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WLFC > SEC Filings for WLFC > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for WILLIS LEASE FINANCE CORP


8-Nov-2013

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 2012 Form 10-K/A.

Results of Operations

Three months ended September 30, 2013, compared to the three months ended September 30, 2012:

Lease Rent Revenue. Lease rent revenue for the three months ended September 30, 2013 increased 12.0% to $25.8 million from $23.0 million for the comparable period in 2012. This increase primarily reflects an increase in the size of the lease portfolio, which translated into a higher amount of equipment on lease. The aggregate of net book value of lease equipment at September 30, 2013 and 2012 was $1,015.6 million and $976.6 million, respectively, an increase of 4.0%. The average utilization for the three months ended September 30, 2013 and 2012 was 84% and 82%, respectively. At September 30, 2013 and 2012, respectively, approximately 85% and 83% of equipment held for lease by book value was on-lease.


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During the three months ended September 30, 2013, we added $39.0 million of equipment and capitalized costs to the lease portfolio. During the three months ended September 30, 2012, we added $25.0 million of equipment and capitalized costs to the lease portfolio.

Maintenance Reserve Revenue. Our maintenance reserve revenue for the three months ended September 30, 2013 decreased 16.5% to $8.9 million from $10.7 million for the comparable period in 2012. The decrease was due to lower maintenance reserve revenues recognized related to the termination of long term leases in the three months ended September 30, 2013 than in the year ago period.

Gain on Sale of Leased Equipment. During the three months ended September 30, 2013, we sold eight engines, three aircraft and other related equipment generating a net gain of $2.0 million. Included in the sales activity for the current period is the sale of 3 aircraft and 4 engines to Hawaii Island Air. Prior to the sale, 2 aircraft and 4 engines were leased to Hawaii Island Air under a finance lease. The third aircraft was leased to Hawaii Island Air under an operating lease. Net proceeds of $4.9 million were received for the assets, which had an aggregate net book value of $3.4 million. The $4.9 million proceeds were included in revenue as follows: Gain on Sale $0.8 million (net of the asset's $3.4 million net book value), Maintenance Reserve Revenue $0.4 million and Other Revenue $0.3 million. In addition, as a result of the sale of assets to Hawaii Island Air, Lease Rent Revenue of $0.4 million was recorded in the current period that was previously deferred. 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.

Other Revenue. Our other revenue generally consists of management fee income and lease administration fees. Other revenue decreased to $1.3 million from $3.3 million for the comparable period in 2012 due to the recording in the year ago quarter 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.

Depreciation Expense. Depreciation expense increased 13.5% to $15.8 million for the three months ended September 30, 2013 from $13.9 million in the comparable period in 2012, due to growth in the lease portfolio and changes in estimates of useful lives and residual values on certain older engine types. As of July 1, 2013, we adjusted the depreciation for certain older engine types in our lease portfolio. It is our policy to review estimates regularly to reflect the cost of equipment over the useful life of these engines. The 2013 change in depreciation estimate resulted in a $2.0 million increase in depreciation for the three months ended September 30, 2013. The net effect of the 2013 change in depreciation estimate is a reduction in net income of $1.3 million or $0.15 in diluted earnings per share for the three months ended September 30, 2013 over what net income would have otherwise been had the change in depreciation estimate not been made.

Write-down of Equipment. Write-down of equipment to its estimated fair value totaled $4.3 million and $2.5 million in the three months ended September 30, 2013 and 2012, respectively. A write-down of $2.6 million was recorded in the three months ended September 30, 2013 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 $1.7 million was recorded in the three months ended September 30, 2013 due to a management decision to consign two engines for part out and 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 three engines for part out and sale.

General and Administrative Expenses. General and administrative expenses decreased 6.9% to $6.8 million for the three months ended September 30, 2013, from $7.3 million in the comparable period in 2012, 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 to $4.5 million for the three months ended September 30, 2013, from $2.0 million in the comparable period in 2012 due primarily to a $2.8 million increase in engine maintenance costs related to higher repair activity in the current period.

Net Finance Costs. Net finance costs include interest expense and interest income. Interest expense increased 31.6% to $9.9 million for the three months ended September 30, 2013, from $7.5 million in the comparable period in 2012, due primarily to an increase in the average debt outstanding and an increase in the cost of WEST II debt. Notes payable balance at September 30, 2013 and 2012, was $744.3 million and $690.0 million, respectively, an increase of 7.9%. As of September 30, 2013, $343.5 million of our debt is tied to one-month U.S. dollar LIBOR which decreased from an average of 0.23% for the three months ended September 30, 2012 to an average of 0.18% for the three months ended September 30, 2013 (average of month-end rates). As of September 30, 2013 and 2012, one-month LIBOR was 0.18% and 0.21%, respectively.


