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WILLIS LEASE FINANCE CORP - Quarter Report: 2017 June (Form 10-Q)

Table of Contents

f

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2017

 

OR

 

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)

 

Delaware

 

68-0070656

(State or other jurisdiction of incorporation or
organization)

 

(IRS Employer Identification No.)

 

 

 

773 San Marin Drive, Suite 2215, Novato, CA

 

94998

(Address of principal executive offices)

 

(Zip Code)

 

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 ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 ☒  No ☐

 

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”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ☐

 

Accelerated filer ☒

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

(Do not check if a smaller reporting company)

 

 

 

 

 

Emerging growth company ☐

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  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 August 7, 2017

Common Stock, $0.01 par value per share

 

6,434,074

 

 

 

 

 

 

 


 

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 June 30, 2017 and December 31, 2016

3

 

 

 

 

Consolidated Statements of Income for the three and six months ended June 30, 2017 and 2016

4

 

 

 

 

Consolidated Statements of Comprehensive Income for the six months ended June 30, 2017 and 2016

5

 

 

 

 

Consolidated Statements of Redeemable Preferred Stock and Shareholders’ Equity for the six months ended June 30, 2017 and 2016

6

 

 

 

 

Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016

7

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

8

 

 

 

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

24

 

 

 

Item 4. 

Controls and Procedures

24

 

 

 

PART II. 

OTHER INFORMATION

25

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

25

 

 

 

Item 6. 

Exhibits

27

 

2


 

Table of Contents

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)

 

 

 

 

 

 

 

 

 

    

June 30,

    

December 31,

 

 

2017

 

2016

ASSETS

 

 

 

 

 

 

Cash and cash equivalents

 

$

11,256

 

$

10,076

Restricted cash

 

 

43,244

 

 

22,298

Equipment held for operating lease, less accumulated depreciation of $351,616 and $351,553 at June 30, 2017 and December 31, 2016, respectively

 

 

1,160,545

 

 

1,136,603

Maintenance rights

 

 

17,159

 

 

17,670

Equipment held for sale

 

 

27,826

 

 

30,710

Operating lease related receivables, net of allowances of $1,058 and $787 at June 30, 2017 and December 31, 2016, respectively

 

 

12,867

 

 

16,484

Spare parts inventory

 

 

22,955

 

 

25,443

Investments

 

 

45,928

 

 

45,406

Property, equipment & furnishings, less accumulated depreciation of $6,586 and $5,858 at June 30, 2017 and December 31, 2016, respectively

 

 

16,400

 

 

16,802

Intangible assets, net

 

 

1,980

 

 

2,182

Other assets

 

 

26,194

 

 

14,213

Total assets

 

$

1,386,354

 

$

1,337,887

 

 

 

 

 

 

 

LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

24,452

 

$

17,792

Deferred income taxes

 

 

114,127

 

 

104,978

Notes payable

 

 

921,782

 

 

900,255

Maintenance reserves

 

 

68,512

 

 

71,602

Security deposits

 

 

23,074

 

 

21,417

Unearned lease revenue

 

 

5,195

 

 

5,823

Total liabilities

 

 

1,157,142

 

 

1,121,867

 

 

 

 

 

 

 

Redeemable preferred stock ($0.01 par value, 1,000,000 shares authorized; 1,000,000 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively)

 

$

19,777

 

$

19,760

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

Common stock ($0.01 par value, 20,000,000 shares authorized; 6,440,049 and 6,401,929 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively)

 

 

64

 

 

64

Paid-in capital in excess of par

 

 

708

 

 

2,512

Retained Earnings

 

 

209,497

 

 

194,729

Accumulated other comprehensive loss, net of income tax benefit of $439 and benefit $551 at June 30, 2017 and December 31, 2016, respectively.

 

 

(834)

 

 

(1,045)

Total shareholders’ equity

 

 

209,435

 

 

196,260

Total liabilities, redeemable preferred stock and shareholders' equity

 

$

1,386,354

 

$

1,337,887

 

 

 

 

 

 

 

(1) Total assets at June 30, 2017 and December 31, 2016 include the

following assets of a variable interest entity (VIE) that can only be used

to settle the liabilities of the VIE:  Cash, $72 and $257; Restricted Cash

$43,244 and $22,298; Equipment, $281,472 and $309,815; and Other, $8,026

and $4,139, respectively.

(2) Total liabilities at June 30, 2017 and December 31, 2016 include

the following liabilities of a VIE for which the VIE creditors do not have

recourse to Willis Lease Finance Corporation: Notes payable, $263,884

and $273,380, respectively.

 

See accompanying notes to the unaudited consolidated financial statements.

3


 

Table of Contents

WILLIS LEASE FINANCE CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Income

(In thousands, except per share data, unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

    

2017

    

2016

    

2017

    

2016

REVENUE

 

 

 

 

 

 

 

 

 

 

 

 

Lease rent revenue

 

$

31,337

 

$

29,181

 

$

61,572

 

$

57,457

Maintenance reserve revenue

 

 

11,881

 

 

15,514

 

 

43,843

 

 

31,333

Spare parts and equipment sales

 

 

19,383

 

 

3,673

 

 

31,979

 

 

6,305

Gain on sale of leased equipment

 

 

3,527

 

 

258

 

 

4,509

 

 

3,250

Other revenue

 

 

1,716

 

 

992

 

 

3,888

 

 

1,992

Total revenue

 

 

67,844

 

 

49,618

 

 

145,791

 

 

100,337

 

 

 

 

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

16,015

 

 

16,188

 

 

32,644

 

 

32,607

Cost of spare parts and equipment sales

 

 

13,730

 

 

2,787

 

 

23,130

 

 

4,719

Write-down of equipment

 

 

2,277

 

 

1,893

 

 

15,285

 

 

3,929

General and administrative

 

 

13,065

 

 

10,685

 

 

26,265

 

 

22,437

Technical expense

 

 

2,448

 

 

1,803

 

 

4,740

 

 

3,499

Net finance costs:

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

11,312

 

 

10,397

 

 

22,178

 

 

20,405

Gain on debt extinguishment

 

 

 —

 

 

137

 

 

 —

 

 

137

Net finance costs

 

 

11,312

 

 

10,534

 

 

22,178

 

 

20,542

Total expenses

 

 

58,847

 

 

43,890

 

 

124,242

 

 

87,733

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings from operations

 

 

8,997

 

 

5,728

 

 

21,549

 

 

12,604

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings from joint ventures

 

 

1,161

 

 

56

 

 

3,015

 

 

243

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

 

10,158

 

 

5,784

 

 

24,564

 

 

12,847

Income tax expense

 

 

4,168

 

 

2,418

 

 

10,406

 

 

5,470

Net income

 

$

5,990

 

$

3,366

 

$

14,158

 

$

7,377

Preferred stock dividends

 

 

324

 

 

 —

 

 

646

 

 

 —

Accretion of preferred stock issuance costs

 

 

 9

 

 

 —

 

 

17

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common shareholders

 

$

5,657

 

$

3,366

 

 

13,495

 

 

7,377

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

$

0.94

 

$

0.50

 

$

2.22

 

$

1.07

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

$

0.92

 

$

0.49

 

$

2.18

 

$

1.05

 

 

 

 

 

 

 

 

 

 

 

 

 

Average common shares outstanding

 

 

6,036

 

 

6,685

 

 

6,075

 

 

6,917

Diluted average common shares outstanding

 

 

6,142

 

 

6,819

 

 

6,201

 

 

7,047

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

4


 

Table of Contents

 

WILLIS LEASE FINANCE CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands, unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30,

 

June 30,

 

    

2017

    

2016

    

2017

    

2016

Net income

 

$

5,990

 

$

3,366

 

$

14,158

 

$

7,377

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustment

 

 

226

 

 

967

 

 

326

 

 

526

Unrealized loss on derivative instruments

 

 

(338)

 

 

 —

 

 

(3)

 

 

 —

Net gain (loss) recognized in other comprehensive income

 

 

(112)

 

 

967

 

 

323

 

 

526

Tax benefit (expense) related to items of other comprehensive income

 

 

40

 

 

(334)

 

 

(112)

 

 

(182)

Other comprehensive income (loss)

 

 

(72)

 

 

633

 

 

211

 

 

344

Total comprehensive income

 

$

5,918

 

$

3,999

 

$

14,369

 

$

7,721

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

5


 

Table of Contents

WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Redeemable Preferred Stock and Shareholders’ Equity
Six months Ended June 30, 2017 and 2016
(In thousands, unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

 

 

 

Stockholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

Redeemable

 

 

 

 

 

 

Paid-in

 

Other

 

 

 

 

Total

 

 

Preferred Stock

 

Common Stock

 

Capital in

 

Comprehensive

 

Retained

 

Shareholders’

 

    

Shares

    

Amount

    

Shares

    

Amount

    

Excess of par

    

Income

    

Earnings

    

Equity

Balances at December 31, 2015

 

 —

 

$

 —

 

7,548

 

$

75

 

$

28,720

 

$

(521)

 

$

180,949

 

$

209,223

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

7,377

 

 

7,377

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized loss from currency translation adjustment, net of tax benefit of $182

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

345

 

 

 —

 

 

345

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares repurchased

 

 —

 

 

 —

 

(942)

 

 

(9)

 

 

(22,390)

 

 

 —

 

 

 —

 

 

(22,399)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued under stock compensation plans

 

 —

 

 

 —

 

112

 

 

 1

 

 

81

 

 

 —

 

 

 —

 

 

82

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cancellation of restricted stock in satisfaction of withholding tax

 

 —

 

 

