UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1996 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number: WILLIS LEASE FINANCE CORPORATION (Exact name of registrant as specified in its charter) California 68-0070656 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 180 Harbor Drive, Suite 200, Sausalito, CA 94965 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (415) 331-5281 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange on Title of Each Class Which Registered ------------------- ---------------- None Securities registered pursuant to Section 12(g) of the Act: Title of Each Class ------------------- None 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Registration S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [X] The aggregate market value of voting stock held by non-affiliates of the registrant as of March 21, 1997 was approximately $31,980,464 (based on a closing sale price of $13.88 per share as reported on the NASDAQ National Market System). Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
The number of shares of the registrant's Common Stock outstanding as of March 21,1997 was 5,430,861. WILLIS LEASE FINANCE CORPORATION 1996 FORM 10-K ANNUAL REPORT <TABLE> TABLE OF CONTENTS <CAPTION> PART I Page ---- <S> <C> <C> Item 1. Business 3 Item 2. Properties 10 Item 3. Legal Proceedings 10 Item 4. Submission of Matters to a Vote of Security Holders 10 PART II Item 5. Market for Registrant's Common Equity and related Stockholder Matters 11 Item 6. Selected Financial Data 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 8. Financial Statements and Supplementary Data 22 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 22 PART III Item 10. Directors and Executive Officers of the Registrant 23 Item 11. Executive Compensation 23 Item 12. Security Ownership of Certain Beneficial Owners and Management 23 Item 13. Certain Relationships and Related Transactions 23 PART IV Item 14. Exhibits, Financial Schedules and Reports on Form 8-K 24 </TABLE> 2
PART I ITEM 1. BUSINESS Willis Lease Finance Corporation and subsidiaries (the "Company") provides operating leases of spare commercial aircraft engines worldwide. The Company is primarily engaged in acquiring spare commercial aircraft engines in the aftermarket and providing operating leases of such engines to foreign and domestic airlines, manufacturers and overhaul/repair facilities. As of December 31, 1996, the Company had 32 engines and related equipment on lease to 22 customers in 12 countries. The Company also engages in the purchase and resale of used and refurbished commercial aircraft engines and airframe and engine components. The Company is a California corporation which commenced its leasing business in 1988. Its executive offices are located at 180 Harbor Drive, Suite 200, Sausalito, California 94965. The Company transacts business directly and through its subsidiaries unless otherwise indicated. Industry Background Commercial airlines typically maintain a number of spare aircraft engines to ensure that their aircraft are not grounded when engines are removed for normal maintenance or as a result of engine failure. Industry analysts estimate that the worldwide fleet of approximately 11,000 commercial aircraft utilizes approximately 30,000 engines, including approximately 5,000 spare engines valued at over $11 billion. Boeing Commercial Airplane Group's publication, 1996 Current Market Outlook (the "Boeing Report"), estimates 15,900 new aircraft will be delivered over the next 20 years, resulting in a projected worldwide fleet of approximately 23,000 aircraft in 2015, net of 3,900 retired aircraft. These 15,900 new deliveries which represent a mixture of two-, three- and four-engined aircraft, will require approximately 39,000 installed engines. Airlines have increasingly turned to operating leases as an alternative to traditional financing of their aircraft, engines and spare parts. According to the Boeing Report, the fleets of operating lessors have grown from just over 200 aircraft in 1986 to over 1,000 in 1995, representing approximately 10% of total commercial aircraft at year-end 1995. Advantages to airlines of leasing include greater flexibility in fleet management, off-balance sheet reporting of operating leases, the ability to augment funds without affecting debt-to-equity ratios, and the shifting of residual value risk to a third party. Strategy The Company's strategy for its leasing business is to focus on operating leases of commercial aircraft engines worldwide while maximizing residual values. In order to maximize the value of engines when they are re-leased or sold at the end of a lease, the Company focuses on commercial jet aircraft engines, particularly the noise compliant Stage III aircraft engines. As of December 31, 1996, all of the Company's engines were Stage III engines and were generally suitable for use on one or more commonly used aircraft such as Boeing 747, 757, 767, 737-300/400/500, McDonnell Douglas MD-80 Series, DC 10-30, MD-11 and Airbus A-300 and A-320. Through the spare parts and component sales operations of Willis Aeronautical Services, Inc. ("WASI"), its subsidiary, the Company sells aircraft spare parts to commercial passenger airlines, air cargo carriers, overhaul/repair facilities and other spare parts distributors. WASI provides parts for maintenance and overhaul of the Company's engines at prices lower than the Company could obtain from third parties. Similarly, WASI provides engine components to the Company's lessees, thus satisfying more of the lessees' needs with respect to their leased engines. Aircraft Engine Leasing All of the Company's current leases to air carriers, manufacturers and overhaul/repair facilities are operating leases rather than finance leases. Under an operating lease, the Company retains title to the engine thereby retaining the benefit and assuming the risk of the residual value of the aircraft engine. Operating leases allow airlines greater fleet and financial flexibility due to their shorter-term nature and the relatively small initial capital outlay necessary to obtain use of the aircraft engine. Operating lease rates are generally priced higher than finance lease rates, in part because of the risks associated with the residual value. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Results - Ownership Risks." 3
The Company targets the medium-term engine lease market, which generally consists of leases with three to ten year terms. Airlines, manufacturers and overhaul/repair facilities leasing for this term do so when their projected utilization of a specific engine is deemed to be less than its useful life, or when they are seeking to manage their cash flow more efficiently while strengthening their balance sheets. Most of the Company's lease transactions are triple-net leases with a specified non-cancelable lease term. A triple-net lease requires the lessee to make the full lease payment and pay any other expenses associated with the use of the engine, such as maintenance, casualty and liability insurance, sales or use taxes and personal property taxes. The leases contain detailed provisions specifying maintenance standards and the required condition of the aircraft engine upon redelivery. During the term of the lease, the Company generally requires the lessee to maintain the aircraft engine in accordance with an approved maintenance program designed to ensure that the aircraft engine meets applicable regulatory requirements in the jurisdictions in which the lessee operates. Under short-term leases and certain medium-term leases, the Company undertakes a portion of the maintenance and regulatory compliance risk. The Company attempts to minimize its currency and exchange risks by negotiating all of its aircraft engine lease transactions in U.S. Dollars. In addition, all guarantees obtained to support various lease agreements are denominated and payable in U.S. Dollars. See " Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Results - International Risks." The Company typically collects maintenance reserves and security deposits from the lessee. Generally, the Company collects, in advance, a security deposit equal to at least one month's lease payment, together with one month's estimated maintenance reserve. The security deposit is returned to the lessee after all return conditions have been met. Maintenance reserves are accumulated in accounts maintained by the Company or its lenders and are used when normal repair associated with engine use or maintenance is required. In most cases, to the extent that cumulative maintenance reserves are inadequate to fund normal repairs required prior to return of the engine to the Company, the lessee is obligated to cover the shortfall. In most cases, any maintenance reserves remaining in a restricted account after the lease has expired and the return conditions have been met are retained by the Company unless the engine is returned with no flight hours since the last refurbishment. The Company makes an independent analysis of the credit risk associated with each lease before entering into such lease. The Company's credit analysis consists of evaluating the prospective lessee's financial statements for the past three years, trade and banking references, working with the Company's lenders to evaluate country and political risk, insurance of hull and liability and expropriation risk. The process for credit approval is a joint undertaking between the Company and the senior lender providing the debt financing for the lease. The Company obtains extensive financial information regarding the lessee and, in certain circumstances where the Company or its lenders believe necessary, requires guarantees from banks or a third party. In addition, the Company continually monitors and evaluates the political and economic climate of the countries involved. While the Company has experienced some collection problems, including delay in lease rental payments, to date the Company has not experienced material losses attributable to such problems; however, there can be no assurance that the Company will not experience collection problems or significant losses in the future. During 1996, the Company began acquiring high-value spare parts packages for its portfolio. These spare parts packages are leased to the same customers as those leasing engines from the Company and are leased at essentially the same profit margin. During a given lease period, the Company's leases require that the leased engines undergo regular maintenance and inspection at pre-approved engine maintenance facilities certified by the FAA or its foreign equivalent. In addition, when engines come off-lease, they undergo thorough inspections to verify compliance with lease return conditions. Regular maintenance and thorough inspections during and after the lease term help ensure that the Company's leased engines maintain their residual value. While there can be no assurance that the Company's rigorous maintenance and inspection requirements will result in a realized return to the Company upon termination of a lease, the Company believes that its emphasis on maintenance and inspection generally helps it to recover its original investment in the engines. Upon termination of a lease, the Company will re-lease or sell the aircraft engine or dismantle the engine and sell the parts. The demand for aftermarket aircraft engines for either sale or re-lease may be affected by a number of variables including general market conditions, regulatory changes (particularly those imposing environmental, maintenance and other requirements on the operation of aircraft engines), changes in the supply and cost of aircraft engines and technological developments. In addition, the value of a particular used aircraft engine varies greatly depending upon its condition, the maintenance services performed during the lease term and the number of hours remaining until the next major maintenance of the engine is required. If the Company is unable to re-lease or sell an engine on favorable terms, its ability to service debt may be adversely affected. See " Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Results - Ownership Risks" and "Business - Aircraft Engine Portfolio." 4
Engine Portfolio As of December 31, 1996, the Company owned 31 engines and related equipment and had 1 engine on capital lease. These engines and equipment were on lease to 22 customers in 12 countries throughout the world, with no single country, other than the United States, accounting for more than 14% of the Company's lease revenue for the year ended December 31, 1996. The following table displays the regional profile of the Company's lessee customer base by operating lease revenue for the year ended December 31, 1996: Operating Lease Revenue Percentage ------- ---------- United States 5,295,084 39% Europe 2,840,428 21% Mexico 1,865,118 14% Canada 1,291,000 9% Australia/New Zealand 1,029,600 7% Asia 889,208 6% South America 530,000 4% -------------------------------------------- Total 13,740,438 100% ============================================ For the year ended December 31, 1996, Aerovias de Mexico, S.A. de C.V., a lessee customer of the Company, contributed 14% of operating lease revenue. The Company markets its operating leases through a direct marketing campaign and relies, to a lesser extent, on referrals and advertising in industry publications. The Company also subscribes to a data package that provides it with access to lists composed of operators and their specific engine requirements. Aircraft Engine Portfolio The Company's management frequently reviews opportunities to acquire suitable aircraft engines based on market demand, customer airline requirements and in accordance with the Company's engine portfolio mix criteria and planning strategies for leasing. Before committing to purchase specific engines, the Company takes into consideration such factors as estimates of future values, potential for remarketing, trends in supply and demand for the particular make, model and configuration of engines and anticipated obsolescence. As a result, certain types and configurations of engines do not necessarily fit the profile for inclusion in the Company's portfolio of engines owned and used in its leasing operation. The Company focuses particularly on the noise compliant Stage III aircraft engines, for use on commonly used aircraft. As of December 31, 1996, all of the Company's engines were Stage III engines and were generally suitable for use on one or more commonly used aircraft such as Boeing 747, 757, 767, 737-300/400/500, McDonnell-Douglas MD-80 Series, DC 10-30, MD-11 and Airbus A-300 and A-320. The Company purchases a majority of its engines in the aftermarket, primarily from airlines or other leasing companies. 5
<TABLE> The Company's commercial aircraft engine portfolio consists of aircraft engines manufactured by CFM International (CFM), General Electric (CF), Pratt & Whitney (JT and PW) and Rolls Royce (RB). The following table shows by engine type the number of engines, the aircraft type on which each engine type is generally used, and the scheduled lease terminations of the Company's lease portfolio at December 31, 1996: <CAPTION> Engine Type Number Aircraft Application ----------- ------ -------------------- Off Scheduled Lease Terminations Lease 1997 1998 1999 2000 2001 2002 2006 ----- ---- ---- ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> CF6-50 C2 3 A300, DC10-30, 3 B-747-200, CF6-80 C2 1 747-400, 1 767-200ER/300/300ER, MD11, A300-600/600R/600F/ST, 600ST A310-200, ADV/300 CFM56-3B 7 737-300/400/500 3 1 1 1 1 CFM56-3C 4 737-300/400/500 1 1 2 CFM56-5A 2 A320/100/200, A319 1 1 JT8D-219 4 MD80 1 3 JT9D-7A 1 747-100/200 1 JT9D-7J 2 747-200/SP 1 1 (OFF-LEASE ENGINE) JT9D-7R4D 1 767-200, B-747-200 1 PW2040 1 757-200 1 PW4060 1 747-400, 767-300 1 A 310, MD 11 RB211-535 2 757-200 1 1 JT8D-217C 1 MD83 1 CF6-80E1 1 AIRBUS 330 1 PW 2037 1 B-757 1 ----------- ------------------------------------------------------------------- Total 32 1 6 9 5 4 5 1 1 </TABLE> 6