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To mitigate exposure to interest rate changes, we have entered into interest rate swap agreements. As of September 30, 2013, such swap agreements had notional outstanding amounts of $100.0 million with a remaining term of two months and a fixed rate of 2.10%. 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%. In the three months ended September 30, 2013 and 2012, $0.4 million and $1.8 million was realized on the statement of income as an increase in interest expense, respectively, as a result of these swaps.

Interest income for the three months ended September 30, 2013, decreased to $0 from $0.02 million for the three months ended September 30, 2012, due to a decrease in deposit balances and a drop in the rate of interest earned on deposit balances.

Income Tax Expense. Income tax expense (benefit) for the three months ended September 30, 2013 and 2012 was ($1.4 million) and ($3.5 million), respectively. The effective tax rate for the three months ended September 30, 2013 and 2012 was 38.3% and 32.6%, 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 recorded in the three months ended September 30, 2012 resulted in a $5.3 million tax benefit, significantly reducing the effective tax rate in the period. 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.

Nine months ended September 30, 2013, compared to the nine months ended September 30, 2012:

Lease Rent Revenue. Lease rent revenue for the nine months ended September 30, 2013 increased 5.8% to $75.0 million from $70.9 million for the comparable period in 2012. This increase primarily reflects an increase in the size of the lease portfolio, which translated into a higher amount of equipment on lease. The aggregate net book value of lease equipment at September 30, 2013 and 2012 was $1,015.6 million and $976.6 million, respectively, an increase of 4.0%. The average utilization for the nine month periods ended September 30, 2013 and 2012 was 83% and 82%, respectively. At September 30, 2013 and 2012, approximately 85% and 83%, respectively, of equipment held for lease by book value was on-lease.

During the nine months ended September 30, 2013, we added $131.2 million of equipment and capitalized costs to the lease portfolio. During the nine months ended September 30, 2012, we added $49.4 million of equipment and capitalized costs to the lease portfolio.

Maintenance Reserve Revenue. Our maintenance reserve revenue for the nine months ended September 30, 2013 increased 4.3% to $29.9 million from $28.7 million for the comparable period in 2012, primarily as a result of higher maintenance reserve revenues recognized related to the termination of long term leases in the current period compared to the year ago period.

Gain on Sale of Leased Equipment. During the nine months ended September 30, 2013, we sold sixteen engines, three aircraft and other related equipment generating a net gain of $3.6 million. 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.

Other Revenue. Our other revenue consists primarily of management fee income and lease administration fees. Other revenue decreased to $2.7 million from $4.3 million for the comparable period in 2012 primarily due to the recording in the year ago quarter 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. This was partially offset by an increase in fees earned related to engines managed on behalf of third parties, which increased in number from the year ago period.

Depreciation Expense. Depreciation expense increased 12.0% to $43.6 million for the nine months ended September 30, 2013 from the comparable period in 2012, due to growth in the lease portfolio and changes in estimates of useful lives and residual values on certain older engine types.

Write-down of Equipment. Write-down of equipment to its estimated fair value totaled $6.3 million and $2.8 million in the nine months ended September 30, 2013 and 2012, respectively. A write-down of $3.5 million was recorded in the nine months ended September 30, 2013 due to a management decision to consign three engines for part out and sale, in which the assets net book value exceeds the estimated proceeds from part-out. A further write-down of $2.8 million was recorded in the nine months ended September 30, 2013 to adjust the carrying value of engine parts held on consignment for which market conditions for the sale of parts has changed. A write-down of $0.3 million was recorded in the nine months ended September 30, 2012 related to the sale of two engines for which the net book value exceeded the proceeds from sale. A write-down of $1.3 million was recorded in the nine months ended September 30, 2012 due to a management decision to consign three engines for part out and sale in which the asset net book value exceeds the expected proceeds from consignment. A further write-down of $1.2 million was recorded in the nine 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.


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General and Administrative Expenses. General and administrative expenses decreased 4.2% to $24.3 million for the nine months ended September 30, 2013, from the comparable period in 2012, due mainly to decreases in third party servicer fees ($0.6 million), consulting fees ($0.3 million), marketing representative fees ($0.3 million) and corporate aircraft expenses ($0.2 million), which was partially offset by increases in accounting and legal fees ($0.5 million).

Technical Expense. Technical expenses consist of the cost of engine repairs, engine thrust rental fees, outsourced technical support services, sublease engine rental expense, engine storage and freight costs. These expenses increased by $5.7 million to $10.4 million for the nine months ended September 30, 2013, from $4.7 million in the comparable period in 2012 due to increases in engine maintenance costs due to higher engine repair activity ($5.0 million), third party technical service fees ($0.3 million) and engine thrust rental fees due to an increase in the number of engines being operated at higher thrust levels under the CFM thrust rental program ($0.3 million).