 —

 

(29)

 

 

 —

 

 

(581)

 

 

 —

 

 

 —

 

 

(581)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation, net of forfeitures

 

 —

 

 

 —

 

 —

 

 

 —

 

 

1,849

 

 

 —

 

 

 —

 

 

1,849

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tax benefit on disqualified disposition of shares

 

 —

 

 

 —

 

 —

 

 

 —

 

 

254

 

 

 —

 

 

 —

 

 

254

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at June 30, 2016

 

 —

 

$

 —

 

6,689

 

$

67

 

$

7,933

 

$

(176)

 

$

188,326

 

$

196,150

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2017

 

1,000

 

$

19,760

 

6,402

 

$

64

 

$

2,512

 

$

(1,045)

 

$

194,729

 

$

196,260

Cumulative-effect adjustment

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1,273

 

 

1,273

Balances at January 1, 2017, adjusted

 

1,000

 

 

19,760

 

6,402

 

 

64

 

 

2,512

 

 

(1,045)

 

 

196,002

 

 

197,533

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

14,158

 

 

14,158

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized gain from currency translation adjustment, net of tax expense of $112

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

214

 

 

 —

 

 

214

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized gain (loss)  from derivative instruments, net of tax expense of $1

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(3)

 

 

 —

 

 

(3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares repurchased

 

 —

 

 

 —

 

(155)

 

 

(2)

 

 

(3,347)

 

 

 —

 

 

 —

 

 

(3,349)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued under stock compensation plans

 

 —

 

 

 —

 

211

 

 

 2

 

 

91

 

 

 —

 

 

 —

 

 

93

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cancellation of restricted stock in satisfaction of withholding tax

 

 —

 

 

 —

 

(18)

 

 

 —

 

 

(622)

 

 

 —

 

 

 —

 

 

(622)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation, net of forfeitures

 

 —

 

 

 —

 

 —

 

 

 —

 

 

2,074

 

 

 —

 

 

 —

 

 

2,074

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accretion of preferred shares issuance costs

 

 —

 

 

17

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(17)

 

 

(17)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividend

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(646)

 

 

(646)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at June 30, 2017

 

1,000

 

$

19,777

 

6,440

 

$

64

 

$

708

 

$

(834)

 

$

209,497

 

 

209,435

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

6


 

Table of Contents

 

WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands, unaudited)

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

    

2017

    

2016

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

14,158

 

$

7,377

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Depreciation and amortization expense

 

 

32,644

 

 

32,607

Write-down of equipment

 

 

15,285

 

 

3,929

Stock-based compensation expenses

 

 

2,074

 

 

1,849

Amortization of deferred costs

 

 

2,361

 

 

2,157

Allowances and provisions

 

 

272

 

 

(419)

Gain on sale of leased equipment

 

 

(4,509)

 

 

(3,250)

Gain on extinguishment of debt

 

 

 —

 

 

137

Income from joint ventures

 

 

(3,015)

 

 

(243)

Excess tax benefit from stock-based compensation

 

 

 —

 

 

254

Deferred income taxes

 

 

10,406

 

 

4,990

Changes in assets and liabilities:

 

 

 

 

 

 

Receivables

 

 

3,345

 

 

(225)

Spare parts inventory

 

 

645

 

 

1,799

Other assets

 

 

(3,315)

 

 

297

Accounts payable and accrued expenses

 

 

8,139

 

 

(2,322)

Maintenance reserves

 

 

(342)

 

 

(1,782)

Security deposits

 

 

1,757

 

 

(105)

Unearned lease revenue

 

 

(628)

 

 

(256)

Net cash provided by operating activities

 

 

79,277

 

 

46,794

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Proceeds from sale of equipment (net of selling expenses)

 

 

37,754

 

 

54,204

Capital contribution to joint ventures

 

 

 —

 

 

(4,610)

Distributions received from joint ventures

 

 

1,880

 

 

1,167

Purchase of equipment held for operating lease

 

 

(112,233)

 

 

(61,472)

Purchase of maintenance rights

 

 

 —

 

 

(4,634)

Purchase of property, equipment and furnishings

 

 

(326)

 

 

(183)

Net cash provided by (used in) investing activities

 

 

(72,925)

 

 

(15,528)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Proceeds from issuance of notes payable

 

 

93,000

 

 

55,000

Debt issuance cost

 

 

 —

 

 

(3,755)

Proceeds from shares issued under stock compensation plans

 

 

93

 

 

82

Cancellation of restricted stock units in satisfaction of withholding tax

 

 

(622)

 

 

(581)

Repurchase of common stock

 

 

(3,348)

 

 

(22,399)

Preferred stock dividends, net

 

 

(596)

 

 

 —

Principal payments on notes payable

 

 

(72,752)

 

 

(42,501)

Net cash provided by (used in) financing activities

 

 

15,775

 

 

(14,154)

Increase (decrease) in cash, cash equivalents and restricted cash

 

 

22,127

 

 

17,112

Cash, cash equivalents and restricted cash at beginning of period

 

 

32,373

 

 

42,758

Cash, cash equivalents and restricted cash at end of period

 

$

54,500

 

$

59,870

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

Net cash paid for:

 

 

 

 

 

 

Interest

 

$

19,426

 

$

18,653

Income Taxes

 

$

332

 

$

72

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental disclosures of non-cash investing activities:

 

 

 

 

 

 

During the six months ended June 30, 2017 and 2016, liabilities of $1,624 and $2,565, respectively, were incurred but not paid in connection with our purchase of aircraft and engines.

 

 

 

 

 

 

During the six months ended June 30, 2017 and 2016, engines and equipment totaling $27,408 and $18,371, respectively, were transferred from Held for Operating Lease to Held for Sale

 

 

 

 

 

 

During the six months ended June 30, 2016 , an aircraft of $2,925 was transferred from Property, equipment and furnishings to Assets Held for Lease.

 

 

 

 

 

 

(1) Certain amounts include adjustments to prior periods see "Note 1. Summary of significant Accounting Policies (c) Correction

of Immaterial Errors - Consolidated Financial Statements" for further disclosure.

 

 

 

 

 

 

 

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 for the fiscal year ended December 31, 2016.

 

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly our financial position as of June 30, 2017 and December 31, 2016, and the results of our operations for the three and six months ended June 30, 2017 and 2016, and our cash flows for the six months ended June 30, 2017 and 2016. The results of operations and cash flows for the period ended June 30, 2017 are not necessarily indicative of the results of operations or cash flows which may be reported for the remainder of 2017.

 

(b)    Principles of Consolidation:

 

We evaluate all entities in which we have an economic interest firstly to determine whether for accounting purposes the entity is a variable interest entity or voting interest entity. If the entity is a variable interest entity we consolidate the financial statements of that entity if we are the primary beneficiary of the entities’ activities. If the entity is a voting interest entity we consolidate the entity when we have a majority of voting interests. All inter-company balances are eliminated upon consolidation.

 

(c)    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. We use a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, 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.

 

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Assets Measured and Recorded at Fair Value on a Nonrecurring Basis

 

We determine 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. an offer to purchase) 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 during the six months ended June 30, 2017 and 2016, and the losses recorded during the six months ended June 30, 2017 and 2016 on those assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets at Fair Value

 

Total Losses

 

 

June 30, 2017

 

June 30, 2016

 

Six Months Ended June 30,

 

   

Level 1

   

Level 2

   

Level 3

   

Total

   

Level 1

   

Level 2

   

Level 3

   

Total

   

2017

   

2016

 

 

(in thousands)

 

(in thousands)

Equipment held for lease

 

$

 —

 

$

11,483

 

$

 —

 

$

11,483

 

$

 —

 

$

758

 

$

 —

 

$

758

 

$

(9,019)

 

$

(1,893)

Equipment held for sale

 

 

 —

 

 

27,547

 

 

 —

 

 

27,547

 

 

 —

 

 

1,448

 

 

 —

 

 

1,448

 

 

(4,423)

 

 

(2,036)

Spare parts inventory

 

 

 —

 

 

21,275

 

 

 —

 

 

21,275

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(1,843)

 

 

 —

Total

 

$

 —

 

$

60,305

 

$

 —

 

$

60,305

 

$

 —

 

$

2,206

 

$

 —

 

$

2,206

 

$

(15,285)

 

$

(3,929)

 

At June 30, 2017, the Company used Level 2 inputs to measure equipment held for sale.  Level 2 inputs include quoted prices for similar assets in inactive markets.

 

An impairment charge is recorded when the carrying value of the asset exceeds its fair value. A write-down of $13.4 million was recorded during the six months ended June 30, 2017 for four engines and three aircraft for which their leases ended or were modified in the period. We evaluated the equipment return condition, end of lease compensation, accumulated maintenance reserves and expected future proceeds from part out and sale to record our initial best estimate of impairment.   An additional asset write-down of $1.8 million was recorded in the six months ended June 30, 2017 based upon a comparison of the spare parts net book values with the revised net proceeds expected from part sales.  A write-down of equipment totaling $3.9 million was recorded in the six months ended June 30, 2016 due to a management decision to consign two engines for part-out and sale, in which the asset’s net book value exceeded the estimated proceeds.

 

(d)    Foreign Currency Translation:

 

The Company’s foreign investments have been converted at rates of exchange at June 30, 2017. The changes in exchange rates in our foreign investments reported under the equity method are included in stockholders’ equity as accumulated other comprehensive income.