Engine Portfolio Value The Company has obtained appraisals of its engines from Aircraft Information Services, Inc. ("AISI"), a recognized appraiser of aircraft engines. AISI has rendered its opinion that the aggregate "Current Fair Market Value" of the Company's aircraft engine portfolio, assuming the engines are in average half-life condition, is $98.5 million, which compares favorably to the aggregate net book value at December 31, 1996 of $93.1 million of the Company's current portfolio of owned engine. "Current Fair Market Value" is the appraiser's opinion as to the value of the aircraft engines under market conditions that are perceived to exist at a specific point in time for a sale between equally willing and knowledgeable buyers and sellers, neither under compulsion to buy or sell, in a cash transaction with no hidden value or liability. "Average half-life condition" assumes that every component or maintenance service which has a prescribed interval that determines its service life, overhaul interval or interval between maintenance services is at a condition which is one-half of the total interval. The Company, through the return conditions required by its leases and the maintenance reserves collected by the Company from its lessees, attempts to put its engines in the equivalent of a "freshly refurbished" condition, after application of the maintenance reserves. "Freshly refurbished" condition is defined to be that of an engine immediately after a major shop visit which refurbished all engine modules or all engine compressor and combustor/turbine stages, as appropriate, with all life-limited components at half-life. AISI has rendered its opinion that the "Current Fair Market Value" of the Company's aircraft engine portfolio, assuming the engines were in freshly refurbished condition, is $108.6 million. The following table sets forth the opinion of AISI as to the aggregate "Future Value Forecast" for the Company's current aircraft engine portfolio for the periods indicated: 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- (in millions) AISI Future Value Forecast ...... $107.1 $105.4 $102.1 $98.9 $95.8 "Future Value Forecast" is the appraiser's opinion as to the expected value of an asset at a specific date in the future and assumes "Base Value" criteria, half-life condition and an assumed annual inflation rate of 3.0%. "Base Value" is similar to Current Fair Market Value; however it assumes theoretically balanced market conditions rather than actual present market conditions or assumed market conditions at a specified future date. Since appraisals are only estimates of resale values, there can be no assurance that such appraised values are accurate or that they will not materially change due to factors beyond the Company's control, including but not limited to, obsolescence and changing market conditions, lack of support by relevant airframe, engine or component manufacturers, or that upon expiration of the leases, due to the absence of purchasers or re-lease demand for the Company's engines, the Company will not realize the then book or appraised value through either sale or re-leasing of the engines. AISI was paid $9,500, plus out-of-pocket expenses, for its services to the Company in connection with its appraisal. 7
Financing/Source of Funds The Company acquires the engines it leases primarily with funds borrowed from banks and finance companies. The Company borrows 80% to 85% of the engine purchase price on a recourse or non-recourse basis. Under the terms of the loans, the lender is entitled to receive most of the lease payments to apply to debt service and takes a security interest in the engine. The Company retains ownership of the engine, subject to the lender's security interest. Loan interest rates are negotiated on a transaction-by-transaction basis and reflect the financial condition of the lessee (and for recourse loans, the financial condition of the Company), the terms of the lease and the amount of the loan. The Company has historically paid the balance of the purchase price of the engine, the "equity" portion, from internally generated funds. The loans available to the Company under recourse arrangements are secured by the financed engines and the assignment of lease payments due under the related leases. Upon default under a loan covering engines financed through recourse borrowings, the lender providing the financing can foreclose on the engine and sell it and seek any balance due on such financing from the Company. Under certain of the Company's lease arrangements, the financial institution providing the financing may seek recourse only at the subsidiary level and not to the Company. The credit standing of certain of the Company's customers and the long operating life of aircraft engines allows the Company to finance some of its equipment on a non-recourse basis. Non-recourse loans represent loans to subsidiaries which own only the assets which secure the loan and as to which the Company has not guaranteed the loan. The Company and its subsidiaries at December 31, 1996 had borrowings of $18.8 million in four loans on a non-recourse basis and $53.5 million in seven loans on a recourse basis. The Company is not liable for the repayment of the non-recourse loans unless the Company breaches certain limited representations and warranties under the applicable pledge agreement. The lender assumes the credit risk of each such lease, and its only recourse, upon a default under a lease, is against the lessee and the leased engine. The Company has negotiated a sharing of residual proceeds with certain lenders in exchange for a higher percentage financing of six aircraft engines. The Company provides for its residual sharing obligation in each period, sufficient to adjust the residual share payable at the balance sheet date to the amount that would be payable at that date if applicable engines were sold on the balance sheet date at their net book values. Spare Parts Sales In October 1994, the Company established WASI as an international provider of aftermarket airframe rotable parts, engine parts, engines and modules. WASI purchases individual engine parts from airlines and others in the aftermarket or acquires whole airframes or engines and dismantles the airframes or engines into their component parts for resale. The component parts acquired are typically overhauled for WASI by an FAA-authorized repair agency and then offered for sale to airlines, maintenance and repair facilities, and distributors. To date, WASI has targeted primarily General Electric CF6-50, Pratt & Whitney JT9D engines and early model Pratt & Whitney JT8D aircraft engines and components. These engines are the most widely used aircraft engines in the world, powering the Boeing 747, 727 and 737, McDonnell Douglas DC10 and DC9 and Airbus A-300 series of aircraft. WASI currently expects to expand into engine components for the CFM-56, a high thrust engine used on the popular Boeing 737. To date, WASI's operations have afforded the Company additional contacts and opportunities in the aircraft engine market. WASI provides parts for maintenance and overhaul of the Company's engines at prices lower than the Company could obtain from third parties. Similarly, WASI provides engine components to the Company's lessees, thus satisfying more of the lessees' needs with respect to their leased engines. As engines in the Company's leasing portfolio age and reach the point at which they are more valuable as component parts, the Company expects that WASI will be able to break them down, salvaging valuable components and thereby maximizing the residual value of the engines. WASI has strict guidelines regulating how parts are procured and overhauled. When procuring aircraft parts, great emphasis is placed on source and traceability. At December 31, 1996, 98% of WASI's inventory on hand was acquired from a certified commercial air carrier or others operating under recognized regulatory agencies accepted by the FAA. Less than 2% of the inventory was acquired from trading companies and in all such cases the parts are certified by the seller as to origin. WASI does not trade in consumable parts such as hardware/fasteners. Hardware/fasteners are the most difficult to identify as unapproved material and in many cases are impossible to identify as unapproved material without conducting detailed analysis. WASI's trades in life-limited parts are restricted to parts that have complete traceability back to the original equipment manufacturer ("OEM") or in few cases traceability from a commercial air carrier back to the OEM. See " Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Results - Government Regulation." 8
WASI advertises its aircraft engine parts availability on the Inventory Locator Service ("ILS") and the Airline Inventory Redistribution System ("AIRS") electronic databases. Users of ILS and AIRS can access the databases and determine which companies have the desired inventory. The Company also advertises in industry publications and receives a number of customers through referrals. WASI also provides aircraft engine management and technical services to airlines. Certain air carriers outsource the management of heavy maintenance and the overhaul of engines to reduce operational overhead and staffing. These services include negotiating engine maintenance agreements and providing repair agencies with engine work orders. As the representative for an airline, WASI collects engine removal data, establishes formal work orders, reviews test cell data and revises, if necessary, the engine work order. The monitoring of aircraft engines enables WASI to have frequent contact with airline clients, source replacement parts and identify parts that have been designated for sale. Further, WASI observes test cell acceptance runs, evaluates the results, reviews invoices for repair and requests warranties on behalf of its airline clients. Currently, WASI manages all engine tests for the Company and monitors the Company's engines that are subject to leases. WASI may from time to time enter into consignment agreements with airlines or related companies to acquire surplus inventories for the purpose of marketing and sales of such consigned parts. Consignment allows WASI to access inventory for sale without the cost and risk of ownership. Equipment Acquired for Resale The Company engages in the short-term trading of commercial aircraft engines in the aftermarket to complement its engine leasing business. It is the Company's general policy to minimize risk by not purchasing engines on speculation; however occasionally the Company purchases engines without having a commitment for the engines' resale. The Company normally makes a contractual commitment to purchase specific engines for its own account only after, or concurrently with, obtaining a firm customer commitment to purchase. Although the Company usually has sale commitments for engines at delivery, it would have financial exposure if it purchased an engine which could not immediately be resold. The Company markets the resale of its engines through a direct marketing campaign and relies, to a lesser extent, on referrals and advertising in industry publications. The Company also subscribes to a data package that provides it with access to lists composed of operators and their specific engine requirements. The Company does not refurbish or perform other maintenance on the engines it resells; however, from time to time, the Company has hired third party contractors to refurbish or repair such engines. Competition In the medium-term engine lease market segment, which is the Company's target market, the Company principally competes with Shannon Engine Services, headquartered in Shannon, Ireland, which is owned in part by SNECMA and CFMI, and Rolls Royce. Rolls Royce limits its leasing activities to products of its parent company and related parties. The Bank of Tokyo, through its recent acquisition of Engine Lease Finance in Shannon, Ireland, also competes with the Company. Each of these competitors is substantially larger and has greater financial resources than the Company which may permit, among other things, greater access to capital markets at more favorable terms. In addition, major aircraft lessors, including International Lease Finance Corporation and General Electric Capital Aviation Services, compete with the Company to the extent that they include spare engine leases with their aircraft leases. With respect to engine marketing and spare parts and component sales, the Company competes with airlines, aircraft manufacturers, aircraft, engine and parts brokers, and parts distributors. The Company's major competitors include the Allen Aircraft division of AAR Corp., The AGES Group and Aviation Sales Company. Certain of these competitors may have, or may have access to, financial resources substantially greater than the Company. Significant increases in competition encountered by the Company in the future may limit the Company's ability to expand its business, which would have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that the primary competitive factors in the aircraft engine leasing industry are flexibility in leasing terms, including price, return conditions and term of lease, and availability of engines. The Company believes that it is able to compete favorably in leasing commercial aircraft engines due to its experience in the industry, reputation and expertise in acquiring and leasing commercial aircraft engines at economical prices and therefore allowing the Company to re-lease or sell such engines at a competitive price. See " Management's Discussion and Analysis of Financial Condition and Results of Operations Factors That May Affect Future Results - Competition." 9
