SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 0-28774 ----------------- WILLIS LEASE FINANCE CORPORATION (Exact name of registrant as specified in its charter) Delaware 68-0070656 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 2320 Marinship Way, Suite 300, Sausalito, CA 94965 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (415) 331-5281 ----------------- 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: <TABLE> <CAPTION> Title of Each Class Outstanding at April 30, 1999 ------------------- ----------------------------- <S> <C> Common Stock, $0.01 Par Value 7,370,645 </TABLE> 1
WILLIS LEASE FINANCE CORPORATION INDEX <TABLE> <CAPTION> PAGE NO. -------- <S> <C> <C> PART I FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets As of March 31, 1999 and December 31, 1998 3 Consolidated Statements of Income 4 Three months ended March 31, 1999 and 1998 Consolidated Statements of Shareholders' Equity 5 Year ended December 31, 1998 and three months ended March 31, 1999 Consolidated Statements of Cash Flows 6 Three months ended March 31, 1999 and 1998 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition 11 and Results of Operations Item 2A. Quantitative and Qualitative Disclosures About Market Risk 17 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 19 </TABLE> 2
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) <TABLE> <CAPTION> MARCH 31, DECEMBER 31, 1999 1998 ----------------- --------------- (UNAUDITED) <S> <C> <C> ASSETS Cash and cash equivalents $4,301 $10,305 Restricted cash 13,090 13,738 Equipment held for operating lease, less accumulated depreciation of $16,696 at March 31, 1999 and $15,456 at December 31, 1998 280,654 274,618 Net investment in direct finance lease 9,114 9,249 Property, equipment and furnishings, less accumulated depreciation of $739 at March 31, 1999 and $577 at December 31, 1998 3,333 2,480 Spare parts inventory 34,649 35,858 Operating lease related receivables 3,560 2,492 Trade receivables, net 7,404 5,310 Notes receivable 9,042 - Other receivables 1,723 757 Other assets 4,890 5,198 ----------------- ---------------- Total assets $371,760 $360,005 ================= ================ LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Accounts payable and accrued expenses $4,752 $9,619 Salaries and commissions payable 635 977 Deferred income taxes 12,227 11,684 Deferred gain 606 157 Notes payable and accrued interest 257,403 245,581 Capital lease obligation 2,613 2,652 Residual shares payable 2,830 2,618 Maintenance reserves 14,315 13,273 Security deposits 4,533 4,561 Unearned lease revenue 3,091 3,041 ----------------- ---------------- Total liabilities $303,005 $294,163 ----------------- ---------------- Shareholders' equity: Preferred stock ($0.01 par value, 5,000,000 shares authorized; none outstanding) - - Common stock, ($0.01 par value, 20,000,000 shares authorized, 7,370,645 and 7,360,813 shares issued and outstanding as of March 31, 1999 and December 31, 1998, respectively) 74 74 Paid-in capital in excess of par 42,161 42,033 Retained earnings 26,520 23,735 ----------------- ---------------- Total shareholders' equity 68,755 65,842 ----------------- ---------------- Total liabilities and shareholders' equity $371,760 $360,005 ================= ================ </TABLE> See accompanying notes to the consolidated financial statements 3
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED MARCH 31, 1999 1998 ------------------ ---------------- <S> <C> <C> REVENUE Lease revenue $10,569 $6,436 Gain on sale of leased equipment 3,411 3,108 Spare part sales 8,971 3,016 Sale of equipment acquired for resale 5,775 - Interest and other income 220 185 ------------------ ---------------- Total revenue $28,946 $12,745 EXPENSES Interest expense 4,893 2,602 Depreciation expense 3,115 1,417 Residual share 211 233 Cost of spare part sales 6,630 2,055 Cost of equipment acquired for resale 4,784 - General and administrative 4,668 3,184 ------------------ ---------------- Total expenses $24,301 $9,491 ------------------ ---------------- Income before income taxes and extraordinary item 4,645 3,254 Income taxes (1,860) (1,305) ------------------ ---------------- Income before extraordinary item 2,785 1,949 Extraordinary item less applicable income taxes - (200) ------------------ ---------------- Net income $2,785 $1,749 ================== ================ Basic earnings per common share: Income before extraordinary item $0.38 $0.27 Extraordinary item - (0.03) ------------------ ---------------- Net income $0.38 $0.24 ================== ================ Diluted earnings per common share: Income before extraordinary item $0.37 $0.26 Extraordinary item - (0.03) ------------------ ---------------- Net income $0.37 $0.23 ================== ================ Average common shares outstanding 7,363 7,192 Diluted average common shares outstanding 7,450 7,440 </TABLE> See accompanying notes to the consolidated financial statements 4
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 1998 AND THREE MONTHS ENDED MARCH 31, 1999 (IN THOUSANDS, EXCEPT SHARE DATA) <TABLE> <CAPTION> Issued and outstanding Paid-in Total shares of Common Capital in Retained shareholders' common stock Stock Excess of Par earnings equity -------------- ------------- ------------- ------------ -------------- <S> <C> <C> <C> <C> <C> Balances at December 31, 1997 7,177,320 $40,117 $ - $14,484 $54,601 Shares issued 183,493 587 737 - 1,324 Tax benefit from disqualified dispositions of qualified shares - - 666 - 666 Conversion to par value stock - (40,630) 40,630 - - Net income - - - 9,251 9,251 ---------------- -------------- -------------- ------------- ------------- Balances at December 31, 1998 7,360,813 74 42,033 23,735 65,842 Shares issued 9,832 - 98 - 98 Tax benefit from disqualified dispositions of qualified shares - - 30 - 30 Net income - - - 2,785 2,785 ---------------- -------------- -------------- ------------- ------------- Balances at March 31, 1999 (unaudited) 7,370,645 $74 $42,161 $26,520 $68,755 ================ ============== ============== ============= ============= </TABLE> See accompanying notes to the consolidated financial statements 5
