Air Lease Corporation - 10-Q quarterly report FY2013 Q2

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2013

OR

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

For the transition period from                   to                  

Commission file number 001-35121

AIR LEASE CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (310) 553-0555

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

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

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

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

At August 8, 2013, there were 99,924,388 shares of Air Lease Corporation’s Class A Common Stock outstanding and 1,829,339 shares of Air Lease Corporation’s Class B Non-Voting Common Stock outstanding.

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NOTE ABOUT FORWARD-LOOKING STATEMENTS

Statements in this quarterly report on Form 10-Q that are not historical facts may constitute “forward-looking statements,” including any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believes,” “can,” “could,” “may,” “predicts,” “potential,” “should,” “will,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “intends” and similar words or phrases. These statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties that could cause actual results to differ materially from those expressed in such statements, including as a result of the following factors, among others:

·                                          our inability to make acquisitions of, or lease, aircraft on favorable terms;

·                                          our inability to obtain additional financing on favorable terms, if required, to complete the acquisition of sufficient aircraft as currently contemplated or to fund the operations and growth of our business;

·                                          our inability to obtain refinancing prior to the time our debt matures;

·                                          impaired financial condition and liquidity of our lessees;

·                                          deterioration of economic conditions in the commercial aviation industry generally;

·                                          increased maintenance, operating or other expenses or changes in the timing thereof;

·                                          changes in the regulatory environment;

·                                          our inability to effectively deploy the net proceeds from our capital raising activities;

·                                          potential natural disasters and terrorist attacks and the amount of our insurance coverage, if any, relating thereto; and

·                                          the factors discussed under “Part I — Item 1A. Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2012 and other SEC filings.

All forward-looking statements are necessarily only estimates of future results, and there can be no assurance that actual results will not differ materially from expectations. You are therefore cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

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Air Lease Corporation and Subsidiaries

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(In thousands, except share amounts)

See accompanying notes

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Air Lease Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes

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Air Lease Corporation and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.         Company Background and Overview

Air Lease Corporation (the “Company”, “ALC”, “we”, “our” or “us”) is incorporated in the State of Delaware and licensed to operate in the State of California. The Company is principally engaged in the leasing of commercial aircraft to airlines throughout the world. We supplement our leasing revenues by providing fleet management and remarketing services to third parties. We typically provide many of the same services that we perform for our fleet, including leasing, releasing, lease management and sales services for which we charge a fee, with the objective of assisting our clients to maximize lease or sale revenues. In addition to our leasing activities and management services, and depending on market conditions, we sell aircraft from our fleet to other leasing companies, financial services companies and airlines.

Note 2.         Basis of Preparation

The Company consolidates financial statements of all entities in which we have a controlling financial interest, including the accounts of any Variable Interest Entity in which we have a controlling financial interest and for which we are determined to be the primary beneficiary. All material intercompany balances are eliminated in consolidation. The accompanying Consolidated Financial Statements have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.

The accompanying unaudited consolidated financial statements include all adjustments, including only normal, recurring adjustments, necessary to present fairly the Company’s financial position, results of operations and cash flows at June 30, 2013, and for all periods presented. The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the operating results expected for the year ending December 31, 2013. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2012.

Note 3.         Debt Financing

The Company’s consolidated debt as of June 30, 2013 and December 31, 2012 are summarized below (in thousands):

At June 30, 2013, we were in compliance in all material respects with the covenants in our debt agreements, including our financial covenants concerning debt-to-equity, tangible net equity, unencumbered assets and interest coverage ratios.

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The Company’s secured obligations as of June 30, 2013 and December 31, 2012 are summarized below (in thousands, except number of aircraft which are reflected in units):

Senior Unsecured Notes

On June 26, 2013, the Company concluded its offer to exchange up to $151.6 million aggregate principal amount of new notes for any and all of its outstanding 7.375% Senior Unsecured Notes due January 30, 2019, pursuant to a Senior Notes Indenture, dated as of March 16, 2012, as supplemented by a Supplemental Indenture, dated as of June 26, 2013.  The Company issued $132.0 million aggregate principal amount of its 5.625% Senior Notes due 2017 in exchange for $125.4 million aggregate principal amount of the old notes.  Our 5.625% Senior Notes due 2017 will bear additional interest of 0.50% per annum during any period from and after March 16, 2013 during which a publicly available rating on the notes is not maintained by at least one rating agency as described in the related indenture.