Insurance The Company requires its lessees to carry the types of insurance customary in the air transportation industry, including comprehensive liability insurance and casualty insurance. In addition to requiring full indemnification under the terms of the lease, the Company is named as an additional insured on liability insurance policies carried by lessees, with the lender normally identified as the payee for loss and damage to the equipment. All policies contain a breach of warranty endorsement or severability of interest clause so that the Company continues to be protected even if the operator/lessee violates one or more of the warranties or conditions of the insurance policy. The Company monitors compliance with the insurance provisions of the leases. Government Regulation The Company's customers are generally subject to a high degree of regulation in the various jurisdictions in which they operate. Such regulations also indirectly affect the Company's business operations. Under the provisions of the Federal Aviation Act of 1958, as amended, the FAA exercises regulatory authority over the air transportation industry. The FAA regulates the manufacture, repair and operation of all aircraft engines operated in the United States. Its regulations are designed to insure that all aircraft and aviation equipment are continuously maintained in proper condition to ensure safe operation of the aircraft. Similar rules apply in other countries. All aircraft must be maintained under a continuous condition monitoring program and must periodically undergo thorough inspection and maintenance. The inspection, maintenance and repair procedures for the various types of aircraft equipment are prescribed by regulatory authorities and can be performed only by certified repair facilities utilizing certified technicians. Certification and conformance is required prior to installation of a part on an aircraft. Presently, whenever necessary, with respect to a particular engine or engine component, the Company utilizes FAA and/or Joint Aviation Authority certified repair stations to repair and certify engines and components to ensure worldwide marketability. The FAA can suspend or revoke the authority of air carriers or their licensed personnel for failure to comply with regulations and ground aircraft if their airworthiness is in question. In addition, by the year 2000, federal regulations will stipulate that all aircraft engines hold, or be capable or holding, a noise certificate issued under Chapter 3 of Volume 1, Part II of Annex 16 of the Chicago Convention, or have been shown to comply with Stage III noise levels set out in Section 36.5 of Appendix C of Part 36 of the Federal Aviation Regulations of the United States. Employees As of December 31, 1996, the Company had 25 full-time employees and 2 part-time employees, including 15 employees in equipment leasing and trading and 12 employees in the airframe and engine component sales. None of the Company's employees is covered by a collective bargaining agreement and the Company believes its employee relations are good. ITEM 2. PROPERTIES The Company's principal offices are located at 180 Harbor Drive, Suite 200, Sausalito, California 94965. The Company occupies space in Sausalito under a lease that covers approximately 5,500 square feet of office space and expires on March 14, 1999. Engine financing, sales, trading and general administrative activities are conducted from the Sausalito location. The Company also leases approximately 22,500 square feet of office and warehouse space for WASI's operations at 291 Harbor Way, South San Francisco, California 94080. The lease expires on May 31, 1998. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of shareholders during the fourth quarter of the fiscal year 1996. 10
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The following information relates to the Company's Common Stock, which is listed on the NASDAQ National Market under the symbol WLFC. As of March 21, 1997, there were 1,170 stockholders of record of the Company's Common Stock. The foregoing number does not include beneficial holders of the Company's common stock. The high and low sales price of the Common Stock for each quarter since the effective date of the Initial Public Offering (the "Offering"), September 18, 1996, as reported by NASDAQ, are set forth below: 1996 ---- High Low Third Quarter $ 10 $ 8 1/2 Fourth Quarter $ 12 7/8 $ 8 3/4 The Company did not declare any dividends for the year ended December 31, 1996. ITEM 6. SELECTED FINANCIAL DATA <TABLE> The following table summarizes selected consolidated financial data and operating information of the Company. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Form 10-K. <CAPTION> Years Ended December 31, ------------------------------------------------------ 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> Revenue: Operating lease revenue $ 13,740 13,740 13,636 10,323 8,744 Gain (loss) on sale of leased engines 2 (483) 633 (281) 659 Spare parts sales 5,843 3,859 795 -- -- Sale of equipment acquired for resale 12,105 5,472 2,184 -- 3,598 Interest and other income 618 119 542 938 70 ------------------------------------------------------- $ 32,308 22,738 17,790 10,980 13,071 Expenses: Cost of spare parts sales $ 3,308 2,546 659 -- -- Cost of equipment acquired for resale 10,789 2,742 1,863 -- 3,140 All other expenses 13,351 14,168 13,295 9,857 9,117 Gain on modification of credit facility -- 2,203 -- -- -- Income before income taxes and minority interest 4,860 5,485 1,973 1,123 814 Net income 2,804 3,216 1,172 669 487 Balance Sheet Data: Total assets $124,933 91,437 83,542 68,632 69,711 Debt financing 73,186 69,911 69,456 59,840 64,349 Shareholders' equity 23,202 4,812 1,959 1,151 463 Lease Portfolio: Engine portfolio at the end of the period 32 31 26 25 26 </TABLE> 11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The Company's primary businesses are the leasing of spare replacement aircraft engines, spare parts packages and the strategic acquisition and resale of aircraft engines and parts to the worldwide commercial airline aftermarket. The Company commenced leasing operations in 1988 and established WASI to conduct its spare parts resale operation in October 1994. Revenue consists primarily of operating lease revenue, income from the sale of leased engines, sales of spare parts and components and equipment sales. Summary of Financial Results for the year ended December 31, 1996. Total revenue for the year ended December 31, 1996 was $32.3 million, compared to $22.7 million in 1995. Net income for the year ended December 31, 1996 was $2.8 million, compared to $3.2 million in 1995, primarily due to the gain on modification of the Company's primary credit facility ($2.2 million) and higher gain on sales of equipment acquired for resale ($1.4 million) in 1995, whereas 1996 had increased margin on spare parts sales ($1.2 million) and lower depreciation and interest expense ($2.9 million) compared to 1995, offset by higher operating expenses ($1.8 million) in 1996 compared to 1995. Leasing Operations. The Company accounts for its leases as operating leases. Under an operating lease, the Company retains title to the engine, thereby retaining the potential benefit and assuming the risk of the residual value of the engine. Operating leases require the Company to re-lease or sell an engine in a timely manner upon termination of a lease. Lease payments are recorded as operating lease revenue and depreciation expense is recognized on a straight-line basis over 15 years to a 55% residual. Third party lenders generally provide 80% to 85% of the financing for the acquisition of engines to be leased on an operating lease basis. In some instances, third party lenders have provided more than 85% of the financing of engines, in which case the lenders have generally required a sharing of the residual value of the engine upon the sale of the engine. The Company provides for the residual sharing obligation as a charge or credit to income or expense each period in an amount sufficient to adjust the residual share payable at the balance sheet date to the amount that would be payable at the balance sheet date if all engines subject to residual sharing were sold on the balance sheet date at their net book values. 12
Year Ended December 31, 1996 compared to Year Ended December 31, 1995 <TABLE> Revenue is summarized as follows: <CAPTION> Years ended December 31, ---------------------------------------------------------------- 1996 1995 ---------------------------------------------------------------- Amount % Amount % ------ --- ------ --- (dollars in thousands) <S> <C> <C> <C> <C> Revenue: Operating lease revenue $13,740 42.5 $13,771 60.6 Gain (loss) on sale of leased engines 2 0.0 (483) (2.1) Spare parts sales 5,843 18.1 3,859 17.0 Sale of equipment acquired for resale 12,105 37.5 5,472 24.0 Interest and other income 618 1.9 119 0.5 ---------------------------------------------------------------- Total $32,308 100.00 $22,738 100.0 ================================================================ </TABLE> The Company's results of operation are significantly impacted by changes in the portfolio of owned equipment. Lease Portfolio. At December 31, 1995, the Company had 31 engines in its operating lease portfolio. During 1996, four engines were transferred from the lease portfolio to the equipment sale portfolio and subsequently sold. One engine was transferred at its net book value to WASI to be dismantled and is held for sale as spare parts inventory. Another engine was sold under a sale and leaseback agreement and is now reflected on the Company's balance sheet as an engine on capital lease. The remaining three engines were sold to third parties. In the third quarter of 1996, the Company acquired one engine for $2.8 million and in the fourth quarter, the Company acquired four engines for a total cost of approximately $16.3 million as well as two auxiliary power units (APU's) and a spare parts package for a total cost of approximately $3.2 million. At December 31, 1996, the Company owned 31 engines in its lease portfolio and had 1 engine on a capital lease. Operating Leases. Operating lease revenue for the year-ended December 31, 1996 decreased to $13.7 million from $13.8 million from the corresponding period in 1995. This decrease is primarily due to a decrease in revenue from one engine which was off-lease and in a repair facility for eight months in 1996 and two engines which were sold in 1996, offset slightly by five engines purchased and leased late in 1996. In 1996, expenses directly related to operating lease activity dropped 23% to $8.1 million from $10.6 million in 1995. The reduction in expenses in 1996 was due to a reduction in depreciation expenses of $1.6 million (33%) as a result of two engines subject to component depreciation in 1995 that were fully depreciated and the sale of two engines in the 3rd quarter of 1996. Interest expense dropped $1.2 million (22%) in 1996 from 1995, due primarily to the modification of the existing term loan in June 1995 resulting in more favorable interest rates. Residual sharing expenses, however, increased 77% to $723,000 in 1996 from the corresponding period in 1995 due to changes in the Company's portfolio of engines subject to such agreements. Gain (Loss) on Sale of Leased Engines. The loss in 1995 was attributable to unanticipated overhaul expenses of $373,000 required in order to prepare an engine for resale and a $110,000 loss on the sale of the engine. Spare Parts Sales. Revenues from spare parts sales increased 51% to $5.8 million and the gross margin rose to 43% in 1996 from 34% in the corresponding period in 1995, primarily due to a changed inventory mix and increased volume. 13
Equipment Sales. During the year ended December 31, 1996, the Company sold 4 engines for proceeds of $12.1 million, generating gains of $1.3 million. In 1995, the Company sold three engines for $4.8 million, a fuselage and miscellaneous components it acquired in connection with an aircraft purchase for $572,000 and other components for $100,000. The aggregate cost of the equipment was $10.8 million and $2.7 million in 1996 and 1995, repectively. The Company expects that equipment sales opportunities and profitability will continue to vary materially from period to period. Interest and Other Income. Interest and other income for 1996 increased to $617,000 from $119,000 in 1995, an increase of 418%. This increase is due primarily to increased marketing/brokerage fee income earned on one engine, nonrecurring credits due the Company regarding excessive engine overhaul costs and increased interest earned on the proceeds from the Offering in September 1996, as well as interest earned on certain engine security deposits. General and Administrative Expenses. General and administrative expenses increased 53% to $5.1 million in 1996, up from $3.3 million in 1995. This increase reflects additional compensation due to an increased workforce and increased bonus payments; increased telephone and travel costs due to increased marketing personnel and activity; increased rent due to the expansion of the WASI facility and an increase in professional fees and insurance as a result of the Offering in 1996. Gain on Modification of Credit Facility. In 1995, the Company modified the terms of a significant credit facility. The gain of $2.2 million in 1995 on the modification of credit facility reflects a gain from the removal of residual sharing provisions of $2.4 million and a $199,000 loss on the sale of two engines to the lender. Income Taxes. Income taxes decreased to $2 million in 1996 from $2.2 million in 1995. The Company's effective tax rates for Federal and State taxes is approximately 41% and 40% in 1996 and 1995, respectively. Therefore, the decrease in tax expense is due to the decrease in the Company's income before taxes and minority interest offset by a slight increase in the effective tax rate. 14
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994 <TABLE> Revenue is summarized as follows: <CAPTION> Years ended December 31, ---------------------------------------------------------------- 1995 1994 ---------------------------------------------------------------- Amount % Amount % ------ --- ------ --- (dollars in thousands) <S> <C> <C> <C> <C> Revenue: Operating lease revenue $13,771 60.6 $13,636 76.7 Gain (loss) on sale of leased engines (483) (2.1) 633 3.6 Spare parts sales 3,859 17.0 795 4.4 Sale of equipment acquired for resale 5,472 24.0 2,184 12.3 Interest and other income 119 0.5 542 3.0 ---------------------------------------------------------------- Total $22,738 100.0 $17,790 100.0 ================================================================ </TABLE> The Company's results of operation are significantly impacted by changes in the portfolio of equipment. Lease Portfolio. During 1995, the Company acquired a total of eight engines and sold three, for a net increase of five. Two of the acquired engines were overhauled in 1995 and became available for sale or lease in 1996 and two additional engines were purchased in late December 1995, both subject to existing leases. Thus, these four engines did not impact results in 1995. The four remaining engines were acquired in July 1995 and were leased on a short-term basis. At December 31, 1995, two of these remaining engines four engines were on lease and the other two engines were being refurbished for ultimate sale. See "Business Aircraft Engine Portfolio." Two of the engines sold during 1995 were sold as part of the Facility Modification and the third engine was sold in June 1995. Operating Leases. Operating lease revenue increased to $13.8 million in 1995 from $13.6 million in 1994, an increase of 1.5%. Although the Company's lease portfolio increased by a net of five engines in 1995, as discussed above a number of the engines acquired did not impact revenue during 1995 and the lease revenue from the engines acquired in July 1995 were offset by the reduction in lease revenue from the engines sold in 1995. Expenses directly related to operating lease activities declined to $10.6 million in 1995 from $11.6 million in 1994, a 9% decrease. The reduction in expenses was largely due to a $877,000 reduction in residual sharing in conjunction with the Facility Modification. A decrease in interest expense to $5.5 million in 1995 from $5.9 million in 1994 as a result of lower interest rates due to the Facility Modification contributed to the overall expense decrease. These decreases in expenses were partially offset by a $256,000 increase in depreciation as a result of a $300,000 write-down of one of the Company's engines in 1995 due to the Company's implementation of Statement of Financial Accounting Standard No. 121 as of December 31, 1995 and increases in the lease portfolio discussed above. Gain (loss) on Sale of Leased Engines. The Company recorded a loss on the sale of an engine at lease termination of $483,000 in 1995 compared to a gain of $633,000 recorded in 1994, resulting in a $1.1 million reduction in total revenue. The loss in 1995 was attributable to unanticipated overhaul expenses of $373,000 required in order to prepare an engine for resale and a $110,000 loss on the sale of the engine. Spare Parts Sales. Revenue from spare parts sales increased to $3.9 million in 1995 from $795,000 in 1994, a 385% increase, while costs of sales increased to $2.5 million from $659,000, a 286% increase. Gross margin increased to 34% in 1995 from 17% in 1994. Interest expense related to spare parts sales activities was $187,000 in 1995 as compared to $51,000 in 1994, an increase of 267%. These increases resulted primarily from commencement of operations by WASI in October of 1994. 15