 

(e)    Recent Accounting Pronouncements:

 

Recent Accounting Pronouncements Already Adopted by the Company:

 

In July 2015, the Financial Accounting Standards Board ("FASB")  issued Accounting Standards Update ("ASU")  2015-11 ,Simplifying the Measurement of Inventory, which simplifies the measurement of inventory by requiring certain inventory to be measured at the lower of cost or net realizable value. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017 and for interim periods therein.  The Company adopted ASU 2015-11 during the quarter ended March 31, 2017 and it did not have a material impact on our consolidated financial statements.

 

In November 2016, the FASB issued ASU 2016-18, Restricted Cash, which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. ASU 2016-08 is effective for fiscal years beginning after December 15, 2018 (including interim periods within those periods) using a retrospective transition method to each period presented. The Company adopted this standard as of March 31, 2017 and included $43.2 million and $22.3 million of restricted cash in the total of cash, cash equivalents and restricted cash in its statements of consolidated cash flows for the six months ended June 30, 2017

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and 2016, respectively.   The adoption of this standard also resulted in an increase (decrease) in cash flows from operating, investing and financing activities of ($5.8 million), $1.3 million and ($1.3 million), respectively, for the six months ended June 30, 2016.

 

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The new guidance became effective for the Company in the first quarter of fiscal 2017.

 

The Company adopted ASU 2016-09 on January 1, 2017 on a modified retrospective method through a cumulative adjustment to  retained earnings of $1.3 million.  As of the six months ended June 30, 2017, excess tax benefit from stock-based compensation of $54,000 were reflected in the Consolidated Statements of Income as income tax expense, whereas they previously were recognized in equity. Additionally, our Consolidated Statements of Cash Flows now present excess tax benefits as an operating activity, with the prior periods adjusted accordingly. We have elected to account for forfeitures as they occur, rather than estimate expected forfeitures. As a result of the adoption of ASU 2016-09, the Consolidated Statement of Cash Flows for the six months ended June 30, 2016 was adjusted as follows: a $0.2 million increase to net cash provided by operating activities and a $0.2 million decrease to net cash used in financing activities.

 

Recent Accounting Pronouncements To Be Adopted by the Company:

 

In 2014, the Financial Accounting Standards Board (“FASB”) issued new guidance applicable to revenue recognition that will be effective January 1, 2018. Early adoption was permitted for the year-ending December 31, 2017. The new guidance applies a more principles based approach to recognizing revenue. Under the new guidance, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration that an entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance must be adopted using either a modified retrospective approach or a full retrospective approach for all periods presented. Under the modified retrospective method, the cumulative effect of applying the standard would be recognized at the date of initial application within retained earnings. Under the full retrospective approach, the standard would be applied to each prior reporting period presented. The Company continued its evaluation of the new guidance and the effect of adoption on the consolidated financial statements and believes the new standard has no impact on lease revenue and initial evaluation concluding no material impact to other revenue streams. 

 

In January 2017, the FASB issued ASU 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” that eliminates “Step 2” from the goodwill impairment test. The new standard is effective for us in the first quarter of fiscal 2020, and early adoption is permitted. The new guidance must be applied on a prospective basis. We do not anticipate that the adoption of this standard will have a significant impact on our consolidated financial statements or the related disclosures.

 

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting,” that provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The new guidance became effective for the Company in the first quarter of fiscal 2018. The new guidance must be applied on a prospective basis. We do not anticipate that the adoption of this standard will have a significant impact on our consolidated financial statements or the related disclosures.

 

 

2.  Management Estimates

 

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

 

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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.  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 and the Company uses the equity method in recording investment activity. The investment has increased to $32.6 million as of June 30, 2017 as a net result of the Company receiving $1.9 million in distributions, recording $0.4 million as deferred gain as a result of the Company selling an engine to WMES and the Company’s share of WMES reported income of $2.4 million during the six months ended June 30, 2017.

 

On June 3, 2014 we entered into an agreement with China Aviation Supplies Import & Export Corporation (“CASC”) to participate in a joint venture named CASC Willis Engine Lease Company Limited (“CASC Willis”), a new joint venture based in Shanghai, China. Each partner holds a fifty percent interest in the joint venture. In October 2014, we made a $15.0 million initial capital contribution, representing our fifty percent, up-front funding contribution to the new joint venture. The company acquires and leases jet engines to Chinese airlines and concentrates on meeting the fast growing demand for leased commercial aircraft engines and aviation assets in the People’s Republic of China. During the six months ended June 30, 2017 the Company recorded $0.5 million as deferred gain as a result of the Company selling an engine to CASC Willis, recorded $0.3 million foreign currency translation adjustment and the Company’s share of CASC Willis reported income of $0.6 million. Our investment in the joint venture is $13.4 million as of June 30, 2017.

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2017

    

WMES

 

CASC

 

Total

 

 

(in thousands)

Investment in joint ventures as of December 31, 2016

 

$

32,470

 

$

12,936

 

$

45,406

Earnings from joint venture

 

 

2,426

 

 

589

 

 

3,015

Deferred gain on engine sale

 

 

(443)

 

 

(496)

 

 

(939)

Distribution

 

 

(1,880)

 

 

 —

 

 

(1,880)

Foreign Currency Translation Adjustment

 

 

 —

 

 

326

 

 

326

Investment in joint ventures as of June 30, 2017

 

$

32,573

 

$

13,355

 

$

45,928

 

“Other revenue” on the Consolidated Statement of Income includes management fees earned of $1.3 million and $0.5 million during the six months ended June 30, 2017 and 2016, respectively, related to the servicing of engines for the WMES lease portfolio. “Gain on sale of leased equipment” on the Consolidated Statement of Income includes $0.9 million for the six months ended June 30, 2017 related to both the sale of an engine to WMES ($0.4 million gain) and the sale of an engine to CASC Willis ($0.5 million gain).  “Gain on sale of  leased equipment” on the Consolidated Statement of Income includes $1.2 million for the six months ended June 30, 2016 related to the sale of four engines to WMES for $46.1 million.  As 50% owners of WMES and CASC Willis, we deferred these gains to our investment which is being amortized over a 15-year period to a 55% residual value. 

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Summarized financial information for 100% of WMES is presented in the following tables:

 

 

 

 

 

 

 

 

 

 

Three Months Ended June,

 

    

2017

    

2016

 

 

(in thousands)

Revenue

 

$

8,199

 

$

7,752

Expenses

 

 

6,700

 

 

7,209

WMES net income

 

$

1,499

 

$

543

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

    

2017

    

2016

 

 

 

 

 

(in thousands)

Revenue

 

$

19,860

 

$

16,998

Expenses

 

 

15,129

 

 

16,390

WMES net income

 

$

4,731

 

$

608

 

 

 

 

 

 

 

 

 

June 30,

 

    

December 31,

 

 

2017

 

 

2016

 

 

(in thousands)

Total assets

 

$

265,341

 

$

307,152

Total liabilities

 

 

190,986

 

 

238,790

Total WMES net equity

 

$

74,355

 

$

68,362

 

 

 

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4.  Notes Payable

 

Notes payable consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

June 30,

    

December 31,

 

 

    

2017

 

2016

 

 

 

(in thousands)

 

Credit facility at a floating rate of interest of LIBOR plus 2.75%, secured by engines. The facility has a committed amount of $890.0 million at June 30, 2017, which revolves until the maturity date of April 2021.

 

$

640,000

 

$

608,000

 

 

 

 

 

 

 

 

 

WEST II Series 2012-A term notes payable at a fixed rate of interest of 5.50%, maturing in September 2037. Secured by engines.

 

 

269,336

 

 

279,541

 

 

 

 

 

 

 

 

 

Note payable at fixed interest rates ranging from 2.60% to 2.97%, maturing in July 2024. Secured by an aircraft.

 

 

13,592

 

 

14,453

 

 

 

 

 

 

 

 

 

Note payable at a variable interest rate of LIBOR plus 2.25%, maturing in January 2018. Secured by engines.

 

 

11,023

 

 

11,709

 

 

 

 

 

 

 

 

 

Notes payable

 

 

933,951

 

 

913,703

 

 

 

 

 

 

 

 

 

Less: unamortized debt issuance costs

 

 

(12,169)

 

 

(13,448)

 

Total notes payable

 

$

921,782

 

$

900,255

 

 

We maintain a revolving credit facility to finance the acquisition of aircraft engines for lease as well as for general working capital purposes.  On April 20, 2016 we entered into a Third Amended and Restated Credit Agreement which increased the revolving credit facility to $890.0 million from $700.0 million and extended the term to April 2021.  This $890 million revolving credit facility has an accordion feature which would expand the entire credit facility up to $1 billion.  The initial interest rate on the facility is LIBOR plus 2.75%.  The interest rate is adjusted quarterly, based on the Company’s leverage ratio, as calculated under the terms of the revolving credit facility.

 

For further information on our debt instruments, see the "Notes Payable" note in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2016.

 

The following is a summary of the aggregate maturities of our long-term debt at June 30, 2017:

 

 

 

 

 

Year

    

(in thousands)

2017

 

$

11,872

2018

 

 

33,294

2019

 

 

23,430

2020

 

 

23,031

2021

 

 

663,268

Thereafter

 

 

179,056

 

 

$

933,951

 

 

5.  Derivative Instruments

 

We periodically hold interest rate derivative instruments to mitigate exposure to changes in interest rates, in particular one-month LIBOR, with $651.0 million and $619.7 million of our borrowings at June 30, 2017 and December 31, 2016, respectively, at variable rates. As a matter of policy, we do not use derivatives for speculative purposes. During 2016, we entered into one interest rate swap agreement which has notional outstanding amount

13


 

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of $100.0 million, with remaining terms of 46 months. The fair value of the swap at June 30, 2017 was $64,000 representing a net asset for us. We recorded a $0.4 million and nil expense to net finance costs during the six months ended June 30, 2017 and 2016,  respectively, from derivative instruments.

