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WLFC > SEC Filings for WLFC > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for WILLIS LEASE FINANCE CORP

Form 10-K for WILLIS LEASE FINANCE CORP


17-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Forward-Looking Statements. This Annual Report on Form 10-K includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including statements regarding prospects or future results of operations or financial position, made in this Annual Report on Form 10-K are forward-looking. We use words such as anticipates, believes, expects, future, intends, and similar expressions to identify forward-looking statements. Forward-looking statements reflect management's current expectations and are inherently uncertain. Actual results could differ materially for a variety of reasons, including, among others: the effects on the airline industry and the global economy of events such as terrorist activity, changes in oil prices and other disruptions to the world markets; trends in the airline industry, including growth rates of markets and other economic factors; risks associated with owning and leasing jet engines and aircraft; our ability to successfully negotiate equipment purchases, sales and leases, to collect outstanding amounts due and to control costs and expenses; changes in interest rates and availability of capital, our ability to continue to meet the changing customer demands; regulatory changes affecting airline operations, aircraft maintenance, accounting standards and taxes; and the market value of engines and other assets in our portfolio. These risks and uncertainties, as well as other risks and uncertainties that could cause our actual results to differ significantly from management's expectations, are described in greater detail in Item 1A of Part I, "Risk Factors," which, along with the previous discussion, describes some, but not all, of the factors that could cause actual results to differ significantly from management's expectations.

General. Our core business is acquiring and leasing pursuant to operating leases, commercial aircraft engines and related aircraft equipment, and the selective sale of such engines, all of which we sometimes refer to as "equipment." As of December 31, 2013, all of our leases were operating leases. As of December 31, 2013, we had 82 lessees in 41 countries. Our portfolio is continually changing due to acquisitions and sales. As of December 31, 2013, our lease portfolio consisted of 202 engines and related equipment, 4 aircraft and 5 spare engine parts packages with an aggregate net book value of $1,033.0 million. As of December 31, 2013, we also managed 43 engines and related equipment on behalf of other parties.

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. WMES owns and leases 26 engines with a net book value of $241.7 million at December 31, 2013.

We actively manage our portfolio and structure our leases to maximize the residual values of our leased assets. Our leasing business focuses on popular Stage III commercial jet engines manufactured by CFMI, General Electric, Pratt & Whitney, Rolls Royce and International Aero Engines. These engines are the most widely used engines in the world, powering Airbus, Boeing, McDonnell Douglas, Bombardier and Embraer aircraft.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our 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 we believe 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.

We believe the following critical accounting policies, grouped by our activities, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Leasing Related Activities. Revenue from leasing of aircraft equipment is recognized as operating lease revenue on a straight-line basis over the terms of the applicable lease agreements. Where collection cannot be reasonably assured, for example, upon a lessee bankruptcy, we do not recognize revenue until cash is received. We also estimate and charge to income a provision for bad debts based on our experience in the business and with each specific customer and the level of past due accounts. The financial condition of our customers may deteriorate and result in actual losses exceeding the estimated allowances. In addition, any deterioration in the financial condition of our customers may adversely affect future lease revenues. As of December 31, 2013, all of our leases are accounted for as operating leases. Under an operating lease, we retain title to the leased equipment, thereby retaining the potential benefit and assuming the risk of the residual value of the leased equipment.


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We generally depreciate engines on a straight-line basis over 15 years to a 55% residual value. Spare parts packages are generally depreciated on a straight-line basis over 15 years to a 25% residual value. Aircraft are generally depreciated on a straight-line basis over 13-20 years to a 15%-17% residual value. Major overhauls paid for by us, which improve functionality or extend the original useful life, are capitalized and depreciated over the shorter of the estimated period to the next overhaul ("deferral method") or the remaining useful life of the equipment. We do not accrue for planned major maintenance. For equipment which is unlikely to be repaired at the end of its current expected life, and is likely to be disassembled upon lease termination, we depreciate the equipment over its estimated life to a residual value based on an estimate of the wholesale value of the parts after disassembly. Currently, 56 engines having a net book value of $127.8 million are depreciated using this policy.

It is our policy to review estimates regularly to accurately expense the cost of equipment over the useful life of the engines. On July 1, 2012 and again on July 1, 2013, we adjusted the depreciation for certain older engine types within the portfolio. The 2013 change in depreciation estimate resulted in a $3.9 million increase in depreciation in 2013 and on an annual basis will result in an increase in depreciation expense of $7.6 million per year assuming no change in our portfolio. The net effect of the 2013 change in depreciation estimate is a reduction in 2013 net income of $2.3 million or $0.28 in diluted earnings per share over what net income would have otherwise been had the change in depreciation estimate not been made. If useful lives or residual values are lower than those estimated by us, future write-downs may be recorded or a loss may be realized upon sale of the equipment.