Equipment Sales. In 1995, the Company sold three engines for $4.8 million, a fuselage and miscellaneous components it acquired in connection with an aircraft purchase for $572,000 and other components for $100,000. The aggregate cost of this equipment was $2.7 million. In 1994, the Company sold an engine for $2.2 million with a related cost of equipment acquired for resale of $1.9 million. Interest and Other Income. Interest and other income decreased to $119,000 in 1995 from $542,000 in 1994 primarily due to the termination of remarketing fee arrangement with the lender in connection with the Facility Modification. In addition, the Company earned broker fees of $137,000 in 1994 which will not reoccur as the related agreement was terminated in 1994. The remaining decrease was due to management fees earned in 1994 for which no similar services were performed in 1995. General and Administrative Expense. General and administrative expense increased to $3.3 million in 1995 from $1.6 in 1994, an increase of 106% . The increase resulted primarily from an increase in compensation and related benefits as a result of a full year of operations at WASI and the addition of staff in marketing and finance as well as increased travel, promotional and insurance expenses. Gain on Modification of Credit Facility. In 1995, the Company modified the terms of a significant credit facility. The gain of $2.2 million on modification of credit facility reflects a gain from the removal of residual sharing provisions of $2.4 million and a $199,000 loss on the sale of two engines to the lender. Income Taxes. Income tax expense increased to $2.2 million in 1995 from $797,000 in 1994, an increase of 178%. The Company's effective tax rate for Federal and state taxes is approximately 40% for both 1995 and 1994; therefore, the increase in tax expense is directly related to the increase in the Company's income before taxes and minority interest to $5.5 million in 1995 from $2.0 million in 1994. 16
Liquidity and Capital Resources Historically, the Company has financed its growth through leveraged financing of its lease portfolio. Approximately $16.1 million, $15.7 million and $19.3 million in 1996, 1995 and 1994, respectively, was derived from this activity. In these same years, $13.5 million, $9.3 million and $11.5 million, respectively, was used to pay down related debt. In 1996, proceeds from the Company's Initial Public Offering generated approximately $15.9 million of cash flow as discussed below. Cash flows from operating activities generated approximately $9.6 million, $0.5 million and $8.9 million in 1996, 1995 and 1994, respectively. The Company's primary uses of funds are for the purchase of equipment for lease. Approximately $25.3 million, $9.3 million and $17.6 million of funds were used for this purpose in 1996, 1995 and 1994, respectively. Additional funds were used in these years to finance the growth of inventories to support parts sales. In September, 1996, the Company completed the Offering for 2,000,000 shares of its Common Stock at $8.00 per share. An additional 300,000 shares of stock were sold in connection with an Over-Allotment Option granted to the Underwriters. The net proceeds to the Company, net of all expenses, was $15,926,101. These proceeds were used to prepay $1.3 million of indebtedness under an existing term facility, and to purchase an interest rate cap to hedge a portion of its exposure to increases in interest rates on its variable rate borrowings ($460,000). The balance of the proceeds, together with debt financing, will be used to acquire additional engines for lease, to acquire engine and airframe component inventory, and for working capital and other general corporate purposes. The Company has a $15.0 million secured term facility for the acquisition of engines for lease. At December 31, 1996, $9.5 million was available under this facility. This term facility bears interest on each drawdown at the rate equal to the rate on five-year Treasury notes at the date of drawdown plus 5.55% and expires on June 29, 1997. Advances against the facility are for not more than 80% of the appraised value of the engine. The loan is repaid by applying not less than 90% of the underlying lease payment to debt service, except that at the end of 60 months the loan must have amortized not less than 40% of its original balance. The Company also has a $15.0 million term facility for the acquisition of engines for lease. This term facility allows for an advance rate of 80% of fair market value of the equipment, not to exceed 100% of the purchase price. The facility is to be used for domestic lessees. Interest rate under this facility will be dependent upon the quality of the credit and the underlying collateral. As of December 31, 1996, no drawdowns had taken place under this facility. As of December 31, 1996, the Company also has a $3 million secured working capital facility for the acquisition of engines to be dismantled and sold for parts through WASI. This facility provides for 80% advances against the purchase price of parts for resale and bears interest at prime plus 1%. This facility requires interest-only payments with the principal balance due six months after drawdown and expires on October 31, 1997. The Company directly guarantees payment under this facility. This facility replaced a comparable facility with a $1.5 million credit limit. In February, 1997 the Company, replaced its $44 million note payable. The note was repaid at a discount which resulted in an extraordinary gain of approximately $2.9 million (pre-tax), net of related costs. The transaction was financed through a note payable for $41,500,000 at an interest rate of LIBOR plus 250 basis points. This note matures on March 1, 1998. The Company has the option to convert the note to an amortizing term loan due in the year 2004. The Company believes that its current and anticipated credit facilities, internally generated funds and the net proceeds of the Offering will be sufficient to fund the Company's anticipated operations until the first quarter of 1998, at which time additional equity capital is anticipated to be required to fund projected growth. The Company is also exploring a possible securitization of its lease portfolio. There can be no assurance that the necessary amount of such capital or debt will continue to be available to the Company on favorable terms or at all. If the Company were unable to continue to obtain any portion of required financing on favorable terms, the Company's ability to add new engines to its portfolio would be impaired, which would have a material adverse effect on the Company's business, financial condition and results of operations. 17
Factors That May Affect Future Results In addition to other information in this Report, the following risk factors should be considered carefully by potential purchasers in evaluating an investment in the Common Stock of the Company. Except for historical information contained herein, the discussion in this Report contains forward-looking statements that involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations and intentions. The cautionary statements made in this Report should be read as being applicable to all related forward-looking statements wherever they appear in this Report. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere herein. Ownership Risks The Company leases its portfolio of aircraft engines primarily under operating leases rather than finance leases. Under an operating lease, the Company retains title to the aircraft engines and assumes the risk of not recovering its entire investment in the aircraft engine through the re-leasing and remarketing process. Operating leases require the Company to re-lease or sell aircraft engines in its portfolio in a timely manner upon termination of the lease in order to minimize off-lease time and recover its original investment in the aircraft engine. Numerous factors, many of which are beyond the control of the Company, may have an impact on the Company's ability to re-lease or sell an aircraft engine on a timely basis. Among the factors are general market conditions, regulatory changes (particularly those imposing environmental, maintenance and other requirements on the operation of aircraft engines), changes in the supply or cost of aircraft engines and technological developments. Further, the value of a particular used aircraft engine varies greatly depending upon its condition, the number of hours remaining until the next major maintenance of the aircraft engine is required and general conditions in the airline industry. In addition, the success of an operating lease depends in part upon having the aircraft engine returned by the lessee in marketable condition as required by the lease. Consequently, there can be no assurance that the Company's estimated residual value for aircraft engines will be realized. As of December 31, 1996, the Company had 32 engines under lease to 22 customers in 12 countries. If the Company is unable to re-lease or resell aircraft engines on favorable terms, its business, financial condition, cash flow, ability to service debt and results of operations could be adversely affected. The Company also engages in the short-term trading of commercial aircraft engines in the aftermarket. Although it is the Company's general policy not to purchase engines on speculation, the Company has and, if it deems appropriate, may in the future occasionally purchase engines without having a commitment for the engines' resale. If the Company were to purchase an engine without having a firm commitment for its resale or if a firm commitment for resale were to exist but not be consummated for whatever reason, the Company would be subject to all the risks of ownership of the engine as described above. The Company also engages in the purchase and resale of aftermarket airframe rotable parts, engine parts, engines and modules. Before parts may be installed in an aircraft, they must meet certain standards of condition established by the Federal Aviation Administration ("FAA") and/or the equivalent regulatory agencies in other countries. See "Government Regulations" below. Parts must also be traceable to sources deemed acceptable by such agencies. See "Business - Spare Parts Sales." Parts owned by the Company may not meet applicable standards or standards may change, causing parts which are already in the Company's inventory to be scrapped or modified. Engine manufacturers may also develop new parts to be used in lieu of parts already contained in the Company's inventory. In all such cases, to the extent the Company has such parts in its inventory, their value may be reduced. Industry Risks The Company is in the business of providing leases of commercial aircraft engines to international and domestic airlines. Consequently, the Company is affected by downturns in the air transportation industry in general. Substantial increases in fuel costs or interest rates, increasing fare competition, slower growth in air traffic, or any significant downturn in the general economy could adversely affect the air transportation industry and may therefore negatively impact the Company's business, financial condition and results of operations. In addition, in recent years, a number of commercial airlines have experienced financial difficulties, in some cases resulting in bankruptcy proceedings. During the three years ended December 31, 1996, two lessees of the Company filed for bankruptcy protection or otherwise became insolvent or ceased operations. While the Company believes that its lease terms protect its engines and the Company's investment in such engines, there can be no assurance that the financial difficulties experienced by a number of airlines will not have an adverse effect on the Company's business, financial condition and results of operations. 18
Customer Credit Risks A lessee may default in performance of its lease obligations and the Company may be unable to enforce its remedies under a lease. A majority of the Company's existing and prospective customers are smaller domestic and foreign passenger airlines, freight and package carriers and charter airlines, which, together with major passenger airlines, may suffer from the factors which have historically affected the airline industry. As a result, certain of these customers may pose credit risks to the Company. The Company's inability to collect receivables under a large dollar engine lease or to repossess engines in the event of a default by a lessee could have a material adverse effect on the Company's business, financial condition and results of operations. A number of airlines have experienced financial difficulties, and certain airlines have filed for bankruptcy and a number of such airlines have ceased operations. In most cases where a debtor seeks protection under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code"), creditors are stayed automatically from enforcing their rights. In the case of United States certified airlines, Section 1110 of the Bankruptcy Code provides certain relief to lessors of the aircraft engines. Specifically, the airline has 60 days from the date the lessor makes its claim to agree to perform its obligations and to cure any defaults. If it does not do so, the lessor may repossess the aircraft engine. The scope of Section 1110 has been the subject of significant litigation and there can be no assurance that the provisions of Section 1110 will protect the Company's investment in an aircraft engine in the event of a lessee's bankruptcy. In addition, Section 1110 does not apply to lessees located outside of the United States and applicable foreign laws may not provide comparable protection. International Risks In 1996, approximately 61% of the Company's lease revenue was generated by leases to foreign customers. Such leases may present greater risks to the Company because certain foreign laws, regulations and judicial procedures may not be as protective of lessor rights as those which apply in the United States. In addition, many foreign countries have currency and exchange laws regulating the international transfer of currencies. The Company attempts to minimize its currency and exchange risks by negotiating all of its aircraft engine lease transactions in U.S. Dollars and all guarantees obtained to support various lease agreements are denominated for payment in U.S. Dollars. To date, the Company has experienced some collection problems under certain leases with foreign airlines, and there can be no assurance that the Company will not experience such collection problems in the future. The Company may also experience collection problems related to the enforcement of its lease agreements under foreign local laws and the attendant remedies in such locales. Consequently, the Company is subject to the timing and access to courts and the remedies local laws impose in order to collect its lease payments and recover its assets. In addition, political instability abroad and changes in international policy also present risks associated with expropriation of the Company's leased engines. To date, the Company has experienced limited problems in reacquiring assets; however, there can be no assurance that the Company will not experience more serious problems in the future. Certain countries have no registration or other recording system with which to locally establish the Company's or its lender's interest in the engines and related leases, potentially making it more difficult for the Company to prove its interest in an engine in the event that it needs to recover an engine located in such a country. The Company's engines and the aircraft on which they are installed can be subject to certain foreign taxes and airport fees. Unexpected liens on an engine or the aircraft on which it is installed could be imposed in favor of a foreign entity, such as Eurocontrol or the airports of the United Kingdom. 19