 

The Company estimates the fair value of derivative instruments using a discounted cash flow technique and has used creditworthiness inputs that corroborate 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.

 

Earnings Effects of Derivative Instruments on the Statements of Income

 

The following table provides information about the income effects of our cash flow hedging relationships for June 30, 2017 and 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of Loss (Gain) Recognized on

 

 

 

 

 

Derivatives in the Statements of Income

 

Derivatives in Cash Flow Hedging

 

Location of Loss (Gain) Recognized on

 

Three Months Ended June 30,

 

Relationships

    

Derivatives in the Statements of Income

    

2017

    

2016

 

 

 

 

 

(in thousands)

 

Interest rate contracts

 

Interest expense

 

$

174

 

$

 —

 

Total

 

 

 

$

174

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of Loss (Gain) Recognized on

 

 

 

 

 

Derivatives in the Statements of Income

 

Derivatives in Cash Flow Hedging

 

Location of Loss (Gain) Recognized on

 

Six Months Ended June 30,

 

Relationships

    

Derivatives in the Statements of Income

    

2017

    

2016

 

 

 

 

 

(in thousands)

 

Interest rate contracts

 

Interest expense

 

$

400

 

$

 —

 

Total

 

 

 

$

400

 

$

 —

 

 

Effect of Cash Flow Hedge Derivative Instruments

 

The following tables provide additional information about the financial statement effects related to our cash flow hedges for the six months ended June 30, 2017 and 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of Gain (Loss) Recognized

 

Location of Loss (Gain)

 

Amount of Loss (Gain) Recognized

 

 

 

in OCI on Derivatives

 

Reclassified from

 

from Accumulated OCI into Income

 

Derivatives in

 

(Effective Portion)

 

Accumulated OCI into

 

(Effective Portion)

 

Cash Flow Hedging

 

Three Months Ended June 30,

 

Income

 

Three Months Ended June 30,

 

Relationships

    

2017

    

2016

    

(Effective Portion)

    

2017

    

2016

 

 

 

(in thousands)

 

 

 

(in thousands)

 

Interest rate contracts

 

$

(338)

 

$

 —

 

Interest expense

 

$

174

 

$

 —

 

Total

 

$

(338)

 

$

 —

 

Total

 

$

174

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of Gain (Loss) Recognized

 

Location of Loss (Gain)

 

Amount of Loss (Gain) Recognized

 

 

 

in OCI on Derivatives

 

Reclassified from

 

from Accumulated OCI into Income

 

Derivatives in

 

(Effective Portion)

 

Accumulated OCI into

 

(Effective Portion)

 

Cash Flow Hedging

 

Six Months Ended June 30,

 

Income

 

Six Months Ended June 30,

 

Relationships

 

2017

    

2016

 

(Effective Portion)

    

2017

    

2016

 

 

 

(in thousands)

 

 

 

(in thousands)

 

Interest rate contracts

 

$

(3)

 

$

 —

 

Interest expense

 

$

400

 

$

 —

 

Total

 

$

(3)

 

$

 —

 

Total

 

$

400

 

$

 —

 

 

The effective portion of the change in fair value on a derivative instrument designated as a cash flow hedge is reported as a component of other comprehensive income and is reclassified into earnings in the period during which the transaction being hedged affects earnings or it is probable that the forecasted transaction will not occur.

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The ineffective portion of the hedges is recorded in earnings in the current period. However, these are highly effective hedges and no significant ineffectiveness occurred in the periods presented.

 

Counterparty Credit Risk

 

The Company evaluates the creditworthiness of the counterparties under its hedging agreements. The swap counterparty for the interest rate swap in place during 2017 was a large financial institution in the United States that possessed an investment grade credit rating. Based on this rating, the Company believes that the counterparty was creditworthy and that their continuing performance under the hedging agreement was probable, and did not require the counterparty to provide collateral or other security to the Company.   

 

 

6.  Stock-Based Compensation Plans

 

Our 2007 Stock Incentive Plan (the 2007 Plan) was adopted on May 24, 2007. Under this 2007 Plan, a total of 2,000,000 shares are authorized for stock based compensation available in the form of either restricted stock or stock options. On May 28, 2015, the Company’s shareholders authorized an increase in the number of shares of Common Stock available for grant by 800,000 shares bringing the total to 2,800,000 shares authorized. 2,615,960 shares of restricted stock were granted under the 2007 Stock Incentive Plan by June 30, 2017. Of this amount, 166,411 shares of restricted stock were cancelled and returned to the pool of shares which could be granted under the 2007 Stock Incentive Plan resulting in a net number of 350,451 shares which were available as of June 30, 2017 for future issuance under the 2007 Incentive Plan. The fair value of the restricted stock awards equaled the stock price at the date of grants.  The following table summarizes restricted stock activity during the year ended December 31, 2016 and the six months ended June 30, 2017

 

 

 

 

    

Shares

Restricted stock at December 31, 2015

 

396,595

Granted in 2016 (vesting over 2 years)

 

20,000

Granted in 2016 (vesting over 3 years)

 

85,000

Granted in 2016 (vesting over 4 years)

 

13,250

Granted in 2016 (vesting on first anniversary from date of issuance)

 

18,395

Cancelled in 2016

 

(20,377)

Vested in 2016

 

(213,528)

Restricted stock at December 31, 2016

 

299,335

Granted in 2017 (vesting over 3 years)

 

200,700

Granted in 2017 (vesting in 1 year)

 

9,903

Granted in 2017 (vesting in less than 1 year)

 

5,000

Vested in 2017

 

(82,413)

Cancelled in 2017

 

(10,666)

Restricted stock at June 30, 2017

 

421,859

 

All cancelled shares have returned to the share reserve and are available for issuance at a later date, in accordance with the 2007 Plan.

 

Our accounting policy is to recognize the associated expense of such awards on a straight-line basis over the vesting period. At June 30, 2017 the stock compensation expense related to the restricted stock awards that will be recognized over the average remaining vesting period of 1.8 years totals $6.8 million. At June 30, 2017, the intrinsic value of unvested restricted stock awards is $11.3 million. The 2007 Plan was extend in May 2015 for 5 years until May 2020.

 

7.  Income Taxes

 

Income tax expense for the three and six month ended June 30, 2017 was $4.2 million and $10.4 million, respectively. Income tax expense for the three and six month ended June 30, 2016 was $2.4 million and $5.5 million, respectively.  The effective tax rates for the three and six month ended June 30, 2017 were 42.3% and

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41.8%, respectively.  The effective tax rates for the three month and six months ended June 30, 2016 were 41.8% and 42.6%, respectively.    

 

The Company records tax expense or benefit for unusual or infrequent items discretely in the period in which they occur.  Our tax rate is subject to change based on changes in the mix of assets leased to domestic and foreign lessees, the proportions of revenue generated within and outside of California, the amount of executive compensation exceeding $1.0 million as defined in IRS code 162(m) and numerous other factors, including changes in tax law.

 

8.  Fair Value of Financial Instruments

 

The carrying amount reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, operating lease related receivable and accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments.

 

The carrying amount of the Company’s outstanding balance on its Notes Payable as of June 30, 2017 and December 31, 2016 was estimated to have a fair value of approximately $858.8 million and $864.0 million, respectively, based on the fair value of estimated future payments calculated using the prevailing interest rates at each period end.

 

9. 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 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 portable aircraft components and leasing of engines destined for disassembly and sale of parts.

 

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.

 

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The following tables present a summary of the operating segments (amounts in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Leasing and 

    

 

 

    

 

 

 

 

For the three months ended June 30, 2017

 

Related Operations

 

Spare Parts Sales

 

Eliminations (1)

 

Total

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Lease rent revenue

 

$

31,337

 

$

 —

 

$

 —

 

$

31,337

Maintenance reserve revenue

 

 

11,881

 

 

 —

 

 

 —

 

 

11,881

Spare parts and equipment sales

 

 

12,874

 

 

6,509

 

 

 —

 

 

19,383

Gain on sale of leased equipment

 

 

3,527

 

 

 —

 

 

 —

 

 

3,527

Other revenue

 

 

1,649

 

 

276

 

 

(209)

 

 

1,716

Total revenue

 

 

61,268

 

 

6,785

 

 

(209)

 

 

67,844

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

15,929

 

 

86

 

 

 —

 

 

16,015

Cost of spare parts and equipment sales

 

 

9,918

 

 

3,812

 

 

 —

 

 

13,730

Write-down of equipment

 

 

1,351

 

 

926

 

 

 —

 

 

2,277

General and administrative

 

 

12,207

 

 

858

 

 

 —

 

 

13,065

Technical expense

 

 

2,448

 

 

 —

 

 

 —

 

 

2,448

Net finance costs

 

 

11,312

 

 

 —

 

 

 —

 

 

11,312

Total expenses

 

 

53,165

 

 

5,682

 

 

 —

 

 

58,847

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) from operations

 

$

8,103

 

$

1,103

 

$

(209)

 

$

8,997

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Leasing and 

    

 

 

    

 

 

 

 

For the six months ended June 30, 2017

 

Related Operations

 

Spare Parts Sales

 

Eliminations (1)

 

Total

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Lease rent revenue

 

$

61,572

 

$

 —

 

$

 —

 

$

61,572

Maintenance reserve revenue

 

 

43,843

 

 

 —

 

 

 —

 

 

43,843

Spare parts and equipment sales

 

 

19,299

 

 

