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WLFC > SEC Filings for WLFC > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for WILLIS LEASE FINANCE CORP

Form 10-Q for WILLIS LEASE FINANCE CORP


9-Nov-2012

Quarterly Report


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

Overview

Our core business is acquiring and leasing, primarily pursuant to operating leases, commercial aircraft engines and related aircraft equipment; and the selective purchase and sale of commercial aircraft engines (collectively "equipment").

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 2011 Form 10-K.

Results of Operations

Three months ended September 30, 2012, compared to the three months ended September 30, 2011:

Lease Rent Revenue. Lease rent revenue for the three months ended September 30, 2012 decreased 13% to $23.0 million from $26.5 million for the comparable period in 2011. This decrease primarily reflects lower portfolio utilization in the current period and a decrease in the average size of the lease portfolio, which translated into a lower amount of equipment on lease. The average net book value of lease equipment for the three months ended September 30, 2012 and 2011 was $973.3 million and $998.0 million, respectively, a decrease of 2.5%. The average utilization for the three months ended September 30, 2012 and 2011 was 82% and 86%, respectively. At September 30, 2012 and 2011, respectively, approximately 83% and 86% of equipment held for lease by book value was on-lease.

During the three months ended September 30, 2012, we added $25.0 million of equipment and capitalized costs to the lease portfolio. During the three months ended September 30, 2011, we added $21.3 million of equipment and capitalized costs to the lease portfolio.

Maintenance Reserve Revenue. Our maintenance reserve revenue for the three months ended September 30, 2012 increased 18.9% to $10.7 million from $9.0 million for the comparable period in 2011. The increase was due to higher maintenance reserve revenues recognized related to the termination of long term leases in the current period as well as higher revenues generated for engines on short term leases, for which usage was higher in the three months ended September 30, 2012 than in the year ago period.

Gain on Sale of Leased Equipment. During the three months ended September 30, 2012, we sold three engines, an airframe and other related equipment generating a net gain of $0.6 million. During the three months ended September 30, 2011, we sold seven engines and other related equipment generating a net gain of $3.6 million.

Other Income. Our other income generally consists of management fee income and lease administration fees. Other income increased to $3.3 million from $0.4 million for the comparable period in 2011 primarily due to the recording of a gain of $2.0 million related to the receipt of an engine in exchange for an engine that was damaged while under lease. Other income also increased in the current period due to an increase in the number of engines managed, an increase in engine purchase arrangement fees and the recording of a gain of $0.2 million related to the settlement of an insurance claim in the current period for a casualty loss on a leased engine.

Depreciation Expense. Depreciation expense increased 11.5% to $13.9 million for the three months ended September 30, 2012 from the comparable period in 2011, due to changes in estimates of useful lives and residual values on certain older engine types. As of July 1, 2012, we adjusted the depreciation for certain older engine types within the portfolio, with the result being an increase of $1.3 million for the three months ended September 30, 2012. The net effect of the change in depreciation estimate is a reduction in net income of $0.8 million or $0.09 in diluted earnings per share for the three months ended September 30, 2012 over what net income would have otherwise been had the change in depreciation estimate not been made.


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Write-down of Equipment. Write-down of equipment to its estimated fair value totaled $2.5 million and $2.3 million in the three months ended September 30, 2012 and 2011, respectively. A write-down of $1.2 million was recorded in the three months ended September 30, 2012 to adjust the carrying value of engine parts held on consignment for which market conditions for the sale of parts has changed. A further write-down of $1.3 million was recorded in the three months ended September 30, 2012 due to a management decision to consign three engines for part out and sale. A write-down of $2.3 million was recorded in the three months ended September 30, 2011 to adjust the carrying value of engine parts held on consignment for which market conditions for the sale of parts has changed.

General and Administrative Expenses. General and administrative expenses decreased 16.0% to $7.3 million for the three months ended September 30, 2012, from the comparable period in 2011, due primarily to a decrease in employee bonus related to the Company's financial results.

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 54.4% to $2.0 million for the three months ended September 30, 2012, from the comparable period in 2011 due mainly to increased engine maintenance costs due to higher repair activity ($0.2 million), increased technical service expenses ($0.2 million) and increased engine storage and freight expenses ($0.3 million).

Net Finance Costs. Net finance costs include interest expense, interest income and net loss on debt extinguishment and derivatives termination. Interest expense decreased 15.2% to $7.5 million for the three months ended September 30, 2012, from the comparable period in 2011, due primarily to a decrease in the notional value of swaps in place from September 30, 2011 to 2012, which were at a higher rate than the prevailing interest rates on our debt. Notes payable balance at September 30, 2012 and 2011, was $690.0 million and $684.1 million, respectively, an increase of 0.9%. As of September 30, 2012, $271.0 million of our debt is tied to one-month U.S. dollar LIBOR which increased from an average of 0.22% for the three months ended September 30, 2011 to an average of 0.23% for the three months ended September 30, 2012 (average of month-end rates). As of September 30, 2012 and 2011, one-month LIBOR was 0.21% and 0.24%, respectively.