Dependence Upon Availability of Financing The operating lease business is a capital intensive business. The Company's typical operating lease transaction requires a cash investment by the Company of approximately 15% to 20% of the aircraft engine purchase price, commonly known as an "equity investment." The Company's equity investments have historically been financed from internally generated cash, and in the future will include a substantial portion of the net proceeds of the Offering. The balance of the purchase price is typically financed with the proceeds of secured borrowings. Accordingly, the Company's ability to successfully execute its business strategy and to sustain its operations is dependent, in part, on the availability of debt and equity capital. There can be no assurance that the necessary amount of such capital will continue to be available to the Company on favorable terms, or at all. If the Company were unable to continue to obtain any portion of required financing on favorable terms, the Company's ability to add new leases to its portfolio would be limited, which would have a material adverse effect on the Company's business, financial condition and results of operations. Interest Rate Risks The Company's engine leases are generally structured at fixed rental rates for specified terms. As of December 31, 1996, borrowings subject to interest rate risk totaled $40.8 million or 56.4% of the Company's total borrowings. Increases in interest rates could narrow or eliminate the spread, or result in a negative spread, between the rental revenue the Company realizes under its leases and the interest rate that the Company pays under its lines of credit or loans. The Company has purchased an interest rate cap to limit its interest rate exposure; however, there can be no assurance that the Company's business, operating results and financial condition will not be adversely affected during any period of increases in interest rates. Competition In the medium-term engine lease market segment, which is the Company's target market, the Company principally competes with Shannon Engine Services, headquartered in Shannon, Ireland, which is owned in part by SNECMA and CFM International ("CFMI"), and Rolls Royce Finance Ltd. ("Rolls Royce"). Rolls Royce limits its leasing activities to products of its parent company and related parties. The Bank of Tokyo, through its recent acquisition of Engine Lease Finance in Shannon, Ireland, also competes with the Company. Each of these competitors is substantially larger and has greater financial resources than the Company which may permit, among other things, greater access to capital markets at more favorable terms. In addition, major aircraft lessors, including International Lease Finance Corporation and General Electric Capital Aviation Services, compete with the Company to the extent that they include spare engine leases with their aircraft leases. With respect to engine marketing and spare parts and component sales, the Company competes with airlines, aircraft manufacturers, aircraft, engine and parts brokers, and parts distributors. The Company's major competitors include the Allen Aircraft division of AAR Corp., The AGES Group and Aviation Sales Company. Certain of these competitors may have, or may have access to, financial resources substantially greater than the Company. Significant competition encountered by the Company in the future may limit the Company's ability to expand its business, which would have a material adverse effect on the Company's business, financial condition and results of operations. Certain of the Company's competitors have substantially greater resources than the Company, including greater name recognition, larger inventories, a broader range of material, complementary lines of business and greater financial, marketing and other resources. In addition, OEMs, aircraft maintenance providers, FAA certified repair facilities and other aviation aftermarket suppliers may vertically integrate into the aircraft engine leasing or aircraft engine/spare parts sales industry, thereby significantly increasing industry competition. A variety of potential actions by any of the Company's competitors, including a reduction of product prices or the establishment by competitors of long-term relationships with new or existing customers, could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will continue to compete effectively against present and future competitors or that competitive pressures will not have a material adverse effect on the Company's business, financial condition and results of operations. Management of Growth The Company has recently experienced significant growth in revenues. Such growth has placed, and is expected to continue to place, a significant strain on its managerial, operational and financial resources. There can be no assurance that the Company will be able to effectively manage the expansion of its operations, or that the Company's systems, procedures or controls will be adequate to support the Company's operations. Any inability to effectively manage growth, if any, could have a material adverse effect on the Company's business, financial condition and results of operations. 20
Product Liability Risks The Company is exposed to product liability claims in the event that the use of its aircraft engines is alleged to have resulted in bodily injury or property damage. In addition to requiring indemnification under the terms of the lease, the Company requires its lessees to carry the types of insurance customary in the air transportation industry, including comprehensive liability insurance and casualty insurance. The Company is named as an additional insured on liability insurance policies carried by lessees, with the Company's lenders normally identified as the payee for loss and damage to the equipment. The Company monitors compliance with the insurance provisions of the leases. To date, the Company has not experienced any significant uninsured or insured aviation-related claims, and has not experienced any product liability claims related to its aircraft engines. However, an uninsured or partially insured claim, or claim for which third-party indemnification is not available, could have a material adverse effect upon the Company's business, financial condition and results of operations. Risk of Changes in Tax Laws or Accounting Principles The Company's leasing activities generate significant depreciation allowances that provide the Company with substantial tax benefits on an ongoing basis. In addition, the Company's lessees currently enjoy favorable accounting and tax treatment by entering into operating leases. Any change to current tax laws or accounting principles that make operating lease financing less attractive could adversely affect the Company's business, financial condition and results of operations. Dependence on Key Management The Company's business operations are dependent in part upon the expertise of certain key employees. Loss of the services of such employees, particularly Charles F. Willis, IV, Chief Executive Officer or William L. McElfresh, Executive Vice President, would have a material adverse effect on the Company's business. The Company has entered into an employment agreement with Mr. McElfresh and the Company maintains key man life insurance of $2.5 million on each of Messrs. Willis and McElfresh. Government Regulation The Company's customers are generally subject to a high degree of regulation in the various jurisdictions in which they operate. Such regulations also indirectly affect the Company's business operations. Under the provisions of the Federal Aviation Act of 1958, as amended, the FAA exercises regulatory authority over the air transportation industry. The FAA regulates the manufacture, repair and operation of all aircraft engines operated in the United States. Its regulations are designed to insure that all aircraft and aviation equipment are continuously maintained in proper condition to ensure safe operation of the aircraft. Similar rules apply in other countries. All aircraft must be maintained under a continuous condition monitoring program and must periodically undergo thorough inspection and maintenance. The inspection, maintenance and repair procedures for the various types of aircraft equipment are prescribed by regulatory authorities and can be performed only by certified repair facilities utilizing certified technicians. Certification and conformance is required prior to installation of a part on an aircraft. Presently, whenever necessary with respect to a particular engine or engine component, the Company utilizes FAA and/or Joint Aviation Authority certified repair stations to repair and certify engines and components to ensure worldwide marketability. The FAA can suspend or revoke the authority of air carriers or their licensed personnel for failure to comply with regulations and ground aircraft if their airworthiness is in question. In addition, by the year 2000, federal regulations will stipulate that all aircraft engines hold, or be capable of holding, a noise certificate issued under Chapter 3 of Volume 1, Part II of Annex 16 of the Chicago Convention, or have been shown to comply with Stage III noise levels set out in Section 36.5 of Appendix C of Part 36 of the Federal Aviation Regulations of the United States. Control by Principal Shareholder The Company's principal shareholder, Mr. Willis, beneficially owns approximately 57.3% of the outstanding shares of Common Stock of the Company and therefore effectively controls the Company. Accordingly, Mr. Willis has the power to contest the outcome of substantially all matters, including the election of the Board of Directors of the Company, submitted to the shareholders for approval. In addition, future sales by the Company's principal shareholder of substantial amounts of Common Stock, or the potential for such sales, could adversely effect the prevailing market price of the Common Stock. 21
Possible Volatility of Stock Price and Shares Eligible for Future Sale The market price of the Common Stock could be subject to significant fluctuations in response to operating results of the Company, changes in general conditions in the economy, the financial markets, the airline industry, changes in accounting principles or tax laws applicable to the Company or its lessees, or other developments affecting the Company, its customers or its competitors, some of which may be unrelated to the Company's performance, and changes in earnings estimates or recommendations by securities analysts. As of March 21, 1997, the Company had 5,426,793 shares of Common Stock outstanding. Of those shares, 2,300,000 shares of Common Stock are freely tradeable without restriction or further registration under the Securities Act of 1933, as amended (the "Securities Act"). The remaining 3,126,793 shares were issued by the Company in private transactions prior to the Offering in 1996 and are "restricted securities" as that term is defined in Rule 144 and are tradeable subject to compliance with Rule 144. The Company is unable to predict the effect, if any, that future sales of shares, or the availability of shares for future sale, will have on the market price for the Common Stock prevailing from time to time. Sales of substantial amounts of Common Stock, or the perception that such sales could occur, could adversely affect market prices for the Common Stock and could impair the Company's future ability to obtain capital through an offering of equity securities. Anti-Takeover Provisions Certain provisions of law, and the Company's Articles of Incorporation and Bylaws, could make more difficult the acquisition of the Company by means of a tender offer, a proxy contest or otherwise, and the removal of incumbent officers and directors. These provisions include authorization of the issuance of up to 5,000,000 shares of Preferred Stock, with such characteristics that may render it more difficult or tend to discourage a merger, tender offer or proxy contest. The Company's Articles of Incorporation also provide that, for as long as the Company has a class of stock registered pursuant to the Exchange Act of 1934, as amended (the "Exchange Act"), shareholder action can be taken only at an annual or special meeting of shareholders and may not be taken by written consent. The Company's Bylaws also limit the ability of shareholders to raise matters at a meeting of shareholders without giving advance notice. In addition, upon qualification of the Company as a "listed corporation" as defined in Section 301.5(d) of the California Corporation Code, cumulative voting will be eliminated. These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids, and to encourage persons seeking to acquire control of the Company to negotiate first with the Company. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is submitted as a separate section of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 22
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is incorporated by reference to the Company's Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the Company's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the Company's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the Company's Proxy Statement. 23
PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) and (2): Financial Statements and Financial Schedules: The response to this portion of Item 14 is submitted as a separate section of this report beginning on page 28. (a) (3) and (c): Exhibits: The response to this portion of Item 14 is submitted as a separate section of this report beginning on page 25. (b) Reports on Form 8-K: The Company filed no reports on Form 8-K during the last quarter of 1996. 24