12,680

 

 

 —

 

 

31,979

Gain on sale of leased equipment

 

 

4,509

 

 

 —

 

 

 —

 

 

4,509

Other revenue

 

 

3,774

 

 

450

 

 

(336)

 

 

3,888

Total revenue

 

 

132,997

 

 

13,130

 

 

(336)

 

 

145,791

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

32,470

 

 

174

 

 

 —

 

 

32,644

Cost of spare parts and equipment sales

 

 

14,623

 

 

8,507

 

 

 —

 

 

23,130

Write-down of equipment

 

 

13,442

 

 

1,843

 

 

 —

 

 

15,285

General and administrative

 

 

24,620

 

 

1,645

 

 

 —

 

 

26,265

Technical expense

 

 

4,740

 

 

 —

 

 

 —

 

 

4,740

Net finance costs

 

 

22,178

 

 

 —

 

 

 —

 

 

22,178

Total expenses

 

 

112,073

 

 

12,169

 

 

 —

 

 

124,242

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) from operations

 

$

20,924

 

$

961

 

$

(336)

 

$

21,549

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Leasing and 

    

 

 

    

 

 

 

 

For the three months ended June 30, 2016

 

Related Operations

 

Spare Parts Sales

 

Eliminations (1)

 

Total

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Lease rent revenue

 

$

29,181

 

$

 

$

 

$

29,181

Maintenance reserve revenue

 

 

15,514

 

 

                      —

 

 

 

 

15,514

Spare parts sales

 

 

900

 

 

2,773

 

 

 

 

3,673

Gain on sale of leased equipment

 

 

258

 

 

 

 

 

 

258

Other revenue

 

 

972

 

 

590

 

 

(570)

 

 

992

Total revenue

 

 

46,825

 

 

3,363

 

 

(570)

 

 

49,618

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

16,103

 

 

85

 

 

 —

 

 

16,188

Cost of spare parts and equipment sales

 

 

648

 

 

2,139

 

 

 —

 

 

2,787

Write-down of equipment

 

 

1,893

 

 

 —

 

 

 —

 

 

1,893

General and administrative

 

 

9,958

 

 

727

 

 

 —

 

 

10,685

Technical expense

 

 

1,803

 

 

 

 

 —

 

 

1,803

Net finance costs

 

 

10,414

 

 

120

 

 

 —

 

 

10,534

Total expenses

 

 

40,819

 

 

3,071

 

 

 —

 

 

43,890

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings from operations

 

$

6,006

 

$

292

 

$

(570)

 

$

5,728

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Leasing and 

    

 

 

    

 

 

 

 

For the six months ended June 30, 2016

 

Related Operations

 

Spare Parts Sales

 

Eliminations (1)

 

Total

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Lease rent revenue

 

$

57,457

 

$

 —

 

$

 —

 

$

57,457

Maintenance reserve revenue

 

 

31,333

 

 

 —

 

 

 —

 

 

31,333

Spare parts sales

 

 

900

 

 

5,405

 

 

 —

 

 

6,305

Gain on sale of leased equipment

 

 

3,250

 

 

 —

 

 

 —

 

 

3,250

Other revenue

 

 

1,905

 

 

948

 

 

(861)

 

 

1,992

Total revenue

 

 

94,845

 

 

6,353

 

 

(861)

 

 

100,337

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

32,440

 

 

167

 

 

 —

 

 

32,607

Cost of spare parts sales

 

 

648

 

 

4,071

 

 

 —

 

 

4,719

Write-down of equipment

 

 

3,929

 

 

 —

 

 

 —

 

 

3,929

General and administrative

 

 

20,938

 

 

1,499

 

 

 —

 

 

22,437

Technical expense

 

 

3,499

 

 

 —

 

 

 —

 

 

3,499

Net finance costs

 

 

20,327

 

 

215

 

 

 —

 

 

20,542

Total expenses

 

 

81,781

 

 

5,952

 

 

 —

 

 

87,733

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings from operations

 

$

13,064

 

$

401

 

$

(861)

 

$

12,604

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Represents revenue generated between our

       operating segments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets as of June 30, 2017

 

$

1,359,406

 

$

26,948

 

$

 —

 

$

1,386,354

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets as of December 31, 2016

 

$

1,307,460

 

$

30,427

 

$

 —

 

$

1,337,887

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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10.  Subsequent Event

 

West III Securitization

 

On July 31, 2017, the Company through, its wholly owned, special-purpose Delaware statutory trust, Willis Engine Structured Trust III (“WEST III”) issued $335.7 million of notes (the “Notes”).  The Notes consist of two series; Initial Series A Notes in the aggregate principal amount of $293.7 million bearing a 4.69% fixed rate coupon  and issued at a price of 99.91%  and Initial Series B Notes in the aggregate principal amount of $42.0 million bearing a 6.36% fixed rate coupon and issued at a price of 98.3%. 

 

The net proceeds from the Notes offering will be applied, in part, to pay fees and expenses related to the issuance and to pay the Company periodically over a 270-day delivery period in consideration for the aircraft engines acquired by WEST III from Willis.  The Company will primarily utilize net proceeds received as consideration for aircraft engine sales to repay certain amounts drawn under our revolving credit facility.  The Notes will be secured by, among other things, WEST III’s direct and indirect interests in a portfolio of 56 aircraft engines.

 

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Explanatory Note: Certain 2016 amounts include adjustments to prior periods see "Note 1. Summary of Significant Accounting Policies (c) Correction of Immaterial Errors - Consolidated Financial Statements" for further disclosure.

 

Overview

 

Our core business is acquiring and leasing commercial aircraft engines and related aircraft equipment pursuant to operating leases, and the selective sale of such engines, all of which we sometimes refer to as “equipment.”    In 2016, we purchased, through our wholly owned subsidiary Willis Asset Management Limited (“Willis Asset Management”), the business and assets of Total Engine Support Limited (“TES”). TES has been the engine management and consulting business of the TES Aviation Group.  In 2013, we launched Willis Aeronautical Services, Inc. (“Willis Aero”), a wholly-owned subsidiary, whose primary focus is the sale of aircraft engine parts and materials through the acquisition or consignment of aircraft and engines from third parties.

 

Critical Accounting Policies and Estimates

 

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies and Estimates included in our 2016 Form 10-K.

 

Results of Operations

 

Three months ended June 30, 2017 compared to the three months ended June 30, 2016:

 

Lease Rent Revenue. Lease rent revenue for the three months ended June 30, 2017 increased 7.4% to $31.3 million from the comparable period in 2016. This increase primarily reflects a higher average lease rate factor and increased net book value of leased equipment in the current period. The aggregate net book value of lease equipment at June 30, 2017 and 2016 was $1,160.5 million and $1,081.5 million, respectively, an increase of 7.3%. The average utilization for the three months ended June 30, 2017 and 2016 was 88% and 90%, respectively.  At June 30, 2017 and 2016, approximately 90% and 91%, respectively, of equipment held for lease by book value was on lease.

 

During the three months ended June 30, 2017, equipment and capitalized costs related to the lease portfolio had a gross addition of $86.2 million. During the three months ended June 30, 2016, equipment and capitalized costs related to the lease portfolio had a gross addition of $22.6 million.

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Maintenance Reserve Revenue. Our maintenance reserve revenue for the three months ended June 30, 2017 decreased 23.4% to $11.9 million from $15.5 million for the comparable period in 2016. $4.1 million of the decrease was due to lower maintenance reserve revenues as one engine came off lease generating $2.1 million of long term maintenance revenue compared to $6.2 million of long term maintenance revenue generated in the comparable prior period by three engines coming off long term lease. 

 

Spare Parts and Equipment Sales. Spare parts and equipment sales for the three months ended June 30, 2017 were $19.4 million, a $15.7 million increase as compared to $3.7 million for the three months ended June 30,  2016. Spare parts sales for the three months ended June 30, 2017 were $6.5 million compared to $2.8 million in the comparable period in 2016.  Equipment sales were $12.9 million for the three months ended June 30, 2017 reflecting the sale of three airframes as compared to $0.9 million for the three months ended June 30, 2016. 

 

Gain on Sale of Leased Equipment. During the three months ended June 30, 2017, we sold four engines and other related equipment generating a net gain of $3.5 million. During the three months ended June 30, 2016, we sold one engine and other related equipment generating a net gain of $0.3 million.

 

Other Revenue. Our other revenue consists of management fee income, lease administration fees, foreign operation subsidies and third party consignment commissions earned by Willis Aero.  Other revenue increased to $1.7 million from $1.0 million for the comparable period in 2016 due to an increase in fees earned related to engines managed on behalf of third parties as well as service fee revenue at our Willis Asset Management subsidiary. 

 

Depreciation and Amortization Expense. Depreciation and amortization expense decreased 1.1% to $16.0 million for the three months ended June 30, 2017 from $16.2 million in the comparable period in 2016, primarily due to changes in portfolio mix associated with our ongoing portfolio management efforts.  As of July 1, 2016, we adjusted the depreciation for certain older engine types. It is our policy to review estimates regularly to reflect the cost of equipment over the useful life of these engines.

 

Cost of Spare Parts and Equipment Sales. Cost of spare parts and equipment sales were $13.7 million and $2.8 million for the three months ended June 30, 2017 and 2016, respectively. Cost of equipment sales were $9.9 million and $0.6 million for the three months ended June 30, 2017 and 2016, respectively.   Cost of spare parts sales for the three months ended June 30, 2017 were $3.8 million compared to $2.1 million in the comparable period in 2016.   Gross margin on parts sales for the three months ended June 30, 2017 quarter was 41.4% compared to 22.9% for the comparable period in 2016 primarily due to a change in the mix of parts sold in 2017. Equipment cost were $9.9 million for the three months ended June 30, 2017 reflecting the sale of three airframes as compared to $0.4 million for the three months ended June 30, 2016 for sale of one airframe. 