To mitigate exposure to interest rate changes, we have entered into interest rate swap agreements. As of September 30, 2012, such swap agreements had notional outstanding amounts of $100.0 million with a remaining term of fourteen months and a fixed rate of 2.10%. As of September 30, 2011, such swap agreements had notional outstanding amounts of $375.0 million, remaining terms of between six and forty-three months and fixed rates of between 2.10% and 5.05%. In the three months ended September 30, 2012 and 2011, $1.8 million and $2.6 million was realized through the income statement as an increase in interest expense, respectively, as a result of these swaps.

We recorded a loss on extinguishment of debt and derivative instruments of $15.4 million in the three months ended September 30, 2012 as a result of the write-off of $5.3 million of unamortized debt issuance costs and unamortized note discount associated with the full repayment of WEST notes on September 17, 2012 and the termination of interest rate swaps totaling $10.1 million. Upon the closing of WEST II on September 17, 2012, at which time the WEST floating rate debt was fully repaid, six interest rate swaps with a notional value of $215.0 million that were assigned to the WEST debt were terminated. The effective portion of the loss on these cash flow hedges was $10.1 million and was reclassified out of accumulated other comprehensive income and recorded in earnings for the three months ended September 30, 2012.

Interest income for the three months ended September 30, 2012, decreased to $0.02 million from $0.04 million for the three months ended September 30, 2011, due to a decrease in deposit balances.

Income Tax Expense. Income tax (benefit) expense for the three months ended September 30, 2012 and 2011 was ($3.5) million and $3.8 million, respectively. The effective tax rate for the three months ended September 30, 2012 and 2011 was 32.6% and 62.4%, respectively. The Company records tax expense or benefit for unusual or infrequent items discretely in the period in which they occur. Our loss on debt extinguishment and derivatives termination resulted in a $5.3 million tax benefit in the current period, significantly reducing our effective tax rate in the third quarter. The Company experienced a higher effective tax rate during 2011 primarily as a result of the tax consequences of the transfer of engines to WMES, which required recognition of $1.3 million tax expense on the entire gain, while only 50% of the gain was recorded for book purposes given our ongoing ownership interest in WMES (see Note 4). 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.


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Nine months ended September 30, 2012, compared to the nine months ended September 30, 2011:

Lease Rent Revenue. Lease rent revenue for the nine months ended September 30, 2012 decreased 10.7% to $70.9 million from $79.4 million for the comparable period in 2011. This decrease primarily reflects lower portfolio utilization in the current period and a decrease in the average size of the lease portfolio, which translated into a lower amount of equipment on lease. The average net book value of lease equipment for the nine months ended September 30, 2012 and 2011 was $973.4 million and $1,005.8 million, respectively, a decrease of 3.2%. The average utilization for the nine months ended September 30, 2012 and 2011 was 82% and 86%, respectively. At September 30, 2012 and 2011, approximately 83% and 86%, respectively, of equipment held for lease by book value was on-lease.

During the nine months ended September 30, 2012, we added $49.4 million of equipment and capitalized costs to the lease portfolio. During the nine months ended September 30, 2011, we added $93.6 million of equipment and capitalized costs to the lease portfolio.

Maintenance Reserve Revenue. Our maintenance reserve revenue for the nine months ended September 30, 2012 increased 4.9% to $28.7 million from $27.3 million for the comparable period in 2011. The increase was due to higher maintenance reserve revenues generated for engines on short term leases, for which usage was higher in the nine months ended September 30, 2012 than in the year ago period, partially offset by a lower number of long term leases terminating in the current period.

Gain on Sale of Leased Equipment. During the nine months ended September 30, 2012, we sold twelve engines, one aircraft, one airframe and other related equipment generating a net gain of $4.6 million. During the nine months ended September 30, 2011, we sold eleven engines and other related equipment generating a net gain of $11.2 million.

Other Income. Our other income generally consists of management fee income and lease administration fees. Other income increased to $4.3 million from $1.0 million for the comparable period in 2011 primarily due to the receipt of an engine at its fair value which had been acquired from the lessee in the period in exchange for an engine that was damaged while under lease. Other income also increased in the current period due to an increase in the number of engines managed, an increase in engine purchases arrangement fees and the recording of a gain of $0.2 million related to the settlement of an insurance claim in the current period of a casualty loss on a leased engine.