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Exhibit Number Description -------------- ----------- 3.1 Articles of Incorporation. Incorporated by reference to Exhibit 3.1 to Registration Statement No. 333-5126-LA filed on June 21, 1996 3.2 Amended and Restated Articles of Incorporation, filed September 11, 1996, together with Certificate of Amendment of Amended and Restated Articles of Incorporation filed on September 24, 1996. 3.3 Bylaws. Incorporated by reference to Exhibit 3.3 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 4.1 Specimen of Common Stock Certificate. Incorporated by reference to Exhibit 4.1 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.1 1996 Stock Option/Stock Issuance Plan and form of agreement thereunder. Incorporated by reference to Exhibit 10.1 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.2 Employee Stock Purchase Plan. Incorporated by reference to Exhibit 10.2 to Registration Statement No. 333-5126- LA filed on June 21, 1996. 10.3 Form of Indemnification Agreement entered into between the Company and its directors and officers. Incorporated by reference to Exhibit 10.3 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.4 Lease dated May 23, 1995 for facilities located in South San Francisco, California, together with amendment thereto dated March 18, 1996. Incorporated by reference to Exhibit 10.4 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.5 Lease dated February 4, 1997, between Atlas Metal Spinning Company and Willis Aeronautical Services, Inc., for an office and a warehouse facility located in South San Francisco. 25
10.6 Lease dated March 16, 1992 for facilities located in Sausalito, California, together with amendments thereto. 10.7 Employment Agreement between the Company and William McElfresh. Incorporated by reference to Exhibit 10.5 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.8 Employment Agreement between the Company and Steven Oldenburg. Incorporated by reference to Exhibit 10.6 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.9 Legal Services Agreement between the Company and John Votruba. Incorporated by reference to Exhibit 10.7 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.10 Assignment and Assumption of Leases and Purchase and Sale of Engines Agreement, dated September 11, 1992 between Terandon Leasing Corporation and International Lease Finance Corporation. Incorporated by reference to Exhibit 10.8 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.11 Engine Loan Agreement dated April 22, 1994, between T-5, Inc. and Ryoshin Leasing (USA) Inc. Incorporated by reference to Exhibit 10.11 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.12 Loan Agreement dated March 1, 1994 between T-7 Inc. and Heller Financial Inc. Incorporated by reference to Exhibit 10.12 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.13 Loan Agreement dated April 1, 1994 between T-7 Inc. and Heller Financial Inc. Incorporated by reference to Exhibit 10.13 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.14 Secured Loan Agreement dated December 29, 1995 between T-10, Inc. and Finova Capital Corporation. Incorporated by reference to Exhibit 10.14 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.15 Credit Agreement dated June 30, 1995 between the Company and Svenska Finans International BV. Incorporated by reference to Exhibit 10.15 to Registration Statement No. 333-5126-LA filed on June 21, 1996. 10.16 Loan Agreement dated January 28, 1997, together with related documents. 10.17 Loan Agreement dated November 6, 1996, between Willis Aeronautical Services, Inc. and The Pacific Bank, N.A., together with related documents. 11.1 Statement regarding computation of per share earnings. 21.1 Subsidiaries of the Company. Incorporated by reference to Exhibit 21.1 to Registration Statement No. 333-5126- LA filed on June 21, 1996. 23.1 Consent of KPMG Peat Marwick, LLP 27.1 Financial Data Schedule 26
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. March 31, 1996 Willis Lease Finance Corporation By: /s/ CHARLES F. WILLIS, IV --------------------------------- Charles F. Willis, IV Chairman of the Board, President, and Chief Executive Officer <TABLE> Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the followings persons on behalf of the Registrant and in the capacities and on the dates indicated. <CAPTION> Date Title Signature ---- ----- --------- <S> <C> <C> <C> Date: March 31, 1997 Chief Executive Officer /s/ CHARLES F. WILLIS, IV (Principal Executive Officer) --------------------- Charles F. Willis, IV Date: March 31, 1997 Executive Vice President and /s/ WILLIAM L. McELFRESH Director -------------------- William L. McElfresh Date: March 31, 1997 Chief Financial Officer and /s/ ELLIOT M. FISCHER Chief Accounting Officer ----------------- (Principal Financial and Elliot M. Fischer Principal Accounting Officer) Date: March 31, 1997 Director /s/ ROSS K. ANDERSON ---------------- Ross K. Anderson Date: March 31, 1997 Director /s/ WILLIAM M. LEROY ---------------- William M. LeRoy Date: March 31, 1997 Director /s/ WILLARD H. SMITH, JR -------------------- Willard H. Smith, Jr. </TABLE> 27
<TABLE> <CAPTION> WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES FORM 10-KSB Item 8, 14(a), and 14(c) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES <S> <C> Report of Independent Accountants Page 29 Consolidated Balance Sheets as of December 31, 1996 and December 31, 1995. Page 30 Consolidated Statements of Income for the years ended December 31, 1996, December 31, 1995 and December 31, 1994. Page 31 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, December 31, 1995 and December 31, 1994. Page 32 Consolidated Statements of Cash Flows for the years ended December 31, 1996, December 31, 1995 and December 31, 1994. Page 33 Notes to Consolidated Financial Statements Page 34 </TABLE> All other financial statement schedules have been omitted as the required information is not pertinent to the Registrant or is not material or because the information required is included in the financial statements and notes thereto. 28
REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of Willis Lease Finance Corporation and Subsidiaries We have audited the accompanying consolidated balance sheets of Willis Lease Finance Corporation and subsidiaries (formerly Charles F. Willis Company) (the "Company") as listed in the accompanying index. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We have conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Willis Lease Finance Corporation and subsidiaries (formerly Charles F. Willis Company) as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in Note 1 to the Consolidated Financial Statements, the Company changed its method of computing depreciation in 1995. KPMG PEAT MARWICK LLP San Francisco, California March 6, 1997 29
<TABLE> WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets <CAPTION> December 31, ------------------------------ 1996 1995 ------------- ------------- <S> <C> <C> ASSETS Cash and cash equivalents $ 6,573,241 $ 815,649 Deposits 13,600,204 11,320,617 Aircraft engines held for operating lease, less accumulated 93,131,972 74,704,379 depreciation of $16,372,418 in 1996 and $13,681,211 in 1995 Aircraft engines on capital lease 2,960,457 -- Property, equipment and furnishings, less accumulated 458,780 207,784 depreciation of $160,407 in 1996 and $86,695 in 1995 Spare parts inventory 4,057,648 2,916,003 Maintenance billings receivable 1,107,283 408,454 Operating lease rentals receivable 405,601 73,658 Receivables from spare parts sales 854,566 772,474 Other receivables 829,522 10,481 Other assets 953,419 207,894 ------------- ------------- $ 124,932,693 $ 91,437,393 Total assets ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: $ 2,753,641 $ 1,052,455 Accounts payable and accrued expenses Salaries and commissions payable 538,658 163,961 Deferred income taxes 5,949,676 4,092,325 Deferred gain 209,774 -- Notes payable and accrued interest 73,185,657 69,910,797 Capital lease obligation 2,960,457 -- Residual share payable 1,199,279 476,526 Maintenance deposits 11,680,525 8,717,170 Security deposits 1,978,505 1,270,021 Unearned lease revenue 1,274,269 857,087 ------------- ------------- $ 101,730,441 $ 86,540,342 Total liabilities Minority interest in net assets of subsidiary -- 84,774 Shareholders' equity: Common stock, no par value. Authorized 20,000,000 and 10,000 shares; 5,426,793 and 1,500 issued and outstanding at December 31, 1996 and 1995, respectively 16,055,689 500 Retained earnings 7,146,563 5,293,566 Advances to shareholders -- (481,789) ------------- ------------- Total shareholders' equity 23,202,252 4,812,277 ------------- ------------- $ 124,932,693 $ 91,437,393 Total liabilities and shareholders' equity ============= ============= <FN> See accompanying notes to the consolidated financial statements </FN> </TABLE> 30
<TABLE> WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Consolidated Statements of Income <CAPTION> Years ended December 31, ------------------------------------------- 1996 1995 1994 ------------ ------------ ------------ <S> <C> <C> <C> REVENUE Operating lease revenue $ 13,740,438 $ 13,770,730 $ 13,635,934 Gain (loss) on sale of leased engines 2,208 (482,894) 632,578 Spare part sales 5,842,607 3,858,610 795,262 Sale of equipment acquired for resale 12,105,315 5,472,362 2,184,000 Interest and other income 617,144 119,188 541,900 ------------ ------------ ------------ Total revenue 32,307,712 22,737,996 17,789,674 EXPENSES Interest expense 4,323,276 5,721,811 5,947,843 Depreciation expense 3,181,216 4,703,487 4,447,082 Residual share 722,753 407,684 1,284,523 Cost of spare part sales 3,307,928 2,545,872 658,864 Cost of sold equipment acquired for resale 10,788,730 2,742,262 1,863,000 General and administrative 5,123,813 3,334,768 1,615,585 ------------ ------------ ------------ Total expenses 27,447,716 19,455,884 15,816,897 Gain on modification of credit facility -- 2,202,928 -- ------------ ------------ ------------ Income before income taxes and minority interest 4,859,996 5,485,040 1,972,777 Income taxes (1,976,471) (2,212,280) (797,159) ------------ ------------ ------------ Income before minority interest 2,883,525 3,272,760 1,175,618 Less: minority interest in net income of subsidiary (79,053) (56,343) (3,431) ------------ ------------ ------------ Net income $ 2,804,472 $ 3,216,417 $ 1,172,187 ============ ============ ============ Net income per share (pro forma for 1995 and 1994) 0.74 1.03 0.38 ============ ============ ============ Weighted average number of shares outstanding 3,796,182 3,110,657 3,110,657 ============ ============ ============ <FN> See accompanying notes to the consolidated financial statements </FN> </TABLE> 31
<TABLE> WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity Years ended December 31, 1996, 1995 and 1994 <CAPTION> Issued and outstanding Advances Total shares of Common Retained to shareholders' common stock stock earnings shareholders equity (deficit) ------------ ----- -------- ------------ ---------------- <S> <C> <C> <C> <C> <C> Balances at December 31, 1994 1,500 $ 500 $2,332,149 ($373,845) $1,958,804 Advances to shareholders, net of repayments -- -- -- (107,944) (107,944) Dividends -- -- (255,000) -- (255,000) Net income -- -- 3,216,417 -- 3,216,417 --------- ----------- ---------- ------- ----------- Balances at December 31, 1995 1,500 500 5,293,566 (481,789) 4,812,277 Common stock issue and proceeds from IPO, net 5,425,293 16,055,189 -- -- 16,055,189 Advances to shareholders, net of repayments -- -- -- 481,789 481,789 Dividends -- -- (951,475) -- (951,475) Net income -- -- 2,804,472 -- 2,804,472 --------- ----------- ---------- ------- ----------- Balances at December 31, 1996 5,426,793 $16,055,689 $7,146,563 $ -- $23,202,252 ========= =========== ========== ======= =========== <FN> See accompanying notes to the consolidated financial statements. </FN> </TABLE> 32
<TABLE> WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows <CAPTION> Years ended December 31, ------------------------------------------- 1996 1995 1994 ------------ ------------ ------------ <S> <C> <C> <C> Cash flows from operating activities: Net income $ 2,804,472 $ 3,216,417 $ 1,172,187 Adjustments to reconcile income to net cash provided by (used in) operating activities: Depreciation of aircraft engines held for operating lease 3,103,601 4,663,949 4,431,039 Depreciation of property, equipment and furnishings 77,615 39,538 16,043 Gain on modification on credit facility -- (2,202,928) -- Loss (gain) on sale of property, equipment, furnishings 5,701 (5,536) (1,530) Loss (gain) on sale of aircraft engines (2,208) 482,894 (632,578) Increase in residual share payable 722,753 407,684 1,284,523 Minority interest in net income of subsidiary 79,053 56,343 3,431 Changes in assets and liabilities: (Increase) in deposits (2,279,587) (11,061,221) (56,564) (Increase) in spare parts inventory (1,176,384) (940,494) (100,871) (Increase) in receivables (1,931,905) (359,173) (538,921) (Increase) decrease in other assets (745,525) 54,785 (67,248) Increase in accounts payable and accrued expenses 1,701,186 606,656 239,797 Increase in salaries and commission payable 374,697 77,201 46,760 Increase in deferred income taxes 1,857,351 2,179,381 791,559 Increase in deferred gain on sale of aircraft engine 209,774 -- -- Increase (decrease) in accrued interest 666,571 (341,379) 259,918 Increase in maintenance deposits 2,963,355 3,294,179 1,637,050 Increase in security deposits 708,484 124,444 407,697 Increase in unearned lease revenue 417,182 243,726 44,702 ------------ ------------ ------------ Net cash provided by operating activities 9,556,186 536,466 8,936,994 Cash flows from investing activities: Proceeds from sale of aircraft engines (net of selling expenses) 3,748,035 2,600,000 2,000,644 Proceeds from sale of property, equipment and furnishings 28,198 38,500 3,000 Purchase of aircraft engines held for operating lease (25,277,021) (9,258,379) (17,634,027) Purchase of property, equipment and furnishings (362,510) (194,403) (62,603) ------------ ------------ ------------ Net cash (used in) investing activities (21,863,298) (6,814,282) (15,692,986) Cash flows from financing activities: Repayments from ( advances to ) shareholder, net 481,789 (107,944) (18,827) Proceeds from issuance of notes payable 16,086,621 15,730,277 19,300,445 Proceeds from issuance of common stock 15,926,101 -- -- Principal payments on notes payable (13,478,332) (9,337,852) (11,473,474) Cash dividends paid on common stock (951,475) (255,000) (345,280) Minority interest in net assets of subsidiary -- -- 25,000 ------------ ------------ ------------ Net cash provided by financing activities 18,064,704 6,029,481 7,487,864 Increase (decrease) in cash and cash equivalents 5,757,592 (248,335) 731,872 Cash and cash equivalents at beginning of period 815,649 1,063,984 332,112 ------------ ------------ ------------ Cash and cash equivalents at end of period $ 6,573,241 $ 815,649 $ 1,063,984 ============ ============ ============ <FN> See accompanying notes to the consolidated financial statements </FN> </TABLE> 33