 

Write-down of Equipment.   Write-down of equipment was $2.3 million and $1.9 million in the three months ended June 30, 2017 and 2016, respectively.  A write-down of $1.4 million was recorded during the three months ended June 30, 2017 for one engine due to be parted out to reflect expected future proceeds. We evaluated the equipment return condition, end of lease compensation, accumulated maintenance reserves and expected future proceeds from part out and sale to record our initial best estimate of impairment.   An additional asset write-down of $0.9 million was recorded in the three months ended June 30, 2017 based upon a comparison of the spare parts net book values with the revised net proceeds expected from part sales.  A write-down of equipment totaling $1.9 million was recorded in the three months ended June 30, 2016 due to the adjustment of the carrying value for an impaired engine within the portfolio to reflect estimated market value.

 

General and Administrative Expenses. General and administrative expenses increased 22.3% to $13.1 million for the three months ended June 30, 2017, from $10.7 million in the comparable period in 2016, due primarily to increased salary and payroll taxes of $0.8 million from increased headcount, primarily related to our TES acquisition, a higher contingency bonus accrual of $1.1 million resulting from improved operating profits and higher commission expense of $0.2 million.

 

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Technical Expense. Technical expenses consist of the cost of engine repairs, engine thrust rental fees, outsourced technical support services, engine storage and freight costs. These expenses increased 35.8% to $2.4 million for the three months ended June 30, 2017 compared to the year ago period due to increased engine maintenance expense $0.1 million due to higher engine shop visits, increased technical services expense $0.3 million and higher engine freight $0.3 million.

 

Net Finance Costs. Net finance costs increased 7.4% to $11.3 million for the three months ended June 30, 2017, from $10.5 million in the comparable period in 2016, due primarily to higher interest expense resulting from higher interest rates and higher average debt balances in the current quarter compared to the year ago period. The average notes payable balances for the three months ending June 30, 2017 and 2016, were $913.8 million and $884.6 million, respectively, an increase of 3.6%. As of June 30, 2017, $651.0 million of our debt is tied to one-month U.S. dollar LIBOR which increased from an average of 0.45% for the three months ended June 30, 2016 to an average of 1.09% for the three months ended June 30, 2017 (average of month-end rates). As of June 30, 2017 and 2016, one-month LIBOR was 1.22% and 0.47%, respectively.

 

To mitigate exposure to interest rate changes, we periodically enter into interest rate swap agreements. As of June 30, 2017, such swap agreements had a notional outstanding amount of $100.0 million, with a remaining term of 46 months. No interest rate swap agreements existed during the three months ended June 30, 2016. We recorded a $174,000 and nil expense to net finance costs during the three months ended June 30, 2017 and 2016, respectively, from derivative investments.

 

Income Tax Expense. Income tax expense for the three months ended June 30, 2017 and 2016 was $4.2 million and $2.4 million, respectively. The effective tax rates for the three months ended June 30, 2017 and 2016 were 41.0% and 41.8%, respectively. 

 

The Company records tax expense or benefit for unusual or infrequent items discretely in the period in which they occur. Our tax rate is subject to change based on changes in the mix of assets leased to domestic and foreign lessees, the proportions of revenue generated within and outside of California, the amount of executive compensation exceeding $1.0 million as defined in IRS code 162(m) and numerous other factors, including changes in tax law.

 

Six months ended June 30, 2017, compared to the six months ended June 30, 2016:

 

Lease Rent Revenue. Lease rent revenue for the six months ended June 30, 2017 increased 7.2% to $61.6 million from the comparable period in 2016. This increase primarily reflects a higher average lease rate factor and increased net book value of leased equipment in the current period. The aggregate net book value of lease equipment at June 30, 2017 and 2016 was $1,160.5 million and $1,081.5 million, respectively, an increase of 7.3%. The average utilization for the six months ended June 30, 2017 and 2016 remained consistent at 89%. At June 30, 2017 and 2016, approximately 90% and 91%, respectively, of equipment held for lease by book value was on lease.

 

During the six months ended June 30, 2016, equipment and capitalized costs related to the lease portfolio had a gross addition of $129.2 million. During the six months ended June 30, 2016, equipment and capitalized costs related to the lease portfolio had a gross addition of $64.3 million.

 

Maintenance Reserve Revenue. Our maintenance reserve revenue for the six months ended June 30, 2017 increased 39.9% to $43.8 million from $31.3 million for the comparable period in 2016. The increase was due to higher maintenance reserve revenues related to the termination of long term leases and higher maintenance reserves billed reflecting increased usage of engines under lease resulting from increased net book value of lease equipment in the six months ended June 30, 2017 than in the year ago period. 

 

Spare Parts and Equipment Sales. Spare parts and equipment sales for the six months ended June 30, 2017 were $32.0 million compared to $6.3 million in the comparable period in 2016.  Equipment sales increased to $4.5 million in the six months ended June 30, 2017 from $3.3 million from the comparable 2016 period. The increase

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was due to the sale of an airframe and an engine. Spare parts sales for the six months ended June 30, 2017 were $12.7 million compared to $5.4 million in the comparable period in 2016. 

 

Gain on Sale of Leased Equipment. During the six months ended June 30, 2017, we sold seven engines and other related equipment generating a net gain of $4.5 million. During the six months ended June 30, 2016, we sold one airframe, seven engines and other related equipment generating a net gain of $3.3 million.

 

Other Revenue. Our other revenue consists primarily of management fee income, lease administration fees and third party consignment commissions earned by Willis Aero.  Other revenue increased to $3.9 million for the six months ended June 30, 2017 from $2.0 million for the comparable period in 2016 due to an increase in fees earned related to engines managed on behalf of third parties as well as service fee revenue at our Willis Asset Management subsidiary.

 

Depreciation and Amortization Expense. Depreciation and amortization expense remained consistent at $32.6 million for the six months ended June 30, 2017 and for the comparable period in 2016, changes in leased asset portfolio mix offset the effect of portfolio growth.    As of July 1, 2016, we adjusted the depreciation for certain older engine types. It is our policy to review estimates regularly to reflect the cost of equipment over the useful life of these engines. The 2016 change in depreciation estimate did not have a material impact on depreciation in the current period.

 

Cost of Spare Parts and Equipment Sales. Cost of spare parts and equipment sales increased $18.4 million to $23.1 million for the six months ended June 30, 2017 compared to $4.7 million for the comparable period in 2016. Cost of equipment sales were $14.6 million for the six months ended June 30, 2016 and $0.6 million for the comparable period in 2016. Cost of spare parts sales for the six months ended June 30, 2017 were $8.5 million compared to $4.1 million in the comparable period in 2016.   Gross margin on parts sales for the six months ended June 30, 2017 quarter was 32.9% compared to 24.7% for the comparable period in 2016 primarily due to a change in the mix of parts sold in 2017.

 

Write-down of Equipment.   Write-down of equipment was $15.3 million and $3.9 million in the six months ended June 30, 2017 and 2016, respectively.  A write-down of equipment totaling $4.4 million was recorded in the six months ended June 30, 2017 due to a management decision to consign four engines for part-out and sale, in which the asset’s net book value exceeded the estimated proceeds.  A further writedown of $9.0 million was recorded due to the adjustment of the carrying value for four engines within the portfolio to reflect estimated market value.  Write-downs of equipment totaling $2.0 million was recorded in the six months ended June 30, 2016 due to a management decision to consign one engine for part-out and sale, in which the asset’s net book value exceeded the estimated proceeds.  A further writedown of $1.9 million was recorded due to the adjustment of the carrying value for an impaired engine within the portfolio to reflect estimated market value.

 

General and Administrative Expenses. General and administrative expenses increased 17.1% to $26.3 million for the six months ended June 30, 2017, from $22.4 million in the comparable period in 2016, due primarily to higher contingency bonus ($1.4 million) resulting from improved operating profits, higher salary expense ($1.1 million) due to increased head count primarily related to our TES acquisition, and higher bad debt expense ($0.5 million). The increases were offset by a decrease in legal expense ($0.7 million).

 

Technical Expense. Technical expenses consist of the cost of engine repairs, engine thrust rental fees, outsourced technical support services, engine storage and freight costs. These expenses increased 35.5% to $4.7 million for the six months ended June 30, 2017 compared to the year ago period due to higher engine technical services expense ($0.5 million) due to increased engine returns, higher engine thrust rental fees ($0.2 million), increased engine maintenance cost ($0.4 million), and increased engine freight ($0.2 million).

 

Net Finance Costs. Net finance costs increased 8.0% to $22.2 million for the six months ended June 30, 2017, from $20.5 million in the comparable period in 2016, due primarily to higher average interest rate and average debt level during the six months ended June 30, 2017 compared to the year ago period. The average notes payable balances for the six months ending June 30, 2017 and 2016, were $902.8 million and $882.4 million, respectively,

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an increase of 2.4%. As of June 30, 2017, $651.0  million of our debt is tied to one-month U.S. dollar LIBOR which increased from an average of 0.44% for the six months ended June 30, 2016 to an average of 0.97% for the six months ended June 30, 2017 (average of month-end rates). As of June 30, 2017 and 2016, one-month LIBOR was 1.22% and 0.47%, respectively.

