the assets at the cost basis, which represents the allocation of our prior investment basis plus the cash paid to the third party investor.

 

The purchase price was allocated to the eight aircraft engines and two airframes. The fair value of the net assets acquired from this transaction is estimated to be $12.6 million, which comprised of $27.0 million of equipment, $1.6 million of cash and receivables, offset by $16.0 million of debt and other liabilities. As a result of the transaction, we now own one hundred percent of WOLF. The WOLF balance sheet and the results of operations related to the WOLF assets have been included in the accompanying consolidated financial statements as of the acquisition date, September 18, 2013.

 

Nine Months Ended September 30, 2013 (in thousands)		WOLF			WMES			Total
Investment in joint ventures as of December 31, 2012		$	10,065		$	11,766		$	21,831
Capital contribution		—			6,145			6,145
Earnings from joint ventures		3,025			161			3,186
Distribution		—			—			—
Transfer to consolidated subsidiary		(13,090		)	—			(13,090		)
Investment in joint ventures as of September 30, 2013		$	—		$	18,072		$	18,072

 

5.  Long Term Debt

 

At September 30, 2013, notes payable consists of loans totaling $744.3 million, payable over periods of approximately four months to nine years with interest rates varying between approximately 3.2% and 5.5% (excluding the effect of our interest rate derivative instruments).

 

Our significant debt instruments are discussed below:

 

At September 30, 2013, we had a $450.0 million revolving credit facility to finance the acquisition of aircraft engines for lease as well as for general working capital purposes. We closed on this facility on November 18, 2011 and the proceeds of the facility, net of $3.3 million in debt issuance costs, was used to pay off the balance remaining from our prior revolving facility. On June 18, 2013, we increased this revolving credit facility to $450.0 million from $430.0 million. As of September 30, 2013 and December 31, 2012, $138.0 million and $148.0 million was available under this facility, respectively. The revolving credit facility ends in November 2016. Based on the Company’s debt to equity ratio of 3.80, as calculated under the terms of the revolving credit facility at June 30, 2013, the interest rate on this facility is LIBOR plus 3.00% as of September 30, 2013. Under the revolving credit facility, all subsidiaries except WEST II  and WOLF jointly and severally guarantee payment and performance of the terms of the loan agreement. The guarantee would be triggered by a default under the agreement.

 

On September 17, 2012, we closed an asset-backed securitization (“ABS”) through a newly-created, bankruptcy-remote, Delaware statutory trust, Willis Engine Securitization Trust II,  or “WEST II”, of which the Company is the sole beneficiary. WEST II issued and sold $390 million aggregate principal amount of Class 2012-A Term Notes (the “Notes”) and received $384.9 million in net proceeds. We used these funds, net of transaction expenses and swap termination costs, in combination with our revolving credit facility, to pay off the prior WEST notes totaling $435.9 million. At closing, 22 engines were pledged as collateral from WEST to the Company’s revolving credit facility, which provided the remaining funds to pay off the WEST notes.

 

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The assets and liabilities of WEST II will remain on the Company’s balance sheet. A portfolio of 79 commercial jet aircraft engines and leases thereof secures the obligations of WEST II under the ABS. The Notes have no fixed amortization and are payable solely from revenue received by WEST II from the engines and the engine leases, after payment of certain expenses of WEST II. The Notes bear interest at a fixed rate of 5.50% per annum. The Notes may be accelerated upon the occurrence of certain events, including the failure to pay interest for five business days after the due date thereof. The Notes are expected to be paid 10 years from the issuance date by September 17, 2022. The legal final maturity of the Notes is September 15, 2037.

 

In connection with the transactions described above, effective September 17, 2012, the Servicing Agreement and Administrative Agency Agreement previously filed by the Company as exhibits to, and described in, its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2005 relating to WEST were terminated. The Company entered into a Servicing Agreement and Administrative Agency Agreement with WEST II to provide certain engine, lease management and reporting functions for WEST II in return for fees based on a percentage of collected lease revenues and asset sales.  Because WEST II is consolidated for financial statement reporting purposes, all fees eliminate upon consolidation.

 

At September 30, 2013 and December 31, 2012, $375.0 million and $386.7 million of WEST II term notes were outstanding, respectively. The assets of WEST II are not available to satisfy our obligations or any of our affiliates other than the obligations specific to WEST II. WEST II is consolidated for financial statement presentation purposes. WEST II’s ability to make distributions and pay dividends to the Company is subject to the prior payments of its debt and other obligations and WEST II’s maintenance of adequate reserves and capital. Under WEST II, cash is collected in a restricted account, which is used to service the debt and any remaining amounts, after debt service and defined expenses, are distributed to the Company. Additionally, a portion of maintenance reserve payments and all lease security deposits are accumulated in restricted accounts and are available to fund future maintenance events and to secure lease payments, respectively. Cash from maintenance reserve payments are held in the restricted cash account equal to the maintenance obligations projected for the subsequent six months, and are subject to a minimum balance of $9.0 million.