Asset Valuation. Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable, and long-lived assets and certain identifiable intangibles to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. Impairment is identified by comparison of undiscounted forecasted cash flows, including estimated sales proceeds, over the life of the asset with the asset's book value. If the forecasted undiscounted cash flows are less than the book value, we write the asset down to its fair value. We determine fair value by reference to independent appraisals, quoted market prices (e.g., an offer to purchase) and other factors. If the undiscounted forecasted cash flows and fair value of our long-lived assets decrease in the future we may incur impairment charges.

Accounting for Maintenance Expenditures and Maintenance Reserves. Use fees received are recognized in revenue as maintenance reserve revenue if they are not reimbursable to the lessee. Use fees that are reimbursable are recorded as a maintenance reserve liability until they are reimbursed to the lessee or the lease terminates, at which time they are recognized in revenue as maintenance reserve revenue. Our expenditures for maintenance are expensed as incurred. Expenditures that meet the criteria for capitalization are recorded as an addition to equipment recorded on the balance sheet.

YEAR ENDED DECEMBER 31, 2013 COMPARED TO THE YEAR ENDED DECEMBER 31, 2012



Revenue is summarized as follows:



                                         Years Ended December 31,
                                         2013                2012
                                    Amount       %      Amount       %
                                          (dollars in thousands)
Lease rent revenue                 $ 101,737    64.2 % $  94,591    63.9 %
Maintenance reserve revenue           46,694    29.5 %    41,387    27.9 %
Gain on sale of leased equipment       5,675     3.6 %     5,499     3.7 %
Other revenue                          4,306     2.7 %     6,613     4.5 %
Total revenue                      $ 158,412   100.0 % $ 148,090   100.0 %

Lease Rent Revenue. Our lease rent revenue for the year ended December 31, 2013, increased by 7.6% over the comparable period in 2012. This increase primarily reflects an increase in the average size of the lease portfolio and higher average portfolio utilization in the current period, which translated into a higher amount of equipment on lease. The aggregate of net book value of equipment held for lease at December 31, 2013 and 2012, was $1,033.0 million and $961.5 million, respectively, an increase of 7.4%. Portfolio utilization is defined as the net book value of on-lease assets as a percentage of the net book value of total lease assets. At each of December 31, 2013 and 2012, approximately 86% of equipment by net book value was on-lease. The average utilization for the year ended December 31, 2013 was 84% compared to 83% in the prior year. During the year ended December 31, 2013, 40 engines were added to our lease portfolio at a total cost of $172.2 million (including capitalized costs). During the year ended December 31, 2012, one aircraft and 7 engines were added to our lease portfolio at a total cost of $67.4 million (including capitalized costs).

Maintenance Reserve Revenue. Our maintenance reserve revenue for the year ended December 31, 2013 increased 12.8% to $46.7 million from $41.4 million for the comparable period in 2012. This increase was primarily due to higher maintenance reserve revenues recognized related to the termination of long term leases in 2013 compared to 2012.


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Gain on Sale of Leased Equipment. During the year ended December 31, 2013, we sold 24 engines, 3 aircraft and various engine-related equipment from the lease portfolio for a net gain of $5.7 million. During the year ended December 31, 2012, we sold 14 engines, 1 aircraft and various engine-related equipment from the lease portfolio for a net gain of $5.5 million.

Other Revenue. Our other revenue consists primarily of management fee income and lease administration fees, and decreased $2.3 million from the prior year. The decrease was primarily due to the recording of a gain of $2.0 million in 2012 related to the receipt of an engine in exchange for an engine that was damaged while under lease.