 

Income Tax Expense. Income tax expense for the six months ended June 30, 2017 and 2016 was $10.4 million and $5.5 million, respectively. The effective tax rates for the six months ended June 30, 2017 and 2016 were 42.4% and 42.6%, respectively. 

 

Liquidity and Capital Resources

 

We finance our growth through borrowings secured by our equipment lease portfolio. Cash of approximately $93.0 million and $55.0 million in the six months periods ended June 30, 2017 and 2016, respectively, was derived from this activity. In these same time periods, $72.8 million and $42.5 million, respectively, was used to pay down related debt.

 

At June 30, 2017, $7.6 million in cash and cash equivalents and restricted cash were held in foreign subsidiaries. We do not intend to repatriate the funds held in foreign subsidiaries to the United States. In the event that we decide to repatriate these funds to the United States, we would be required to accrue and pay taxes upon the repatriation.

 

Our primary use of funds is for the purchase of equipment for lease. Purchases of equipment (including capitalized costs) totaled $112.2 million and $61.5 million for the six-month periods ended June 30, 2017 and 2016, respectively.

 

Cash flows from operations are driven significantly by payments made under our lease agreements, which comprise lease rent revenue, security deposits and maintenance reserves, and are offset by net finance costs and general and administrative costs. Note that cash received from maintenance reserve arrangements for some of our engines on lease are restricted per our WEST II debt agreement. Cash from WEST II engine maintenance reserve payments, that can be used to fund future maintenance events, are held in the restricted cash account equal to the maintenance obligations projected for the subsequent nine months, and are subject to a minimum balance of $9.0 million. The lease revenue stream, in the short-term, is at fixed rates while a portion of our debt is at variable rates. If interest rates increase, it is unlikely we could increase lease rates in the short term and this would cause a reduction in our earnings and operating cash flows. Lease rent revenue and maintenance reserves are also affected by the amount of equipment off-lease. Approximately 90% and 93%, by book value, of our assets were on lease at June 30, 2017 and December 31, 2016, respectively. The average utilization rate was 89% for the six month periods ended June 30, 2017 and 2016.  If there is any increase in off-lease rates or deterioration in lease rates that are not offset by reductions in interest rates, there will be a negative impact on earnings and cash flows from operations.

 

At June 30, 2017, notes payable consists of loans totaling $934.0 million payable over periods of approximately 0.5 years to 7.1 years with interest rates varying between approximately 2.6% and 5.5%. Substantially all of our assets are pledged to secure our obligations to creditors. For further information on our debt instruments, see the "Notes Payable" Note 5 in Part I, Item 1 of this Form 10-Q.

 

Virtually all of the above debt is subject to our ongoing compliance with the covenants of each financing, including debt/equity ratios, minimum tangible net worth and minimum interest coverage ratios, and other eligibility criteria including customer and geographic concentration restrictions. In addition, under these facilities, we can typically borrow up to 85% of an engine’s net book value and 65% of spare part’s net book value. Therefore we must have other available funds for the balance of the purchase price of any new equipment to be purchased or we will not be permitted to draw on these facilities. The facilities are also cross-defaulted against other facilities. If we do not comply with the covenants or eligibility requirements, we may not be permitted to borrow additional funds and accelerated payments may become necessary. Additionally, much of the above debt is secured by engines to the extent that engines are sold, repayment of that portion of the debt could be required.

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At June 30, 2017, we are in compliance with the covenants specified in the revolving credit facility, including the Interest Coverage Ratio requirement of at least 2.25 to 1.00, and the Total Leverage Ratio requirement to remain below 4.25 to 1.00. 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 June 30, 2017, we are in compliance with the covenants specified in the WEST II indenture and servicing agreement.

 

Approximately $33.6 million of our debt is repayable during the next 12 months. Such repayments consist of scheduled installments due under term loans. Repayments are funded by the use of unrestricted cash reserves and from cash flows from ongoing operations. The table below summarizes our contractual commitments at June 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payment due by period (in thousands)

 

 

 

 

 

Less than

 

 

 

 

 

 

 

More than

 

    

Total

    

1 Year

    

1-3 Years

    

3-5 Years

    

5 Years

Long-term debt obligations

 

$

933,951

 

$

33,587

 

$

46,487

 

$

686,511

 

$

167,366

Interest payments under long-term debt obligations

 

 

170,105

 

 

42,870

 

 

81,505

 

 

43,025

 

 

2,705

Operating lease obligations

 

 

2,271

 

 

1,422

 

 

849

 

 

 -

 

 

 -

Purchase obligations

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Total

 

$

1,106,327

 

$

77,879

 

$

128,841

 

$

729,536

 

$

170,071

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We have estimated the interest payments due under long-term debt by applying the interest rates applicable at June 30, 2017 to the remaining debt, adjusted for the estimated debt repayments identified in the table above. Actual interest payments made will vary due to changes in leverage and in the rates for one-month LIBOR.

 

We believe our equity base, internally generated funds and existing debt facilities are sufficient to maintain our level of operations for the next twelve months. A decline in the level of internally generated funds, resulting from an increase in the amount of equipment off-lease or a decrease in availability under our existing debt facilities, would impair our ability to sustain our level of operations. We continually discuss additions to our capital base with our commercial and investment banks. If we are not able to access additional capital, our ability to grow our asset base consistent with historical trends will be impaired and our future growth limited to that which can be funded from internally generated capital.

 

Cash flow provided from operating activities was $79.3 million and $46.8 million in the six month periods ended June 30, 2017 and 2016, respectively.  The increase was primarily due to the increase in net income, adjusted for non-cash expenses, and change in accounts payable.

 

Cash flow provided by (used in) investing activities was $(72.9)    million and $(15.5) million in the six month periods ended June 30, 2017 and 2016, respectively.  The increase in cash used was primarily due to the an increase in cash used for purchase of equipment held for operating lease and a decrease in proceeds from the sale of equipment.

 

Cash flow provided by (used in) financing activities was $15.8 and $(14.2) million in the six month periods ended June 30, 2017 and 2016, respectively.  The increase was primarily due to the increase in principal payments on notes payable partially offset by a decrease in the repurchase of common stock.

 

On July 31, 2017, the Company through, its wholly owned, special-purpose Delaware statutory trust, Willis Engine Structured Trust III (“WEST III”) issued $335.7 million of notes (the “Notes”).  The Notes consist of two series; Initial Series A Notes in the aggregate principal amount of $293.7 million bearing a 4.69% fixed rate coupon and issued at a price of 99.91%  and Initial Series B Notes in the aggregate principal amount of $42.0 million bearing a 6.36% fixed rate coupon and issued at a price of 98.3%. 

 

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The net proceeds from the Notes offering will be applied, in part, to pay fees and expenses related to the issuance and to pay the Company periodically over a 270-day delivery period in consideration for the aircraft engines acquired by WEST III from Willis.  The Company will primarily utilize net proceeds received as consideration for aircraft engine sales to repay certain amounts drawn under our revolving credit facility.  The Notes will be secured by, among other things, WEST III’s direct and indirect interests in a portfolio of 56 aircraft engines.

 

Recent Accounting Pronouncements

 

The most recent adopted accounting pronouncements are described in Note 1(g) to our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q.

 

Management of Interest Rate Exposure

 

At June 30, 2017, $651.0 million of our borrowings were on a variable rate basis at various interest rates tied to one-month LIBOR. Our equipment leases are generally structured at fixed rental rates for specified terms. Increases in interest rates could narrow or result in a negative spread, between the rental revenue we realize under our leases and the interest rate that we pay under our borrowings. We periodically enter into interest rate derivative instruments to mitigate our exposure to interest rate risk and not to speculate or trade in these derivative products.  During 2016, we entered into one interest rate swap agreement which has a  notional outstanding amount of $100.0 million, with remaining term of 46 months. The fair value of the swap at June 30, 2017 was $64,000 representing a net asset for us.

 

Item 3.Quantitative and Qualitative Disclosures about Market Risk

 

Our primary market risk exposure is that of interest rate risk. A change in LIBOR rates would affect our cost of borrowing. Increases in interest rates, which may cause us to raise the implicit rates charged to our customers, could result in a reduction in demand for our leases. Alternatively, we may price our leases based on market rates so as to keep the fleet on-lease and suffer a decrease in our operating margin due to interest costs that we are unable to pass on to our customers. As of June 30, 2017,  $651.0 million of our outstanding debt is variable rate debt. We estimate that for every one percent increase or decrease in interest rates on our variable rate debt, our annual interest expense would increase or decrease $5.5 million.

 

We hedge a portion of our borrowings from time to time, effectively fixing the rate of these borrowings. This hedging activity helps protect us against reduced margins on longer term fixed rate leases. Based on the implied forward rates for one-month LIBOR, we expect interest expense will be increased by approximately $0.6 million for the year ending December 31, 2017 as a result of our hedges. Such hedging activities may limit our ability to participate in the benefits of any decrease in interest rates, but may also protect us from increases in interest rates. Furthermore, since lease rates tend to vary with interest rate levels, it is possible that we 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.

 

We are also exposed to currency devaluation risk. Most of our leases require payment in U.S. dollars. During the six months ended June 30, 2017, 86% of our lease rent revenues came from non-United States domiciled lessees.  If these lessees’ currency devalues against the U.S. dollar, the lessees could potentially encounter difficulty in making their lease payments.

 

No customer accounted for more than 10% of total lease rent revenue during the six months ended June 30, 2017 and 2016.

 

Item 4.Controls and Procedures

 

(a) Evaluation of disclosure controls and procedures. Based on management’s evaluation (with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO)), as of the end of the period

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covered by this report, our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Inherent Limitations on Controls

 

Management, including the CEO and CFO, does not expect that our disclosure controls and procedures will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.