 

On September 18, 2013,  we completed the acquisition of the fifty percent membership interest held by the other joint venture partner in WOLF, with the transaction being accounted for as an asset acquisition. With this acquisition, WOLF is consolidated for financial statement presentation purposes. Two term notes with an original principal amount of $36.0 million, with a current balance outstanding of $31.5 million as of September 30, 2013, are included in Notes payable. The two term notes are non-recourse to the Company, have a maturity date of  May 2017 and interest is payable at one-month LIBOR plus 4.0%.

 

The assets of WOLF are not available to satisfy our obligations or any of our affiliates other than the obligations specific to WOLF. WOLF’s ability to make distributions to the Company is subject to the prior payments of all of its debt and other obligations. Under WOLF, cash related to parts sale and leasing of engine assets is collected in a restricted account and used to pay certain operating expenses, service the debt, and upon full debt repayment are distributed to the Company.

 

On September 28, 2012, we closed on a loan for a five year term totaling $8.7 million. Interest is payable monthly at a fixed rate of 5.50% and principal is paid quarterly. The loan is secured by one engine. The funds were used to purchase the engine secured under the loan. The balance outstanding on this loan is $8.3 million and $8.6 million as of September 30, 2013 and December 31, 2012, respectively.

 

On September 30, 2011, we closed on a loan for a three year term totaling $4.0 million. Interest is payable at a fixed rate of 3.94% and principal and interest is paid monthly. The loan is secured by our corporate aircraft. The funds were used to refinance the loan for our corporate aircraft. The balance outstanding on this loan is $1.3 million and $2.3 million as of September 30, 2013 and December 31, 2012, respectively.

 

On January 11, 2010, we closed on a loan for a four year term totaling $22.0 million, the proceeds of which were used to pay down our revolving credit facility. Interest is payable at a fixed rate of 4.50% and principal and interest is paid quarterly. The loan is secured by three engines. The balance outstanding on this loan is $16.2 million and $17.3 million as of September 30, 2013 and December 31, 2012, respectively.

 

Virtually all of the debt instruments above have covenant requirements such as minimum tangible net worth, maximum balance sheet leverage and various interest coverage ratios. The Company also has certain negative financial covenants such as liens, advances, change in business, sales of assets, dividends and stock repurchase. These covenants are tested quarterly and the Company was in full compliance with all covenant requirements at September 30, 2013.

 

At September 30, 2013, we are in compliance with the covenants specified in the revolving credit facility Credit Agreement, including the Interest Coverage Ratio requirement of at least 2.50 to 1.00, and the Total Leverage Ratio requirement to remain below 4.75 to 1.00. At September 30, 2013, the Company’s calculated Minimum Consolidated Tangible Net Worth exceeded the minimum required amount of $191.1 million. As defined in the revolving credit facility Credit Agreement, the Interest Coverage Ratio is the ratio of Earnings before Interest, Taxes, Depreciation and Amortization and other one-time charges (EBITDA) to Consolidated Interest Expense and the Total Leverage Ratio is the ratio of Total Indebtedness to Tangible Net Worth. At September 30, 2013, we are in compliance with the covenants specified in the WEST II indenture and servicing agreement.

 

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At September 30, 2013 and 2012, one-month LIBOR was 0.18% and 0.21%, respectively.

 

The following is a summary of the aggregate maturities of notes payable at September 30, 2013:

 

Year		(in thousands)
2013		$	11,186
2014		42,023
2015		32,934
2016 (includes $312.0 million outstanding on revolving credit facility)		338,215
2017		32,873
Thereafter		287,069
		$	744,300

 

6.  Derivative Instruments

 

We hold interest rate derivative instruments to mitigate exposure to changes in interest rates, in particular one-month LIBOR, with $343.5 million and $282.0 million of our borrowings at September 30, 2013 and December 31, 2012, respectively, at variable rates. As a matter of policy, we do not use derivatives for speculative purposes. At September 30, 2013 and December 31, 2012, under our revolving credit facility, we were a party to one interest rate swap agreement with a notional outstanding amount of $100.0 million with a fixed rate of 2.10% and a remaining term of two months as of September 30, 2013. The net fair value of the swap at September 30, 2013 and December 31, 2012 was negative $0.3 million and negative $1.7 million, respectively, representing a net liability for us. The amount represents the estimated amount we would be required to pay if we terminated the swap.

 

The Company estimates the fair value of derivative instruments using a discounted cash flow technique and, as of September 30, 2013, has used creditworthiness inputs that can be corroborated by observable market data evaluating the Company’s and counterparties’ risk of non-performance. Valuation of the derivative instruments requires certain assumptions for underlying variables and the use of different assumptions would result in a different valuation. Management believes it has applied assumptions consistently during the period. We apply hedge accounting and account for the change in fair value of our cash flow hedges through other comprehensive income for all derivative instruments.

 

Based on the implied forward rate for LIBOR at September 30, 2013, we anticipate that net finance costs will be increased by approximately $0.3 million for the 12 months ending September 30, 2014 due to the interest rate derivative contract currently in place.

 

Fair Values of Derivative Instruments in the Consolidated Balance Sheets

 

The following table provides information about the fair value of our derivatives, by contract type:

 

		Derivatives
				Fair Value
Derivatives Designated as Hedging Instruments		Balance Sheet Location		September 30, 2013			December 31, 2012
				(in thousands)
Interest rate contracts		Liabilities under derivative instruments		$	301		$	1,690

 

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