Depreciation and Amortization Expense. Depreciation and amortization expense increased $6.1 million or 11.6% to $58.7 million for the year ended December 31, 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. On July 1, 2012 and again on July 1, 2013, we adjusted the depreciation for certain older engine types within the portfolio. It is our policy to review estimates regularly to accurately expense the cost of equipment over the useful life of the engines. The 2013 change in depreciation estimate resulted in a $3.9 million increase in depreciation for 2013. The net effect of the 2013 change in depreciation estimate is a reduction in 2013 net income of $2.3 million or $0.28 in diluted earnings per share 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 their estimated fair values totaled $6.5 million for the year ended December 31, 2013, an increase of $0.6 million from the $5.9 million recorded in the comparable period in 2012. A write-down of $3.7 million was recorded in the year ended December 31, 2013 due to a management decision to consign four 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 year ended December 31, 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 $4.7 million was recorded in the year ended December 31, 2012 due to a management decision to sell 2 engines and consign 5 engines for part out and sale. A further write-down of $1.2 million was recorded for the year ended December 31, 2012 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 2.0% to $33.9 million for the year ended December 31, 2013, from the comparable period in 2012 due primarily to decreases in third party servicer fees ($0.9 million), bad debt expense ($0.8 million), marketing representative fees ($0.3 million) and corporate aircraft expenses ($0.1 million), which was partially offset by increases in accounting and legal fees ($0.7 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 84.3% to $12.9 million for the year ended December 31, 2013, from the comparable period in 2012 due primarily to increases in engine maintenance costs due to higher engine repair activity ($5.5 million), as well as increases in 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 ($0.2 million).

Net Finance Costs. Net finance costs include interest expense, interest income and loss/(gain) on debt extinguishment and derivatives termination. Interest expense increased 22.0% to $38.7 million for the year ended December 31, 2013, from the comparable period in 2012, primarily to an increase in the average debt outstanding and an increase in the cost of WEST II debt. As of December 31, 2013, $392.0 million of our debt is tied to one-month U.S. dollar LIBOR which was 0.19% and 0.23% for the years ended December 31, 2013 and 2012 (average of month-end rates), respectively. At December 31, 2013 and 2012, one-month LIBOR was 0.17% and 0.21%, respectively. To mitigate exposure to interest rate changes, we periodically enter into interest rate swap agreements. The last of our interest rate swap agreements matured in November 2013. In 2013 and 2012, $1.5 million and $6.4 million were realized through the income statement as an increase in interest expense, respectively, as a result of the swap agreements.

Interest income for the year ended December 31, 2013 decreased to $0 from $0.08 million during the year ago period due to a decrease in deposit balances and a drop in the rate of interest earned on deposit balances.

Income Taxes. Income tax expense (benefit) for the year ended December 31, 2013, decreased to ($4.3 million) from $1.2 million for the comparable period in 2012. The effective rate for the year ended December 31, 2013 differs from the U.S. federal statutory rate primarily due to an income tax benefit of $8.7 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 overall effective tax rate for the year ended December 31, 2013 was 38.9 % (excluding the ETI benefit) compared to 43.0% for the prior year. 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


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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.

YEAR ENDED DECEMBER 31, 2012 COMPARED TO THE YEAR ENDED DECEMBER 31, 2011



Revenue is summarized as follows:



                                         Years Ended December 31,
                                         2012                2011
                                    Amount       %      Amount       %
                                          (dollars in thousands)
Lease rent revenue                 $  94,591    63.9 % $ 104,663    66.8 %
Maintenance reserve revenue           41,387    27.9 %    39,161    25.0 %
Gain on sale of leased equipment       5,499     3.7 %    11,110     7.1 %
Other revenue                          6,613     4.5 %     1,719     1.1 %
Total revenue                      $ 148,090   100.0 % $ 156,653   100.0 %

Lease Rent Revenue. Our lease rent revenue for the year ended December 31, 2012, decreased by 9.6% over 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 aggregate of net book value of equipment held for lease at December 31, 2012 and 2011, was $961.5 million and $981.5 million, respectively, a decrease of 2.0%. Portfolio utilization is defined as the net book value of on-lease assets as a percentage of the net book value of total lease assets. At December 31, 2012, and 2011, respectively, approximately 86% and 82% of equipment by net book value was on-lease. The average utilization for the year ended December 31, 2012 was 83% compared to 86% in the prior year. During the year ended December 31, 2012, one aircraft and 7 engines were added to our lease portfolio at a total cost of $67.4 million (including capitalized costs). During the year ended December 31, 2011, 10 aircraft and 30 engines were added to our lease portfolio at a total cost of $135.4 million (including capitalized costs).

Maintenance Reserve Revenue. Our maintenance reserve revenue for the year ended December 31, 2012 increased 5.7% to $41.4 million from $39.2 million for the comparable period in 2011. This increase was primarily due to higher maintenance reserve revenues generated for engines on short term leases, for which usage was higher in 2012 than in the year ago period.