 

(b) Changes in internal control over financial reporting. There has been no change in our internal control over financial reporting during our fiscal quarter ended June 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II — OTHER INFORMATION

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

 

(a) None.

 

(b) None.

 

(c) Issuer Purchases of Equity Securities. On September 27, 2012, the Company announced that its Board of Directors has authorized a plan to repurchase up to $100.0 million of its common stock over the next 5 years. The Board of Directors reaffirmed the repurchase plan on April 21, 2015.  This plan extends the previous plan authorized on December 8, 2009, and increases the number of shares authorized for repurchase up to $100.0 million.

 

Common stock repurchases, under our authorized plan, in the three months ended June 30, 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Approximate

 

 

 

 

 

 

 

 

Total Number of

 

Dollar Value of

 

 

 

 

 

Average

 

Shares Purchased

 

Shares that May

 

 

Total Number of

 

Price

 

as Part of Publicly

 

Yet be Purchased

Period

    

Shares Purchased

    

per Share

    

Announced Plans

    

Under the Plans

 

 

(in thousands, except per share data)

April 1, 2017 - April 30, 2017

 

 

78

 

$

22.39

 

 

78

 

$

30,246

May 1, 2017 - May 31, 2017

 

 

36

 

$

24.88

 

 

36

 

$

29,339

June 1, 2017 - June 30, 2017

 

 

 —

 

$

 —

 

 

 —

 

$

29,339

Total

 

 

114

 

$

23.18

 

 

114

 

$

29,339

 

 

ITEM 5.OTHER INFORMATION

 

The Company has considered the outcome of the stockholder voting results with respect to the advisory vote on the frequency of future advisory voting on executive compensation  in which every three years received the

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highest number of votes cast on the frequency proposal and the Company has determined to hold advisory votes on executive compensation every three years.

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EXHIBITS

 

 

 

 

Exhibit 
Number

 

Description

3.1

 

Certificate of Incorporation, dated March 12, 1998, as amended by the Certificate of Amendment of Certificate of Incorporation, dated May 6, 1998 (incorporated by reference to Exhibit 3.1 to our report on Form 10-K filed on March 31, 2009).

3.2

 

Bylaws, dated April 18, 2001 as amended by (1) Amendment to Bylaws, dated November 13, 2001, (2) Amendment to Bylaws, dated December 16, 2008, (3) Amendment to Bylaws, dated September 28, 2010, (4) Amendment to Bylaws, dated August 5, 2013 (incorporated by reference to Exhibit 3.1 to our report on Form 8-K filed on August 9, 2013), and (5) Amendment to Bylaws, dated October 7, 2016 (incorporated by reference to Exhibit 10.1 to our report on Form 8-K filed on October 18, 2016).

4.1

 

Rights Agreement dated as of September 24, 1999, by and between Willis Lease Finance Corporation and American Stock Transfer and Trust Company, as Rights Agent (incorporated by reference to Exhibit 4.1 to our report on Form 8-K filed on October 4, 1999).

4.2

 

Second Amendment to Rights Agreement dated as of December 15, 2005, by and between Willis Lease Finance Corporation and American Stock Transfer and Trust Company, as Rights Agent (incorporated by reference to Exhibit 4.5 to our report on Form 10-K filed on March 31, 2009).

4.3

 

Third Amendment to Rights Agreement dated as of September 30, 2008, by and between Willis Lease Finance Corporation and American Stock Transfer and Trust Company, as Rights Agent (incorporated by reference to Exhibit 4.6 to our report on Form 10-K filed on March 31, 2009).

4.4

 

Form of Certificate of Designations of the Registrant with respect to the Series I Junior Participating Preferred Stock (formerly known as “Series A Junior Participating Preferred Stock”) (incorporated by reference to Exhibit 4.7 to our report on Form 10-K filed on March 31, 2009).

4.5

 

Form of Amendment No. 1 to Certificate of Designations of the Registrant with respect to Series I Junior Participating Preferred Stock (incorporated by reference to Exhibit 4.8 to our report on Form 10-K filed on March 31, 2009).

10.1

 

Form of Indemnification Agreement entered into between the Registrant and its directors and officers (incorporated by reference to Exhibit 10.1 to our report on Form 8-K filed on October 1, 2010).

10.2

 

1996 Stock Option/Stock Issuance Plan, as amended and restated as of March 1, 2003 (incorporated by reference to Exhibit 99.1 to Form S-8 filed on September 26, 2003).

10.3

 

Amended and Restated 2007 Stock Incentive Plan (incorporated by reference to the Registrant’s Proxy Statement for 2015 Annual Meeting of Stockholders filed on April 28, 2015).

10.4

 

Amended and Restated Employment Agreement between the Registrant and Charles F. Willis IV dated as of December 1, 2008 (incorporated by reference to Exhibit 10.1 to our report on Form 8-K filed on December 22, 2008).

10.5

 

Employment Agreement between the Registrant and Scott B. Flaherty dated May 20, 2016 (incorporated by reference to Exhibit 10.1 to our report on Form 8-K filed on May 25, 2016).

10.6

 

Employment Agreement between the Registrant and Dean M. Poulakidas dated March 31, 2013 (incorporated by reference to Exhibit 10.23 to our report on Form 8-K filed on June 19, 2013).

10.7*

 

Indenture dated as of September 14, 2012 among Willis Engine Securitization Trust II, Deutsche Bank Trust Company Americas, as trustee, the Registrant and Crédit Agricole Corporate and Investment Bank (incorporated by reference to Exhibit 10.14 to our report on Form 10-Q filed on November 9, 2012).

10.8*

 

Security Trust Agreement dated as of September 14, 2012 by and among Willis Engine Securitization Trust II, Willis Engine Securitization (Ireland) Limited, the Engine Trusts listed on Schedule V thereto, each of the additional grantors referred to therein and from time to time made a party thereto and Deutsche Bank Trust Company Americas, as trustee (incorporated by reference to Exhibit 10.15 to our report on Form 10-Q filed on November 9, 2012).

10.9*

 

Note Purchase Agreement dated as of September 6, 2012 by and among Willis Engine Securitization Trust II, the Registrant, Credit Agricole Securities (USA) Inc. and Goldman, Sachs & Co. (incorporated by reference to Exhibit 10.16 to our report on Form 10-Q filed on November 9, 2012).

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10.10*

 

Servicing Agreement dated as of September 17, 2012 between Willis Engine Securitization Trust II, the Registrant and the entities listed on Appendix A thereto (incorporated by reference to Exhibit 10.17 to our report on Form 10-Q filed on November 9, 2012).

10.11*

 

Administrative Agency Agreement dated as of September 17, 2012 among Willis Engine Securitization Trust II, the Registrant, Deutsche Bank Trust Company Americas, as trustee, and the entities listed on Appendix A thereto (incorporated by reference to Exhibit 10.18 to our report on Form 10-Q filed on November 9, 2012).

10.12*

 

Third Amended and Restated Credit Agreement, dated as of April 20, 2016, among the Company, MUFG Union Bank, N.A. as administrative agent and security agent, and certain other lenders and financial institutions named therein (incorporated by reference to Exhibit 10.15 to our report on Form 10-Q filed on August 16, 2016).

10.13 

 

Employment Agreement between the Company and Brian R. Hole dated January 14, 2016 (incorporated by reference to Exhibit 10.1 to our report on Form 8-K filed on February 16, 2016).

10.14

 

Employment Agreement between the Company and Austin C. Willis dated February 9, 2016 (incorporated by reference to Exhibit 10.2 to our report on Form 8-K filed on February 16, 2016).

10.15

 

Trust Amendment No. 2 dated as of September 9, 2016 to Amended and Restated Trust Agreement of Willis Engine Securitization Trust II dated as of September 14, 2012 (incorporated by reference to Exhibit 10.1 to our report on Form 8-K filed on September 20, 2016).

10.16

 

General Supplement 2016-1 dated as of September 9, 2016 to Trust Indenture dated as of September 14, 2012 (incorporated by reference to Exhibit 10.2 to our report on Form 8-K filed on September 20, 2016).

10.17

 

Series A Preferred Stock Purchase Agreement dated as of October 11, 2016 (incorporated by reference to Exhibit 10.1 to our report on Form 8-K filed on October 18, 2016).

10.18

 

Amended and Restated Certificate of Designations, Preferences, and Relative Rights and Limitations of Series A Cumulative Redeemable Preferred Stock dated as of October 13, 2016 (incorporated by reference to Exhibit 10.2 to our report on Form 8-K filed on October 18, 2016).

10.19

 

Certificate Eliminating Series I Junior Participating Preferred Stock of Willis Lease Finance Corporation dated as of October 7, 2016 (incorporated by reference to Exhibit 10.3 to our report on Form 8-K filed on October 18, 2016).

11.1

 

Statement re Computation of Per Share Earnings.

14.1

 

Code of Ethics (incorporated by reference to Exhibit 14.1 to our report on Form 10-K filed on March 11, 2016).

31.1

 

Certification of Charles F. Willis, IV, pursuant to Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Certification of Scott B. Flaherty, pursuant to Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase

101.LAB

 

XBRL Taxonomy Extension Labels Linkbase

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase


*Confidential treatment has been requested for certain portions of this exhibit. These portions have been omitted and filed separately with the SEC.

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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: August 9, 2017

 

 

 

 

 

Willis Lease Finance Corporation

 

 

 

 

By:

/s/ Scott B. Flaherty

 

 

Scott B. Flaherty

 

 

Chief Financial Officer

 

 

(Principal Accounting Officer)

 

 

 

 

29