Net Finance Costs. Net finance costs include interest expense and interest income. Interest expense increased 28.3% to $29.0 million for the nine months ended September 30, 2013, from the comparable period in 2012, due primarily to an increase in the average debt outstanding and an increase in the cost of WEST II debt. Notes payable balance at September 30, 2013 and 2012, was $744.3 million and $690.0 million, respectively, an increase of 7.9%. As of September 30, 2013, $343.5 million of our debt is tied to one-month U.S. dollar LIBOR which decreased from an average of 0.24% for the nine months ended September 30, 2012 to an average of 0.19% for the nine months ended September 30, 2013 (average of month-end rates). At September 30, 2013 and 2012, one-month LIBOR was 0.18% and 0.21%, respectively.

To mitigate exposure to interest rate changes, we have entered into interest rate swap agreements. As of September 30, 2013, such swap agreements had notional outstanding amounts of $100.0 million with a remaining term of two months and a fixed rate of 2.10%. 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%. In the nine months ended September 30, 2013 and 2012, $1.1 million and $6.0 million was realized through the income statement as an increase in interest expense, respectively, as a result of these swaps.

Interest income for the nine months ended September 30, 2013, decreased to $0 million from $0.08 million for the nine months ended September 30, 2012, due to a decrease in deposit balances and a drop in the rate of interest earned on deposit balances.

Income Tax Expense. Income tax expense (benefit) for the nine months ended September 30, 2013 and 2012 was ($8.2 million) and $0.4 million, respectively. The effective tax rate for the nine months ended September 30, 2013 and 2012 was 43.6% and 149.4%, respectively. The effective rate for the nine months ended September 30, 2013 differs from the U.S. federal statutory rate primarily due to an income tax benefit of $8.6 million related to an extraterritorial income ("ETI") adjustment recorded in the period for certain of our engines. We recognized this income tax benefit in the current period resulting from adjustments made to the tax basis of certain of our engines due to a decision in a recent court case on behalf of another company in which our circumstances are similar. The effective tax rate for the nine months ended September 30, 2012 differs from the U.S. federal statutory rate primarily due to our loss on debt extinguishment and derivatives termination resulted in a $5.3 million tax benefit in the period, significantly reducing our effective tax rate in the third quarter a year ago. 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 February 2013, the FASB issued Accounting Standards Update ("ASU") 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." ASU 2013-02 require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this ASU did not have a material impact on our Consolidated Financial Statements.


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In July 2013, the FASB issued Accounting Standards Update ("ASU") 2013-11, "Income Taxes - Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" which is part of Accounting Standards Codification ("ASC") 740: Income Taxes. The new guidance requires an entity to present an unrecognized tax benefit and an NOL carryforward, a similar tax loss, or a tax credit carryforward on a net basis as part of a deferred tax asset, unless the unrecognized tax benefit is not available to reduce the deferred tax asset component or would not be utilized for that purpose, then a liability would be recognized. We are currently evaluating the impact of the January 1, 2014 adoption of this guidance on our financial statements.

Liquidity and Capital Resources

We finance our growth through borrowings secured by our equipment lease portfolio. Cash of approximately $72.0 million and $537.7 million, in the nine-month periods ended September 30, 2013 and 2012, respectively, was derived from this activity. In these same time periods, $56.2 million and $567.9 million, respectively, was used to pay down related debt. Cash flow from operating activities was $59.1 million and $53.9 million in the nine-month periods ended September 30, 2013 and 2012, respectively.

At September 30, 2013, $1.3 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 $93.9 million and $46.9 million for the nine-month periods ended September 30, 2013 and 2012, respectively.

On February 27, 2013, we entered into a transaction to purchase and lease back a total of 19 aircraft engines with SAS Group subsidiary Scandinavian Airlines ("SAS") for $119.5 million. We purchased 11 of the engines for $63.0 million and our joint venture, Willis Mitsui & Company Engine Support Limited ("WMES") purchased the remaining 8 engines for $54.5 million. We funded our portion of this transaction with available funds from our revolving credit facility. As part of this transaction, we made a $5.5 million capital contribution to WMES to support its purchase of the 8 SAS engines.

Cash flows from operations are driven significantly by payments received under our lease agreements, which comprise lease rent 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 rent 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. Lease rent revenue and maintenance reserves are also affected by the amount of equipment off lease. Approximately 85%, by book value, of our assets were on-lease at September 30, 2013 compared to 83% at September 30, 2012. The average utilization rate was 83% for the nine month period ended September 30, 2013 and 82% for the nine month period ended September 30, 2012. 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, 2013, Notes Payable consists of loans totaling $744.3 million, payable over periods of approximately four months to nine years with interest rates varying between approximately 3.2% and 5.5% (excluding the effect of our interest rate derivative instruments).

Our significant debt instruments are discussed below:

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


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

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

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

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

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

The assets of WOLF are not available to satisfy our obligations or any of our affiliates other than the obligations specific to WOLF. WOLF's ability to make distributions to the Company is subject to the prior payments of all of its debt and other obligations. Under WOLF, cash related to parts sales and leasing of . . .

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