On February 5, 2013, the Company issued $400.0 million in aggregate principal amount of senior unsecured notes due 2020 pursuant to the Company’s effective shelf registration statement previously filed with the SEC. The notes are senior unsecured obligations of the Company and bear interest at a rate of 4.75% per annum. The notes will bear additional interest of 0.50% per annum during any period from and after February 5, 2014 during which a publicly available rating on the notes is not maintained by at least one rating agency as described in the related indenture.

Unsecured Revolving Credit Facilities

On May 7, 2013, the Company entered into an amendment and restatement of its Syndicated Unsecured Revolving Credit Facility. We have increased the aggregate principal amount by $607.0 million to $1.7 billion, extended the availability period from 3 years to 4 years to May 2017, and reduced the pricing from LIBOR plus a margin of 1.75% with no LIBOR floor and an undrawn fee of 0.375% to LIBOR plus 1.45% with no LIBOR floor and a 0.30% facility fee.

The total amount outstanding under our unsecured revolving credit facilities was $950.0 million and $420.0 million as of June 30, 2013 and December 31, 2012, respectively.

Unsecured Term Financings

During the second quarter of 2013, the Company entered into four additional unsecured term facilities aggregating $120.5 million with terms ranging from two to five years and with three of them bearing interest at fixed rates of 3.00% to 3.10% per annum and the fourth bearing interest at a floating rate of LIBOR plus a margin of 1.45%.  The outstanding balance on our unsecured term facilities as of June 30, 2013 and December 31, 2012 was $285.4 million and $248.9 million, respectively.

Warehouse Facilities

On June 21, 2013, a wholly-owned subsidiary of the Company, entered into an amendment and restatement of its “2010 Warehouse Facility”. The 2010 Warehouse Facility, as amended, provides the Company with financing of up to $1.0 billion, modified from the previous facility size of $1.25 billion. The Company is able to draw on the 2010 Warehouse Facility, as amended, during an availability period that was extended from June 2013 to June 2015 with a subsequent four year term out option. The interest rate on the 2010 Warehouse Facility, as amended, was reduced from LIBOR plus 2.50% to LIBOR plus 2.25% on drawn balances and from 0.75% to 0.50% per annum on undrawn balances.

As of June 30, 2013, the Company had borrowed $842.1 million under our Warehouse Facilities and pledged 32 aircraft as collateral with a net book value of $1.3 billion. As of December 31, 2012, the Company had borrowed $1.1 billion under the Warehouse Facilities and pledged 38 aircraft as collateral with a net book value of $1.6 billion. The Company had pledged cash collateral and lessee deposits of $70.5 million and $104.3 million at June 30, 2013 and December 31, 2012, respectively.

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Maturities

Maturities of debt outstanding as of June 30, 2013 are as follows (in thousands):

(1)         As of June 30, 2013, the Company had $664.3 million of debt outstanding under the 2010 Warehouse Facility, as amended, for which the availability period expires in June 2015. The outstanding drawn balance at the end of the availability period may be converted at the Company’s option to an amortizing, four-year term loan and has been presented as such in the maturity schedule above.

(2)         As of June 30, 2013, the Company had $950.0 million of debt outstanding under our unsecured revolving credit facilities. The outstanding drawn balances may be rolled until the maturity date of each respective facility and have been presented as such in the maturity schedule above.

Note 4.         Commitments and Contingencies

Aircraft Acquisition

As of June 30, 2013 we had commitments to acquire a total of 346 new aircraft for delivery as follows:

(1)         As of June 30, 2013, five of the Airbus A350-1000 aircraft were subject to reconfirmation.

(2)         As of June 30, 2013, 20 of the Boeing 737-8 MAX aircraft were subject to reconfirmation.

(3)         As of June 30, 2013, 33 of the Boeing 787-9/10 aircraft were subject to a non-binding memorandum of understanding.

Commitments for the acquisition of these aircraft and other equipment at an estimated aggregate purchase price (including adjustments for inflation) of approximately $28.4 billion at June 30, 2013 are as follows (in thousands):

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We have made non-refundable deposits on the aircraft for which we have commitments to purchase of $861.4 million and $564.7 million as of June 30, 2013 and December 31, 2012, respectively, which are subject to manufacturer performance commitments. If we are unable to satisfy our purchase commitments, we may forfeit our deposits. Further, we would be subject to breach of contract claims by our lessees and manufacturers.