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED MARCH 31, --------------------------------------- 1999 1998 ------------------- ------------------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $2,785 $1,749 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of equipment held for lease 2,932 1,382 Depreciation of property, equipment and furnishings 183 35 Gain on sale of property, equipment and furnishings (1) (9) Gain on sale of leased equipment (3,411) (3,108) Increase (decrease) in residual share payable 212 (45) Changes in assets and liabilities: Restricted Cash 648 (790) Spare parts inventory 1,209 (1,410) Receivables (4,128) 1,321 Other assets (173) 181 Accounts payable and accrued expenses (4,867) (1,785) Salaries and commission payable (342) (571) Deferred income taxes (543) 442 Deferred gain 449 (7) Accrued interest 1,304 130 Maintenance reserves 1,042 1,052 Security deposits (28) 753 Unearned lease revenue 50 (137) ----------------- ----------------- Net cash (used in) provided by operating activities (1,593) (817) CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of equipment held for operating lease (net of selling expenses) 8,318 6,456 Proceeds from sale of property, equipment and furnishings 1 15 Purchase of equipment held for operating lease (22,917) (50,342) Deposits made in connection with inventory purchases 481 (6,560) Purchase of property, equipment and furnishings (1,037) (18) Principal payments received on direct finance lease 135 142 ----------------- ----------------- Net cash used in investing activities (15,019) (50,307) CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings under notes payable 30,907 49,395 Proceeds from issuance of common stock 128 73 Principal payments on notes payable (20,388) (8,007) Principal payments on capital lease obligation (39) (36) ----------------- ----------------- Net cash provided by financing activities 10,608 41,425 (Decrease) in cash and cash equivalents (6,004) (9,697) Cash and cash equivalents at beginning of period 10,305 13,095 ----------------- ----------------- Cash and cash equivalents at end of period $4,301 $3,398 ================= ================= Supplemental information: Net cash paid for: Interest $3,590 $2,472 ----------------- ----------------- Income Taxes $ 3 $2,249 ----------------- ----------------- Non-cash investing activity: Short-term loans related to sale of equipment held for operating lease $7,000 $ - ----------------- ----------------- Installment loan related to sale of equipment held for operating lease $2,042 $ - ----------------- ----------------- </TABLE> See accompanying notes to the consolidated financial statements 6
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited consolidated financial statements of Willis Lease Finance Corporation and its subsidiaries (the "Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Pursuant to such rules and regulations, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The accompanying unaudited interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company's Annual Report to Shareholders incorporated by reference in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal and recurring adjustments) necessary to present fairly the financial position of the Company as of March 31, 1999, and December 31, 1998, and the results of its operations for the three month periods ended March 31, 1999 and 1998 and its cash flows for the three month periods ended March 31, 1999 and 1998. The results of operations and cash flows for the period ended March 31, 1999 are not necessarily indicative of the results of operations or cash flows which may be reported for the remainder of 1999. 2. MANAGEMENT ESTIMATES The preparation of financial statements, in conformity with generally accepted accounting principles, 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. 3. SHAREHOLDERS' EQUITY Authorized capital shares of the Company include 5,000,000 shares of preferred stock and 20,000,000 shares of common stock with a par value of $0.01 per share. As of March 31, 1999 and December 31, 1998, 7,370,645 and 7,360,813 shares, respectively, of common stock were issued and outstanding. No preferred stock was issued or outstanding as of March 31, 1999 or December 31, 1998. The rights and preferences of preferred stock are established by the Company's Board of Directors upon issuance. The Company has a 1996 Employee Stock Purchase Plan (the "Purchase Plan") under which 75,000 shares of common stock have been reserved for issuance. This plan became effective in September 1996. Eligible employees may designate not more than 10% of their cash compensation to be deducted each pay period for the purchase of common stock under the Purchase Plan, and participants may purchase not more than $25,000 of common stock in any one 7