Write-down of Equipment. Write-down of equipment to its estimated fair values totaled $2.8 million and $2.3 million in the nine months ended September 30, 2012 and 2011, respectively. A write-down of $0.3 million was recorded in the three months ended March 31, 2012 related to the sale of two engines in April 2012 for which the net book value exceeded the proceeds from sale. A write-down of $1.2 million was recorded in the three months ended September 30, 2012 to adjust the carrying value of engine parts held on consignment for which market conditions for the sale of parts has changed. A further write-down of $1.3 million was recorded in the three months ended September 30, 2012 due to a management decision to consign 3 engines for part out and sale in which the asset net book value exceeds the expected proceeds from consignment. A write-down of $2.3 million was recorded in the three months ended September 30, 2011 to adjust the carrying value of engine parts held on consignment for which market conditions for the sale of parts has changed.

General and Administrative Expenses. General and administrative expenses decreased 2.9% to $25.3 million for the nine months ended September 30, 2012, from the comparable period in 2011, due primarily to a decrease in employee bonus related to the Company's financial results.

Technical Expense. Technical expenses consist of the cost of engine repairs, engine thrust rental fees, outsourced technical support services, sublease rental expense, engine storage and freight costs. These expenses decreased 17.8% to $4.7 million for the nine months ended September 30, 2012, from the comparable period in 2011 due mainly to a decrease in engine maintenance costs due to lower repair activity ($0.8 million), lower engine thrust rental fees due to a decrease in the number of engines being operated at higher thrust levels under the CFM thrust rental program ($0.3 million) and decreased sub-lease rental expense resulting from the termination of a sublease rental program in September 2011 ($0.3 million). The decreases are partially offset by an increase in the current period in storage expenses ($0.4 million).


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Net Finance Costs. Net finance costs include interest expense, interest income and net loss on debt extinguishment and derivative termination. Interest expense decreased 16.0% to $22.6 million for the nine months ended September 30, 2012, from the comparable period in 2011, due primarily to a decrease in the notional value of swaps in place from 2011 to 2012 and a decrease in the average debt outstanding. The average Notes payable balance for the three months ended September 30, 2012 and 2011was $696.5 million and $722.6 million, respectively, representing a decrease of 3.6%. Notes payable balance at September 30, 2012 and 2011, was $690.0 million and $684.1 million, respectively, an increase of 0.9%. As of September 30, 2012, $271.0 million of our debt is tied to one-month U.S. dollar LIBOR which increased from an average of 0.22% for the nine months ended September 30, 2011 to an average of 0.24% for the nine months ended September 30, 2012 (average of month-end rates). At September 30, 2012 and 2011, one-month LIBOR was 0.21% and 0.24%, respectively.

To mitigate exposure to interest rate changes, we have entered into interest rate swap agreements. As of September 30, 2012, such swap agreements had notional outstanding amounts of $100.0 million with a remaining term of fourteen months and a fixed rate of 2.10%. As of September 30, 2011, such swap agreements had notional outstanding amounts of $375.0 million, remaining terms of between six and forty-three months and fixed rates of between 2.10% and 5.05%. In the nine months ended September 30, 2012 and 2011, $6.0 million and $8.8 million was realized through the income statement as an increase in interest expense, respectively, as a result of these swaps.

We recorded a loss on extinguishment of debt and derivative instruments of $15.4 million in the three months ended September 30, 2012 as a result of the write-off of $5.3 million of unamortized debt issuance costs and unamortized note discount associated with the full repayment of WEST notes on September 17, 2012 and the termination of interest rate swaps totaling $10.1 million. Upon the closing of WEST II on September 17, 2012, at which time the WEST floating rate debt was fully repaid, six interest rate swaps with a notional value of $215.0 million that were assigned to the WEST debt were terminated. The effective portion of the loss on these cash flow hedges was $10.1 million and was reclassified out of accumulated other comprehensive income and recorded in earnings for the three months ended September 30, 2012.

Interest income for the nine months ended September 30, 2012, decreased to $0.08 million from $0.1 million for the nine months ended September 30, 2011, due to a decrease in deposit balances.

Income Tax Expense. Income tax expense for the nine months ended September 30, 2012 and 2011 was $0.4 million and $9.3 million, respectively. The effective tax rate for the nine months ended September 30, 2012 and 2011 was 149.4% and 46.2%, respectively. The Company records tax expense or benefit for unusual or infrequent items discretely in the period in which they occur. Our loss on debt extinguishment and derivatives termination resulted in a $5.3 million tax benefit in the current period, significantly reducing our effective tax rate in the third quarter. The Company experienced a higher effective tax rate during 2011 primarily as a result of the tax consequences of the transfer of engines to WMES, which required recognition of $1.3 million tax expense on the entire gain, while only 50% of the gain was recorded for book purposes given our ongoing ownership interest in WMES (see Note 4). 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.