Note 5.        Net Earnings Per Share

Basic net earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock; however, potential common equivalent shares are excluded if the effect of including these shares would be anti-dilutive. The Company’s two classes of common stock, Class A and Class B Non-Voting, have equal rights to dividends and income, and therefore, basic and diluted earnings per share are the same for each class of common stock.

Diluted net earnings per share takes into account the potential conversion of stock options, restricted stock units, and warrants using the treasury stock method and convertible notes using the if-converted method.  For the three and six months ended June 30, 2013 and 2012, the Company excluded 3,357,658 and 3,358,574 shares related to stock options which were potentially dilutive securities from the computation of diluted earnings per share because including these shares would be anti-dilutive.  In addition, the Company excluded 1,574,271 and 2,116,157 shares related to restricted stock units for which the performance metric had yet to be achieved as of June 30, 2013 and 2012, respectively.

The following table sets forth the reconciliation of basic and diluted net income per share (in thousands, except share amounts):

Note 6.         Fair Value Measurements

Assets and Liabilities Measured at Fair Value on a Recurring and Non-recurring Basis

The Company had no assets or liabilities which are measured at fair value on a recurring or non-recurring basis as of June 30, 2013 or December 31, 2012.

Financial Instruments Not Measured at Fair Value

The fair value of debt financing is estimated based on the quoted market prices for the same or similar issues, or on the current rates offered to the Company for debt of the same remaining maturities, which would be categorized as a Level 2 measurement in the fair value hierarchy. The estimated fair value of debt financing as of June 30, 2013 was $5,305.5 million compared to a book value of $5,226.3 million. The estimated fair value of debt financing as of December 31, 2012 was $4,517.6 million compared to a book value of $4,384.7 million.

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The following financial instruments are not measured at fair value on the Company’s consolidated balance sheet at June 30, 2013, but require disclosure of their fair values: cash and cash equivalents and restricted cash. The estimated fair value of such instruments at June 30, 2013 approximates their carrying value as reported on the consolidated balance sheet.  The fair value of all these instruments would be categorized as Level 1 of the fair value hierarchy.

Note 7.         Stock-based Compensation

In accordance with the Amended and Restated Air Lease Corporation 2010 Equity Incentive Plan (“Plan”), the number of stock options (“Stock Options”) and restricted stock units (“RSUs”) authorized under the Plan is approximately 8,193,088 as of June 30, 2013. Options are generally granted for a term of 10 years and generally vest over a three year period. There are two kinds of RSUs: those that vest based on the attainment of book-value goals and those that vest based on the attainment of Total Shareholder Return (“TSR”) goals. The book-value RSUs generally vest ratably over three to four years, if the performance condition has been met. Book-value RSUs for which the performance metric has not been met are forfeited.  The TSR RSUs vest at the end of a three year period.  The number of TSR RSUs that will ultimately vest is based upon the percentile ranking of the Company’s TSR among a peer group. The number of shares that will ultimately vest will range from 0% to 200% of the RSUs initially granted depending on the extent to which the TSR metric is achieved.

The Company recorded $7.3 million and $9.2 million of stock-based compensation expense for the three months ended June 30, 2013 and 2012, respectively. Stock-based compensation expense for the six months ended June 30, 2013 and 2012 totaled $14.1 million and $17.4 million, respectively.

Stock Options

A summary of stock option activity in accordance with the Company’s stock option plan as of June 30, 2013, and changes for the six month period then ended, follows:

(1)         The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing stock price of our Class A Common Stock as of the respective date.

Stock-based compensation expense related to employee stock options for the three months ended June 30, 2013 and 2012 totaled $2.4 million and $3.0 million, respectively.  Stock-based compensation expense related to employee stock options for the six months ended June 30, 2013 and 2012 totaled $5.4 million and $5.8 million, respectively.

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The following table summarizes additional information regarding exercisable and vested options at June 30, 2013:

Restricted Stock Units

Compensation cost for stock awards is measured at the grant date based on fair value and recognized over the vesting period.  The fair value of book-value RSUs is determined based on the closing market price of the Company’s Class A Common Stock on the date of grant, while the fair value of TSR RSUs is determined at the grant date using a Monte Carlo simulation model. Included in the Monte Carlo simulation model were certain assumptions regarding a number of highly complex and subjective variables, such as expected volatility, risk-free interest rate and expected dividends. To appropriately value the award, the risk-free interest rate is estimated for the time period from the valuation date until the vesting date and the historical volatilities were estimated based on a historical timeframe equal to the time from the valuation date until the end date of the performance period. Due to our limited stock history since the completion of our initial public offering on April 25, 2011, historical volatility was estimated based on all available information.