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Organization and Summary of Significant Accounting Policies (a) Organization Willis Lease Finance Corporation (formerly Charles F. Willis Company) (Willis) is a California corporation which began leasing operations in 1988. Willis is a provider of operating leases of spare commercial aircraft engines worldwide. Willis is primarily engaged in acquiring aftermarket commercial aircraft, spare engines and providing operating leases of such engines to foreign and domestic airlines, manufacturers and overhaul/repair facilities. Terandon Leasing Corporation (Terandon), T-2 Inc. (T-2), T-4 Inc. (T-4), T-5 Inc. (T-5), T-7 Inc. (T-7), T-8 Inc. (T-8) and T-10 Inc. (T-10) are wholly-owned subsidiaries of Willis. They are all California corporations and were established to purchase and lease commercial aircraft engines. Terandon, T-2 and T-5 were incorporated in 1986, 1991 and 1993, respectively, T-7 and T-8 were both incorporated in 1994, and T-10 was incorporated in 1995. T-4 was acquired by Willis in 1996 and was incorporated in 1993. Willis Aeronautical Services, Inc. (WASI) is a wholly-owned subsidiary of Willis. WASI is a California corporation established in 1994 for the purpose of commercial aircraft, airframe and powerplant component marketing and sales. (b) Principles of Consolidation The consolidated financial statements include the accounts of Willis, Terandon, T-2, T-4, T-5, T-7, T-8, T-10, and WASI (together, the Company). Minority interest includes a twenty percent minority interest in WASI which was acquired by the Company on September 18, 1996 through the issuance of $129,088 in Common Stock. All significant intercompany balances and transactions have been eliminated in consolidation. (c) Advances to Shareholder The advances to the sole shareholder are noninterest bearing (except for a $10,000 interest bearing note). All such notes were repaid in 1996. Advances are accounted for through a reduction of shareholders' equity. (d) Revenue Recognition Revenue from leasing of aircraft engines is recognized as operating lease revenue over the terms of the applicable lease agreements. The Company includes in operating lease revenue non-refundable maintenance payments received from lessees to the extent that, in the Company's opinion, it would not be economically advantageous to overhaul the engine the next time the life-limited parts need to be replaced. In this circumstance, the engines are normally dismantled and sold as parts. (e) Aircraft Engines Held for Operating Lease and Capital Lease Aircraft engines held for operating lease are stated at cost, less accumulated depreciation. Certain professional fees incurred in connection with the acquisition of aircraft engines are capitalized as part of the cost of the engines. Effective January 1, 1995, the Company changed its depreciation policy with respect to engines on long-term lease and has restated its previously issued financial statements. Previously, the Company depreciated such assets on a straight line basis over their estimated useful life of 25 years to a salvage value of 15%. The Company has changed its methodology to depreciate the engine on a straight line basis over a 15 year period from the acquisition date to a 55% residual value. The Company believes that this methodology more accurately reflects the Company's typical holding period for the assets and, further, that the residual value assumption reasonably approximates the selling price of the assets in 15 years from date of acquisition. The effect of this change in accounting principle was a reduction of depreciation expense of $357,999 and $405,657 for the years ended December 31, 1995 and 1994, respectively. 34
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) This change in accounting principle also resulted in an increase in net loss on sale of leased aircraft engines of $48,237 in 1995 and a reduction in net gain on sale of leased aircraft engines of $176,788 in 1994. Engines that in the Company's opinion would not be economically advantageous to overhaul the next time the life-limited parts need to be replaced, are depreciated over the remaining life using component depreciation based on usage as reported monthly by the lessees. In March of 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," (SFAS 121). SFAS 121 requires that (i) long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable and (ii) long-lived assets and certain identifiable intangibles to be disposed of generally be reported at the lower of carrying amount or fair value less cost to sell. The Company adopted SFAS 121 in 1995 and reviewed the carrying value of its equipment considering residual values and release rates. This review resulted in a loss on revaluation related to one engine of $300,000 in 1995, which has been included in depreciation expense. There were no write-downs required during 1996. (f) Spare Parts Inventory The Company, through one or more of its subsidiaries, buys used aircraft spare parts for resale. This inventory is valued at the lower of cost or market value. Costs of such sales are specifically identified. (g) Loan Commitment and Related Fees To the extent that the Company is required to pay loan commitment fees in order to secure debt, such fees are amortized over the life of the related loan on a straight-line basis. (h) Maintenance Costs Maintenance costs under the Company's long-term leases are generally the responsibility of the lessees. Maintenance deposits in the accompanying balance sheet include refundable maintenance payments and certain non-refundable maintenance payments received from the lessees. If in the Company's opinion, it would not be economically advantageous to overhaul the engine the next time the life-limited parts need to be replaced, the maintenance fees are included in operating lease revenue. Major overhauls paid for by the Company are capitalized and depreciated over the estimated remaining useful life of the engine. (i) Interest Rate Hedge In 1996, the Company purchased an interest rate cap in order to hedge its exposure to increases in interest rates on a portion of its variable rate borrowings. The instrument minimizes the Company's exposure to interest rate fluctuations for a period of four years. The cost of this instrument is amortized on a straight-line basis over the four year period. (j) Income Taxes The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in the tax rates is recognized in income in the period that includes the enactment date. (k) Property, Equipment and Furnishings Property, equipment and furnishings are recorded at cost and depreciated by the straight-line method over the estimated useful lives of the related assets, which range from three to seven years. 35
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (l) Residual Sharing with Lenders Certain of the Company's credit agreements require the Company to share "residual proceeds" as defined in the agreements with the lenders upon sale of engines held for operating lease. The Company provides for its residual sharing obligation with respect to each engine by a charge or credit to income or expense, each period, sufficient to adjust the residual share payable at the balance sheet date to the amount that would be payable at that date if all engines under said agreements were sold on the balance sheet date at their net book values. Residual share payable totaled $1,199,279 and $476,526 as of December 31, 1996 and 1995, respectively. As of December 31, 1996 and 1995, a total of six and nine engines, respectively, with a net book value of $16,457,439 and $17,866,935, respectively, were subject to residual value arrangements (notes 4, 5 and 14). (m) Equipment Acquired for Resale The Company periodically engages in transactions involving the purchase and immediate resale of aircraft engines. Generally, the Company makes a contractual commitment to purchase specific assets for its own account for resale only after or concurrently with obtaining a firm order from a customer. All aircraft engines purchased by the Company for such transactions during 1996 and 1995 were sold in the year acquired. (n) Reclassifications Certain items in the consolidated financial statements of prior years have been reclassified to conform to the current year's presentation. (o) Management Estimates These financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. This requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. (p) Per share information Per share information is computed using the weighted average number of common and diluted common equivalent shares outstanding. For primary and fully diluted earnings per share, common equivalent shares consist of the incremental shares issued upon the assumed exercise of diluted stock options, using the treasury stock method. 36
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (2) Aircraft Engines Held For Operating Lease At December 31, 1996, the Company owned 31 aircraft engines and related equipment with an aggregate original cost of $109,504,390. At December 31, 1995, the Company owned 31 aircraft engines with an aggregate original cost of $88,385,590. As of December 31, 1996, minimum future rentals under the noncancelable operating leases of these aircraft engines are as follows: 1997 ................................... $13,845,290 1998 ................................... 10,828,463 1999 ................................... 7,423,338 2000 ................................... 5,736,712 2001 ................................... 2,926,444 Thereafter ............................. 2,021,000 ----------------- $42,781,247 ================= Approximately 90% of these future rentals will be applied to service principal and interest payments on outstanding notes payable (notes 5 and 14). Contingent rentals included in operating lease revenue totaled $266,000, $362,000 and $145,000 for the years ended December 31, 1996, 1995 and 1994, respectively. Certain of the Company's aircraft engines are leased and operated internationally. All leases relating to this equipment are denominated and payable in U.S. dollars. <TABLE> The Company leases its aircraft engines to lessees domiciled in seven geographic regions: United States, Canada, Mexico, Australia/New Zealand, Europe, South America and Asia. The tables below set forth geographic information about the Company's aircraft engines grouped by domicile of the lessee: <CAPTION> Region Years ended December 31, -------------------------------------------------------- 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Operating lease revenue: United States $5,295,084 $4,560,472 $4,851,286 Canada 1,291,000 1,080,000 964,666 Mexico 1,865,118 1,900,699 1,178,474 Australia/New Zealand 1,029,600 1,339,433 1,689,600 Europe 2,840,428 3,858,792 2,762,629 South America 530,000 308,316 716,575 Asia 889,208 723,018 1,472,704 -------------------------------------------------------- Total operating lease revenue $13,740,438 $13,770,730 $13,635,934 ======================================================== </TABLE> 37
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) <TABLE> (2) Aircraft Engines Held for Operating Lease (Continued) <CAPTION> Years ended December 31, -------------------------------------------------------------- Region 1996 1995 1994 - ------ ---- ---- ---- <S> <C> <C> <C> Operating lease revenue less depreciation, interest, spare parts interest and residual share: United States $2,405,061 $463,336 $275,681 Canada 548,769 301,039 185,746 Mexico 306,007 348,900 307,843 Australia/New Zealand 471,293 271,355 410,112 Europe 1,409,631 1,521,563 675,408 South America 185,297 77,569 82,059 Asia 339,545 185,196 125,121 Off-lease and other (60,711) (231,210) (105,484) -------------------------------------------------------------- Total operating lease revenue less depreciation, interest, spare parts interest and residual share $5,604,892 $2,937,748 $1,956,486 ============================================================== Years ended December 31, -------------------------------------------------------------- Region 1996 1995 1994 - ------ ---- ---- ---- Net book value of engines: United States $31,352,388 $24,138,266 $23,601,123 Canada 7,115,984 7,356,011 7,596,038 Mexico 13,441,445 9,255,029 9,506,072 Australia/New Zealand 5,509,070 5,706,410 9,332,036 Europe 30,051,738 19,056,190 16,921,539 South America 2,033,831 1,951,012 4,829,647 Asia 4,109,446 4,243,830 7,202,126 Off-lease 2,498,527 2,997,631 -- -------------------------------------------------------------- Total net book value of engines owned and on Capitol Lease $76,092,429 $74,704,379 $78,988,581 ============================================================== </TABLE> 38
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (3) Property, Equipment and Furnishings Property, equipment and furnishings consist of the following: As of December 31, ------------------------------ 1996 1995 ---- ---- Automobiles $140,297 $36,049 Computer equipment 186,272 93,726 Furniture and equipment 292,618 164,704 ------------------------------ 619,187 294,479 Accumulated depreciation (160,407) (86,695) ------------------------------ Net book value $458,780 $207,784 ============================== (4) Gain on Modification of Credit Facility In June 1995, the Company's primary credit facility was modified into a 10 year full payout loan. As part of this transaction, the residual sharing agreement was terminated. Furthermore, the lender agreed to acquire two engines from the portfolio, with a net book value of $5,724,045, as payment in full for the respective outstanding loan balance on each of the engines. The modification resulted in a net gain of $2,202,928. <TABLE> (5) Notes Payable and Accrued Interest Notes payable consisted of the following: <CAPTION> As of December 31, --------------------------------- 1996 1995 ---- ---- <S> <C> <C> Notes payable with an interest rate of LIBOR plus 1%. Secured by aircraft engines and rental payments on leased aircraft engines. The loan requires quarterly payments in arrears, through June 30, 2005. This note is the result of the credit modification (notes 4 and 14). $44,221,306 $48,400,889 Notes payable with fixed interest rates ranging between 8% and 10%. Secured by aircraft engines and rental payments on leased aircraft engines. These notes mature in 1998 or are due upon the sale of the collateral property. 5,982,236 6,513,190 Notes payable with an interest rate of LIBOR plus 5%. Secured by aircraft engines and rental payments on leased aircraft engines. The notes mature in the year 2001 or are due upon the sale of the collateral property. 5,189,286 6,617,509 Notes payable for a spare parts purchase. Interest accrued at 8% on the unpaid balance. This note was secured by the spare parts. The note matured in August 1996. -- 1,332,641 </TABLE> 39