Recent Accounting Pronouncements

In November 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-11, "Balance Sheet Disclosures about Offsetting Assets and Liabilities" ("ASU 2011-11"). This ASU requires companies to provide information about trading financial instruments and related derivatives in expanded disclosures. This ASU is the result of a joint project conducted by the FASB and the IASB to enhance disclosures and provide converged disclosures about financial instruments and derivative instruments that are either offset on the statement of financial position or subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset on the statement of financial position. The guidance provided in ASU 2011-11 is effective for interim and annual period beginning on or after January 1, 2013 and should be applied retrospectively. We do not expect the adoption of this ASU to have a material impact on our Consolidated Financial Statements.

In December 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-12, "Comprehensive Income Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05" ("ASU 2011-12"). This ASU defers only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. The amendments are being made to allow the Board time to re-deliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. All other requirements in ASU 2011-05 are not affected by this ASU, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The guidance provided in ASU 2011-12 is effective for interim and annual period beginning on or after December 15, 2011 and should be applied retrospectively. The adoption of this ASU did not have a material impact on our Consolidated Financial Statements.


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Liquidity and Capital Resources

We finance our growth through borrowings secured by our equipment lease portfolio. Cash of approximately $537.7 million and $74.4 million, in the nine-month periods ended September 30, 2012 and 2011, respectively, was derived from this activity. In these same time periods, $567.9 million and $122.4 million, respectively, was used to pay down related debt. Cash flow from operating activities was $53.9 million and $56.3 million in the nine-month periods ended September 30, 2012 and 2011, respectively.

At September 30, 2012, $0.7 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 $46.9 million and $92.9 million for the nine-month periods ended September 30, 2012 and 2011, respectively.

Cash flows from operations are driven significantly by payments received under our lease agreements, which comprise lease revenue, security deposits and maintenance reserves, and are offset by general and administrative expenses and interest expense. 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 six 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 part 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. Revenue and maintenance reserves are also affected by the amount of equipment off lease. Approximately 83%, by book value, of our assets were on-lease at September 30, 2012 compared to 86% at September 30, 2011 and the average utilization rate for the nine months ended September 30, 2012 was 82% compared to 86% in the prior year. 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 September 30, 2012, Notes payable consists of loans totaling $690.0 million, payable over periods of fifteen months to ten years with interest rates varying between approximately 2.71% and 5.50% (excluding the effect of our interest rate derivative instruments).

Our significant debt instruments are discussed below:

At September 30, 2012, we had a $430.0 million revolving credit facility to finance the acquisition of aircraft engines for lease as well as for general working capital purposes. We closed on this facility on November 18, 2011 and the proceeds of the new facility, net of $3.3 million in debt issuance costs, was used to pay off the balance remaining from our prior revolving facility. On September 7, 2012, we increased this revolving credit facility to $430.0 million from $345.0 million. As of September 30, 2012, $159.0 million was available under this facility. The revolving credit facility ends in November 2016. Based on the Company's debt to equity ratio of 2.82 as calculated under the terms of the revolving credit facility at June 30, 2012, the interest rate on this facility is LIBOR plus 2.50% as of September 30, 2012. Under the revolving credit facility, all subsidiaries except WEST II jointly and severally guarantee payment and performance of the terms of the loan agreement. The guarantee would be triggered by a default under the agreement.

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


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

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

As a result of this transaction the Company recorded a loss on extinguishment of debt and derivative instruments of $15.4 million in the three months ended September 30, 2012 as a result of the write-off of $5.3 million of unamortized debt issuance costs and unamortized note discount associated with the full repayment of WEST notes on September 17, 2012 and the termination of interest rate swaps totaling $10.1 million.

At September 30, 2012, $390.0 million of WEST II term notes were outstanding. The assets of WEST II are not available to satisfy our obligations or any of our affiliates other than the obligations specific to WEST II. WEST II is consolidated for financial statement presentation purposes. WEST II's ability to make distributions and pay dividends to the Company is subject to the prior payments of its debt and other obligations and WEST II's maintenance of adequate reserves and capital. Under WEST II, cash is collected in a restricted account, which is used to service the debt and any remaining amounts, after debt service and defined expenses, are distributed to the Company. Additionally, a portion of maintenance reserve payments and all lease security deposits are accumulated in restricted accounts and are available to fund future maintenance events and to . . .

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