During the six months ended June 30, 2013, the Company granted 418,473 RSUs of which 201,058 are TSR RSUs. The following table summarizes the activities for our unvested RSUs for the six months ended June 30, 2013:

(1)  RSUs expected to vest reflect an estimated forfeiture rate.

The Company recorded $4.9 million and $6.2 million of stock-based compensation expense related to RSUs for the three months ended June 30, 2013 and 2012, respectively. The Company recorded $8.7 million and $11.6 million of stock-based compensation expense related to RSUs for the six months ended June 30, 2013 and 2012, respectively.

As of June 30, 2013, there was $20.0 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested RSUs granted to employees. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures and is expected to be recognized over a weighted-average remaining period of 1.6 years.

Note 8. Litigation

On April 24, 2012, the Company was named as a defendant in a complaint filed in Superior Court of the State of California for the County of Los Angeles by American International Group, Inc. and ILFC. The complaint also names as defendants certain executive officers and employees of the Company. The complaint was amended on November 30, 2012, January 18, 2013 and July 16, 2013. In connection with these amendments, American International Group withdrew as a plaintiff, leaving ILFC as the sole remaining plaintiff. Among other things, the suit alleges breach of fiduciary duty, misappropriation of trade secrets, the wrongful recruitment of ILFC employees, and the wrongful diversion of potential ILFC leasing opportunities. The complaint seeks an unspecified amount of damages and injunctive relief. The Company believes that it has meritorious defenses to these claims and intends to defend this matter vigorously. The amount or range of loss, if any, is not estimable at this time.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Overview

During the quarter ended June 30, 2013, the Company continued to execute on our primary business plan to acquire new, fuel-efficient commercial aircraft from aircraft manufacturers and to lease those aircraft to airlines around the world. We grew our fleet primarily through the acquisition of 10 aircraft from our order book supplemented by two purchases of used aircraft acquired in the secondary market. We continued to supplement our leasing revenues by providing management services to investors and/or owners of aircraft portfolios, for which we receive fee-based revenue. These services include leasing, re-leasing, and lease management and sales services, with the goal of helping our clients maximize lease and sale revenues. As of June 30, 2013, we managed four aircraft compared to three aircraft as of June 30, 2012. In addition to our leasing activities and management services, and depending on market conditions, we sell aircraft from our fleet to other leasing companies, financial services companies and airlines.

We ended the second quarter of 2013 with 174 aircraft comprised of 132 single-aisle narrowbody jet aircraft, 30 twin-aisle widebody jet aircraft and 12 turboprop aircraft, with a weighted average age of 3.5 years. We ended 2012 with 155 aircraft, comprised of 118 single-aisle narrowbody jet aircraft, 27 twin-aisle widebody jet aircraft and 10 turboprop aircraft, with a weighted average age of 3.5 years. Our fleet grew by 11.7% based on net book value to $7.0 billion as of June 30, 2013 compared to $6.3 billion as of December 31, 2012.

The acquisition and lease of additional aircraft resulted in a 33.1% increase in our rental revenue to $206.3 million for the quarter ended June 30, 2013 compared to $155.1 million for the quarter ended June 30, 2012. Rental revenue for the six months ended June 30, 2013 and 2012 increased 38.2%, totaling $396.4 million and $286.8 million, respectively. Due to the timing of aircraft deliveries the full impact on rental revenue for aircraft acquired during a given period will be reflected in subsequent periods.

We recorded earnings before income taxes of $66.3 million for the quarter ended June 30, 2013 compared to $43.9 million for the quarter ended June 30, 2012, an increase of $22.4 million or 51.1%. We recorded earnings before income taxes of $128.0 million for the six months ended June 30, 2013 compared to $85.5 million for the six months ended June 30, 2012, an increase of $42.5 million, or 49.7%.  Our profitability increased year over year as our pretax profit margin increased to 31.9% for the quarter ended June 30, 2013 compared to 27.7% for the quarter ended June 30, 2012. Diluted earnings per share increased to $0.41 for the quarter ended June 30, 2013 compared to $0.28 for the quarter ended June 30, 2012, an increase of 46.4%. Our pretax profit margin increased to 32.0% for the six months ended June 30, 2013 compared to 29.4% for the six months ended June 30, 2012. Diluted earnings per share increased to $0.79 for the six months ended June 30, 2013 compared to $0.54 for the six months ended June 30, 2012, an increase of 46.3%