<TABLE> WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) <CAPTION> As of December 31, ------------------------------------- 1996 1995 ---- ---- <S> <C> <C> Notes payable at an interest rate of 11.03%. Secured by aircraft engines. The notes mature on December 29, 2000. 3,128,943 3,360,000 Note payable at an interest rate of 11.68%. Secured by an aircraft engine. The note matures on December 31, 2001. This note and the preceding 11.03% notes are part of a $15 million secured term facility for the acquisition of engines. 2,368,242 -- Note payable at a fixed interest rate of 9.0%. Secured by aircraft engines and subordinated to the $3,128,943 note discussed above. -- 420,000 Notes payable with variable interest rate of LIBOR plus 1.5% secured by four engines. Fixed principal payments plus interest are made monthly, and the notes have maturity dates ranging from August 1996 through July 1997. 325,000 1,358,333 Note payable, secured by two engines. The note was noninterest bearing beginning August, 1996 at the Paris Interbanking Operations Rate plus 2% and was paid on December 30, 1996. -- 1,395,874 Capital line of credit extended to WASI not to exceed $1,000,000. Interest accrued at prime plus 1%, with repayment terms of interest only for 6 months. The loan was secured by all of the assets of WASI. This facility expired on October 31, 1996. -- 282,139 Capital line of credit extended to WASI for $3,000,000. Interest accrues at prime plus 1%, with repayment terms of interest only for 6 months. The loan is secured by all of the assets of WASI. This facility expires on October 31, 1997. 661,000 -- Notes payable to two employees of the Company ($25,000 of the notes at 8% interest). The remaining balance was noninterest bearing and both notes were paid on September 18, 1996. -- 50,000 Short-term bridge note with an interest rate of 7%. Secured by aircraft engines and spare parts purchased 12/31/96. The note matures on January 31, 1997 (note 14). 8,632,313 -- Note payable at a fixed interest rate of 7%. Secured by aircraft engines and spare parts. This note is subordinated to the bridge note discussed above and also to the permanent notes replacing the bridge note. The note matures on June 30, 2004. 1,830,538 -- ===================================== $72,338,864 $69,730,575 ===================================== </TABLE> 40
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) The Company also has a $15.0 million term facility for the acquisition of engines for lease. This term facility allows for an advance rate of 80% of fair market value of the equipment, not to exceed 100% of the purchase price. The facility is to be used for domestic lessees. Interest rate under this facility will be dependent upon the quality of the credit and the underlying collateral. As of December 31, 1996, no drawdowns had taken place under this facility. The fair value of the Company's long-term debt is estimated based on 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. The fair value of the Company's debt is estimated by the Company to be $72,202,487 at December 31, 1996. The fair value of the interest rate cap as estimated by the financial institution providing the instrument is $266,257 at December 31, 1996. In accordance with three of the loan agreements, the Company must maintain certain net worth levels and, additionally, with respect to one of these loans, must maintain a certain current ratio and certain earnings levels. In addition, the Company must prepay loan amounts in the event a collateral engine is sold or otherwise disposed of. Repayment schedules as of December 31, 1996 for the notes payable for each of the next five years are presented below. A substantial amount of operating lease revenue is applied to the repayment of principal and interest. Principal outstanding at December 31, 1996 is repayable as follows: Year ---- 1997 ................................... $14,516,505 1998 ................................... 10,194,820 1999 ................................... 4,492,805 2000 ................................... 7,920,608 2001 ................................... 12,667,933 Thereafter ............................. 22,546,193 ----------------- Total .................................. $72,338,864 ================= As of December 31, 1996 and 1995, accrued interest in the amounts of $846,793 and $180,222, respectively, is included in notes payable and accrued interest. At December 31, 1996 and 1995, the Company held deposits in the amount of $13,600,204 and $11,320,617, respectively, consisting of bank accounts that are subject to withdrawal restrictions as per lease or loan agreements. The deposits received in prior years are reflected as a reduction of the note payable balance in accordance with the terms of the previous loan agreement (note 4). Certain lease agreements require prepayments to the Company for periodic engine maintenance. In addition, this account includes security deposits held. Substantially all of the deposits bear interest for the Company's benefits. In February 1997, the Company obtained a new credit facility for $41.5 million and repaid the $44.2 million existing note payable (note 14). In February 1997, the Bridge Loan noted in above was replaced with permanent financing in the amount of $11,010,875. This financing has an interest rate of 10.52% and has a maturity date of January 30, 2002 (note 14). 41
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (6) Income Taxes Federal State Total ------- ----- ----- December 31, 1996 Current $93,864 $25,256 $119,120 Deferred 1,580,360 276,991 1,857,351 -------------------------------------------------------- $1,674,224 $302,247 $1,976,471 ======================================================== December 31, 1995 Current $25,833 $7,066 $32,899 Deferred 1,670,220 509,161 2,179,381 -------------------------------------------------------- $1,696,053 $516,227 $2,212,280 ======================================================== December 31, 1994 Current $0 $5,600 $5,600 Deferred 612,877 178,682 791,559 -------------------------------------------------------- $612,877 $184,282 $797,159 ======================================================== The following is a reconciliation of the statutory federal income tax expense to the effective income tax expense: Years ended December 31, ------------------------------------ 1996 1995 1994 ---- ---- ---- Statutory federal income tax expense $1,652,397 $1,864,914 $ 670,744 State taxes, net of federal benefit 298,307 340,710 121,626 Other 25,767 6,656 4,789 ------------------------------------ Effective income tax expense $1,976,471 $2,212,280 $ 797,159 ==================================== 42
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (6) Income Taxes (Continued) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below: As of December 31, ---------------------------- 1996 1995 ---- ---- Deferred tax assets: Prepaid rent $ 511,466 $ 344,018 Residual sharing expenses 481,367 191,268 Uniform capitalization expenses 48,166 26,394 Other 7,462 2,403 Passive activity loss carryforwards 6,185,615 4,325,565 ----------- ---------- Total gross deferred tax assets 7,234,076 4,889,648 Less valuation allowances -- -- ----------- ---------- Net deferred tax assets 7,234,076 4,889,648 Deferred tax liabilities: Depreciation on aircraft engines (13,183,752) (8,981,973) ----------- ---------- Net deferred tax liability (5,949,676) (4,092,325) =========== ========== As of December 31, 1996 the Company has passive activity loss carryforwards totaling $17,706,748 for federal and $2,693,391 for state income tax purposes which have no expiration date and will be available to offset future passive revenue. (7) Supplementary Disclosures of Cash Flow Information During the years ended December 31, 1996 and 1995, the Company paid interest totaling $3,656,707 and $6,063,190, respectively. Income taxes paid were $31,552 and $13,218 for the years ended December 31, 1996 and 1995. During the years ended December 31,1996, 1995 and 1994, the Company made loans of $265,478, $165,635 and $19,600 to a Company shareholder. Repayments on such loans for the years ended December 31, 1996, 1995 and 1994 were $747,267, $57,691 and $773, respectively. The outstanding balance as of December 31, 1996 and 1995 were $0 and $481,789, respectively. (8) Dividends During the years ended December 31, 1996 and 1995, the Company paid dividends totaling $951,475 and $255,000 to a Company shareholder, respectively. 43
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (9) Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash deposits and receivables. The Company places its cash deposits with financial institutions and other creditworthy issuers and limits the amount of credit exposure to any one party. Concentrations of credit risk with respect to lease receivables are limited due to the large number of customers comprising the Company's customer base, and their dispersion across different geographic areas. As of December 31, 1996 and 1995, management believes the Company had no significant concentrations of credit risk. For the years ended December 31, 1996, the Company had one significant customer, Aerovias Mexico, S.A. de C.V., which accounted for approximately 14 % of lease revenue. The Company does not believe that the loss of this customer would have a material impact on its operations. (10) Commitments The Company has two leases for its office and warehouse space. The annual lease rental commitments are $123,408 and $124,692 and the leases expire on March 14, 1999 and May 31, 1998, respectively. Maturities of capital lease obligation as of December 31, 1996 are as follows: 1997............................................ $ 376,536 1998............................................. 376,536 1999............................................. 376,536 2000............................................. 376,536 2001............................................. 376,536 Thereafter....................................... $2,568,841 ----------- Net Minimum Lease Payments $4,451,521 Less: Amount Representing Interest (1,491,064) ----------- Present Value of Net Minimum Lease Payments $2,960,457 =========== (11) Related party transaction During 1996, the Company had a note payable to two employees of the Company, who were minority shareholders of a subsidiary of the company. This amount was repaid in September of 1996. (12) Security deposit and maintenance reserve In connection with the Bridge Loan (note 4) for the purchase of an engine and parts package, the Company recorded a liability for maintenance reserves and security deposits relating to such equipment and a corresponding receivable from the seller. These funds continued to be held by the seller until permanent financing was in place. Upon completion of permanent financing in February 1997, these funds were transferred from the seller to the new lender. 44
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (13) Accounting for Stock Based Compensation (SFAS 123) In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation (SFAS 123). SFAS 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. SFAS 123 encourages all entities to adopt a fair value based method of accounting for stock based compensation plans in which compensation cost is measured at the date the award is granted based on the value of the award and is recognized over the employee service period. However, SFAS 123 allows an entity to continue to use the method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), with pro forma disclosures of net income and earnings per share as if the fair value based method had been applied. APB 25 requires compensation expense to be recognized over the employee service period based on the excess, if any, of the quoted market price of the stock at the date the award is granted or other measurement date, as applicable, over an amount an employee must pay to acquire the stock. SFAS 123 is effective for financial statements for fiscal years beginning after December 31, 1995. At December 31, 1996, the Company has two stock-based compensation plans and has issued warrants, which are described below. The Company applies APB 25 in accounting for its plans. According, no compensation cost has been recognized for its fixed stock option plans and its stock purchase plan. Had compensation cost for the Company's two stock-based compensation plans and warrants been determined consistent with SFAS 123, the Company's net income and earnings per share would have been reduced to $2,398,699 and $.63, respectively. Employee Stock Purchase Plan Under the 1996 Stock Purchase Plan, the Company is authorized to issue up to 75,000 shares of its Common Stock to its full-time employees, nearly all of whom are eligible to participate. Under the terms of the Plan, the employees may elect to have up to 10% of their annual base salary, to a maximum of $25,000 per year, withheld for the purchase of the Company's Common Stock. Purchase intervals are six months each, ending on January 31 and July 31. The purchase price is the lesser of 85% of the market price of the Common Stock at the beginning of each purchase interval or 85% of the market price of the Common Stock at the end of each purchase interval. The first stock purchase date was January 31, 1997; accordingly, the Company had sold no shares to employees under the plan through December 31, 1996. Under FASB Statement 123, compensation cost is recognized for the fair value of the employees' purchase rights, which was estimated using the Black Scholes model with the following assumptions for 1996: Dividend yield of zero; an expected life of 1.25 years; expected volatility of 84 percent; and weighted average risk-free interest rate of 6.22 percent. The weighted average fair value of those purchase rights granted in 1996 was $3.08. 1996 Stock Option/Stock Issuance Plan Under the 1996 Stock Option/Stock Issuance Plan, 525,000 shares of the Company's shares have been set aside to provide eligible persons with the opportunity to acquire a proprietary interest in the Company. The plan includes a Discretionary Option Grant Program, a Stock Issuance Program, and an Automatic Option Grant Program for eligible non-employee Board members. The fair value of each option grant was estimated on the date of grant using the Black Scholes option-pricing model with the following assumptions for 1996: weighted average risk-free interest rate of 6.22 percent; dividend yield of zero; expected life of 2.43 years, and volatility of 84 percent. 45
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) A summary of the status of the Company's Stock Option/Stock Issuance Plan as of December 31, 1996, and changes during the year then ended is as follows: 1996 ------------------------ Weighted Average Exercise Shares Price Outstanding at beginning of year 0 0 Granted 315,000 $8.00 Exercised 0 -- Forfeited 0 -- Outstanding at end of year 315,000 $8.00 Options exercisable at end of year 90,000 $8.00 Weighted-average fair value of options granted during the year $4.19 As of December 31, 1996, the 315,000 options outstanding under the Plan are all exercisable at $8.00 per share, and have a weighted average remaining contractual life of 9.71 years. The Company expects that approximately 90 percent of the non-vested options awarded at December 31, 1996 will eventually vest. Warrants In conjunction with the Offering, the Company sold five-year purchase warrants for $.01 per warrant covering an aggregate of 100,000 shares of Common Stock exercisable at a price equal to 130% of the initial public offering price. The warrants are exercisable commencing 24 months after the effective date of the Offering or earlier, but not earlier that 12 months after the effective date of this Offering, if and when the Company files a registration for the sale by the Company of shares of Common Stock or securities exercisable for, convertible into or exchangeable for shares of Common Stock (other than pursuant to a stock option or other employee benefit or similar plan, or in connection with a merger or an acquisition). The warrants' exercise price and the number of shares of Common Stock are subject to adjustment to protect the warrant holders against dilution in certain events. (14) Subsequent Events In February 1997, the Company obtained a new credit facility for $41.5 million to replace the existing note of $44.2 million. The transaction resulted in an extraordinary gain of approximately $2.9 million (pre-tax) (note 5). In February 1997, the Company's Bridge Loan was replaced with permanent financing in the amount of $11,010,875 (note 5). 46