Gain on Sale of Leased Equipment. During the year ended December 31, 2012, we sold 14 engines, 1 aircraft and various engine-related equipment from the lease portfolio for a net gain of $5.5 million. During the year ended December 31, 2011, we sold 12 engines and various engine-related equipment from the lease portfolio for a net gain of $11.1 million. The 2011 gain on sales included $3.6 million which represents 50% of the total $7.2 million gain related to the sale by the Company of seven engines to WMES in 2011, as described in footnote 3 to our consolidated financial statements.

Other Revenue. Our other revenue consists primarily of management fee income and lease administration fees, and increased $4.9 million from the prior year. The increase was 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 revenue also increased in the current period due to an increase in the number of engines managed, an increase in engine purchase arrangement fees, an increase in termination and other lessee settlements and the recording of a $0.2 million gain related to the settlement of an insurance claim of a casualty loss on a leased engine.

Depreciation and Amortization Expense. Depreciation and amortization expense increased $1.3 million or 2.6% to $52.6 million for the year ended December 31, 2012, from the comparable period in 2011 due to changes in estimates of useful lives and residual values on certain older engine types. On July 1, 2011 and again on July 1, 2012, we adjusted the depreciation for certain older engine types within the portfolio. It is our policy to review estimates regularly to reflect the cost of equipment over the useful life of these engines. The 2012 change in depreciation estimate resulted in a $2.0 million increase in depreciation for 2012. The net effect of the 2012 change in depreciation estimate is a reduction in 2012 net income of $1.0 million or $0.12 in diluted earnings per share 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 their estimated fair values totaled $5.9 million for the year ended December 31, 2012, an increase of $2.5 million from the $3.3 million recorded in the comparable period in 2011. A write-down of $1.2 million was recorded for the year ended December 31, 2012 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 $4.7 million was recorded in the year ended December 31, 2012 due to a management decision to sell 2 engines and consign 5 engines for part out and sale. A write-down of $2.3 million was recorded for the year ended December 31, 2011 to adjust the carrying values


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of engine parts held on consignment for which market conditions for the sale of parts has changed. Write-downs on held for use equipment to their estimated fair values totaled $1.0 million for the year ended December 31, 2011, due to the adjustment of carrying values for certain impaired engines within the portfolio to reflect estimated market values.

General and Administrative Expenses. General and administrative expenses decreased 3.2% to $34.6 million for the year ended December 31, 2012, from the comparable period in 2011 due to a decrease in employee bonus related to the Company's financial results ($1.5 million), decreased legal and consulting expense (0.7 million) and decreased selling expenses ($0.3 million), which was partially offset by increases in taxes, fees and licenses ($0.5 million), bad debt expense ($0.4 million), employee benefits ($0.2 million) and system conversion expenses ($0.2 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 decreased 16.5% to $7.0 million for the year ended December 31, 2012, from the comparable period in 2011 due mainly to a decrease in engine maintenance costs due to lower repair activity ($1.3 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 ($0.4 million) and decreased sub-lease rental expense resulting from the termination of a sublease rental program in September 2011 ($0.3 million). The decreases were partially offset by an increase in storage expenses ($0.7 million).

Net Finance Costs. Net finance costs include interest expense, interest income and net (gain)/loss on debt extinguishment and derivatives termination. Interest expense decreased 9.8% to $31.7 million for the year ended December 31, 2012, from the comparable period in 2011, due to a decrease in the average debt outstanding and a decrease in the average notional value of interest rate swaps held throughout the period which were at a higher rate than the prevailing interest rates on our debt. As of December 31, 2012, $282.0 million of our debt is tied to one-month U.S. dollar LIBOR which was 0.23% for each of the years ended December 31, 2012 and 2011 (average of month-end rates). At December 31, 2012 and 2011, one-month LIBOR was 0.21% and 0.30%, respectively. To mitigate exposure to interest rate changes, we have entered into interest rate swap agreements. As of December 31, 2012, such swap agreements had notional outstanding amounts of $100.0 million, with a remaining term of eleven months and a fixed rate of 2.10%. In 2012 and 2011, $6.4 million and $11.3 million were realized through the income statement as an increase in interest expense, respectively.

We recorded a loss on extinguishment of debt and derivative instruments of $15.5 million for the year ended December 31, 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 $10.2 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 year ended December 31, 2012.

Interest income for the year ended December 31, 2012 and 2011, decreased by 52.1% to $0.08 million compared to the year ago period due to a decrease in deposit balances.

Income Taxes. Income taxes for the year ended December 31, 2012, decreased to $1.2 million from $9.4 million for the comparable period in 2011 reflecting decreased pre-tax income. The overall effective tax rate for the year ended December 31, 2012 was 43.0% compared to 39.1% for the prior year. 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 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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