Our financing plans remained focused on raising unsecured debt in the global bank and capital markets, reinvesting cash flow from operations and, to a limited extent, credit financing. During the quarter ended June 30, 2013 and through August 8, 2013, we entered into additional debt facilities aggregating $747.7 million, which included a $607.0 million addition to our Syndicated Unsecured Revolving Credit Facility and additional facilities aggregating $140.7 million.  The Company’s unsecured debt as as percentage of total debt increased to 68.8% as of June 30, 2013 from 60.2% as of December 31, 2012, while maintaining a composite cost of funds of 3.74%.

During the quarter ended June 30, 2013, the Company became a launch customer for Boeing’s 787-10 Dreamliner at the Le Bourget airshow in June, signing a non-binding memorandum of understanding for 30 787-10 aircraft and three additional 787-9 aircraft. Deliveries of these aircraft are scheduled to commence in 2019 and continue through 2023.

Our fleet

Portfolio metrics of our fleet as of June 30, 2013 and December 31, 2012 are as follows (dollars in thousands):

(1)               Weighted-average fleet age and remaining lease term calculated based on net book value.

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The following table sets forth the net book value and percentage of the net book value of our aircraft portfolio operating in the indicated regions as of June 30, 2013 and December 31, 2012 (dollars in thousands):

The following table sets forth the number of aircraft we leased by aircraft type as of June 30, 2013 and December 31, 2012:

As of June 30, 2013 we had commitments to acquire a total of 346 new aircraft for delivery as follows:

(1)         As of June 30, 2013, five of the Airbus A350-1000 aircraft were subject to reconfirmation.

(2)         As of June 30, 2013, 20 of the Boeing 737-8 MAX aircraft were subject to reconfirmation.

(3)         As of June 30, 2013, 33 of the Boeing 787-9/10 aircraft were subject to a non-binding memorandum of understanding.

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Debt

Our debt financing was comprised of the following at June 30, 2013 and December 31, 2012 (in thousands):

(1)                                 This rate does not include the effect of upfront fees, undrawn fees or issuance cost amortization

Senior unsecured notes

On June 26, 2013, the Company concluded its offer to exchange up to $151.6 million aggregate principal amount of new notes for any and all of its outstanding 7.375% Senior Unsecured Notes due January 30, 2019, pursuant to a Senior Notes Indenture, dated as of March 16, 2012, as supplemented by a Supplemental Indenture, dated as of June 26, 2013.  The Company issued $132.0 million aggregate principal amount of its 5.625% Senior Notes due 2017 in exchange for $125.4 million aggregate principal amount of the old notes.  The 5.625% Senior Notes due 2017 will bear additional interest of 0.50% per annum during any period from and after March 16, 2013 during which a publicly available rating on the notes is not maintained by at least one rating agency as described in the related indenture.

On February 5, 2013, the Company issued $400.0 million in aggregate principal amount of senior unsecured notes due 2020 pursuant to the Company’s effective shelf registration statement previously filed with the SEC. The notes are senior unsecured obligations of the Company and bear interest at a rate of 4.75% per annum. The notes will bear additional interest of 0.50% per annum during any period from and after February 5, 2014 during which a publicly available rating on the notes is not maintained by at least one rating agency as described in the related indenture.

Unsecured revolving credit facilities

On May 7, 2013, the Company entered into an amendment and restatement of its Syndicated Unsecured Revolving Credit Facility. We have increased the aggregate principal amount by $607.0 million to $1.7 billion, extended the availability period from 3 years to 4 years to May 2017, and reduced the pricing from LIBOR plus a margin of 1.75% with no LIBOR floor and an undrawn fee of 0.375% to LIBOR plus 1.45% with no LIBOR floor and a 0.30% facility fee.

The total amount outstanding under our unsecured revolving credit facilities was $950.0 million and $420.0 million as of June 30, 2013 and December 31, 2012, respectively.

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Results of Operations

The following table presents our historical operating results for the three and six month periods ended June 30, 2013 and 2012 (in thousands):

(1)         Adjusted net income (defined as net income before stock-based compensation expense and non-cash interest expense, which includes the amortization of discounts and debt issuance costs and extinguishment of debt) is a measure of both operating performance and liquidity that is not defined by GAAP and should not be considered as an alternative to net income, income from operations or any other performance measures derived in accordance with GAAP. Adjusted net income is presented as a supplemental disclosure because management believes that it may be a useful performance measure that is used within our industry. We believe adjusted net income provides useful information on our earnings from ongoing operations, our ability to service our long-term debt and other fixed obligations, and our ability to fund our expected growth with internally generated funds. Set forth below is additional detail as to how we use adjusted net income as a measure of both operating performance and liquidity, as well as a discussion of the limitations of adjusted net income as an analytical tool and a reconciliation of adjusted net income to our GAAP net income and cash flow from operating activities.

Operating Performance:  Management and our board of directors use adjusted net income in a number of ways to assess our consolidated financial and operating performance, and we believe this measure is helpful in identifying trends in our performance. We use adjusted net income as a measure of our consolidated operating performance exclusive of income and expenses that relate to the financing, income taxes, and capitalization of the business. Also, adjusted net income assists us in comparing our operating performance on a consistent basis as it removes the impact of our capital structure and stock-based compensation expense from our operating results. In addition, adjusted net income helps management identify controllable expenses and make decisions designed to help us meet our current financial goals and optimize our financial performance. Accordingly, we believe this metric measures our financial performance based on operational factors that we can influence in the short term, namely the cost structure and expenses of the organization.

Liquidity:  In addition to the uses described above, management and our board of directors use adjusted net income as an indicator of the amount of cash flow we have available to service our debt obligations, and we believe this measure can serve the same purpose for our investors.

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Limitations:  Adjusted net income has limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our operating results or cash flows as reported under GAAP. Some of these limitations are as follows:

· adjusted net income does not reflect (i) our cash expenditures or future requirements for capital expenditures or contractual commitments, or (ii) changes in or cash requirements for our working capital needs; and

·  our calculation of adjusted net income may differ from the adjusted net income or analogous calculations of other companies in our industry, limiting its usefulness as a comparative measure.

The following tables show the reconciliation of net income and cash flows from operating activities, the most directly comparable GAAP measures of performance and liquidity, to adjusted net income (in thousands):

(2)         Adjusted EBITDA (defined as net income before net interest expense, stock-based compensation expense, income tax expense, and depreciation and amortization expense) is a measure of both operating performance and liquidity that is not defined by GAAP and should not be considered as an alternative to net income, income from operations or any other performance measures derived in accordance with GAAP. Adjusted EBITDA is presented as a supplemental disclosure because management believes that it may be a useful performance measure that is used within our industry. We believe adjusted EBITDA provides useful information on our earnings from ongoing operations, our ability to service our long-term debt and other fixed obligations, and our ability to fund our expected growth with internally generated funds. Set forth below is additional detail as to how we use adjusted EBITDA as a measure of both operating performance and liquidity, as well as a discussion of the limitations of adjusted EBITDA as an analytical tool and a reconciliation of adjusted EBITDA to our GAAP net income and cash flow from operating activities.

Operating Performance:  Management and our board of directors use adjusted EBITDA in a number of ways to assess our consolidated financial and operating performance, and we believe this measure is helpful in identifying trends in our performance.

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We use adjusted EBITDA as a measure of our consolidated operating performance exclusive of income and expenses that relate to the financing, income taxes, and capitalization of the business. Also, adjusted EBITDA assists us in comparing our operating performance on a consistent basis as it removes the impact of our capital structure and stock-based compensation expense from our operating results. In addition, adjusted EBITDA helps management identify controllable expenses and make decisions designed to help us meet our current financial goals and optimize our financial performance. Accordingly, we believe this metric measures our financial performance based on operational factors that we can influence in the short term, namely the cost structure and expenses of the organization.

Liquidity: In addition to the uses described above, management and our board of directors use adjusted EBITDA as an indicator of the amount of cash flow we have available to service our debt obligations, and we believe this measure can serve the same purpose for our investors.

Limitations:  Adjusted EBITDA has limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our operating results or cash flows as reported under GAAP. Some of these limitations are as follows:

· adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;

· adjusted EBITDA does not reflect changes in or cash requirements for our working capital needs;

· adjusted EBITDA does not reflect interest expense or cash requirements necessary to service interest or principal payments on our debt; and

· other companies in our industry may calculate this measure differently from how we calculate this measure, limiting its usefulness as a comparative measure.

The following tables show the reconciliation of net income and cash flows from operating activities, the most directly comparable GAAP measures of performance and liquidity, to adjusted EBITDA (in thousands):