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) calendar year. Each January 31 and July 31, shares of common stock are purchased with the employees' payroll deductions over the immediately preceding six months at a price per share of 85% of the lesser of the market price of the common stock on the purchase date or the market price on the date of entry into an offering period. During the three month period ended March 31, 1999, the Company issued 4,382 shares of Common Stock as a result of employee stock purchases under the Purchase Plan. Under the 1996 Stock Option/Stock Issuance Plan, as amended and restated February 24, 1998, 1,025,000 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 nonemployee Board Members. During the three month period ended March 31, 1999, 7,500 options were exercised. In connection with the exercise of a portion of these options, the Company recognized a tax benefit of approximately $30,000. In conjunction with its initial public offering, the Company sold five-year purchase warrants for $0.01 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 became exercisable in December 1997. 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. In February 1998, a holder of 50,000 of the warrants exercised the warrants under the net issuance rights of the warrants. Based on the closing price on such date, the exercise resulted in the issuance of 25,238 shares to the holder of the warrants. 4. FINANCING In March 1998, the Company repaid a loan that had residual sharing provisions. The repayment resulted in an extraordinary expense of $0.2 million, net of tax. 5. COMMITMENTS The Company has three leases for its office and warehouse space. The annual lease rental commitments are $309,481, $420,000, and $25,814 and the leases expire on May 31, 2003, December 31, 2010 and July 31, 1999, respectively. The Company has committed to purchase during 1999, additional used aircraft and new and used engines for its operations. Certain deposits were made in connection with these commitments. The Company's current, remaining commitment to such purchases is not more than $31.1 million. 6. OPERATING SEGMENTS The Company operates in two business segments: (i) Leasing and Related Operations which involves acquiring and leasing, primarily pursuant to operating leases, commercial aircraft, aircraft spare engines and other aircraft equipment and the selective purchase and resale of commercial aircraft engines and other aircraft equipment and (ii) Spare Parts Sales which involves the purchase and resale of after-market engine and airframe parts, whole engines, engine modules and rotable aircraft components and leasing of engines destined for disassembly and sale of parts. In 1998, the Company formed Pacific Gas Turbine Center, Incorporated ("PGTC") to engage in engine disassembly and maintenance, repair and overhaul services. During the three months ended March 31, 1999, the majority of PGTC's revenue was derived from services provided to WASI. Revenue from third parties during this period was not material. Accordingly, for the three months ended March 31, 1999, the operations of PGTC are included in the Spare Parts Sales segment. PGTC was not in operation during the three months ended March 31, 1998. 8
The Company evaluates the performance of each of the segments based on profit or loss after general and administrative expenses and inter-company allocation of interest expense. While the Company believes there are synergies between the two business segments, the segments are managed separately because each requires different business strategies. The following tables present a summary of the operating segments (in thousands): <TABLE> <CAPTION> Spare Parts For the quarter ended March 31, 1999 Leasing Sales Total - ------------------------------------ ------------------------------------------ <S> <C> <C> <C> Revenue Lease revenue $10,065 $504 $10,569 Gain on sale of leased equipment 3,411 - 3,411 Spare parts sales - 8,971 8,971 Sale of equipment acquired for resale 5,775 - 5,775 Other 219 1 220 ---------------------------------------- Total revenue 19,470 9,476 28,946 Expenses Interest expense 4,216 677 4,893 Depreciation expense 2,836 279 3,115 Residual share 211 - 211 Cost of spare parts - 6,630 6,630 Cost of equipment acquired for resale 4,784 - 4,784 General and administrative 2,557 2,111 4,668 ---------------------------------------- Total expenses 14,604 9,697 24,301 ---------------------------------------- Income (loss) before income tax and extraordinary item $4,866 ($221)(1) $4,645 ======================================== Total assets as of March 31, 1999 $321,812 $49,948 $371,760 ======================================== </TABLE> - ------------------------------------------------ (1) The Company estimates that income before income tax and extraordinary item would have been $0.4 million if the effect of PGTC's operations, after intercompany eliminations, were eliminated from the results of the Spare Parts Sales segment. 9
<TABLE> <CAPTION> Spare Parts For the quarter ended March 31, 1998 Leasing Sales Total - ------------------------------------ ------------------------------------------ <S> <C> <C> <C> Revenue Lease revenue $6,436 $ - $6,436 Gain on sale of leased equipment 3,108 - 3,108 Spare parts sales - 3,016 3,016 Sale of equipment acquired for resale - - - Other 177 8 185 ---------------------------------------- Total revenue 9,721 3,024 12,745 Expenses Interest expense 2,484 118 2,602 Depreciation expense 1,402 15 1,417 Residual share 233 - 233 Cost of spare parts - 2,055 2,055 Cost of equipment acquired for resale - - - General and administrative 2,379 805 3,184 ---------------------------------------- Total expenses 6,498 2,993 9,491 ---------------------------------------- Income before income tax and extraordinary item $3,223 $31 $3,254 ======================================== Total assets as of March 31, 1998 $234,245 $7,193 $241,438 ======================================== </TABLE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company's core business is acquiring and leasing, primarily pursuant to operating leases, commercial aircraft spare engines, aircraft and other aircraft equipment. The Company, through WASI, also specializes in the purchase and resale of aftermarket airframe and engine parts, engines, modules and rotable components. In July 1998, the Company formed Pacific Gas Turbine Center, Incorporated ("PGTC"). PGTC provides engine disassembly and maintenance, repair and overhaul services to WASI and third parties from the Company's San Diego location. In addition, the Company engages in the selective purchase and resale of commercial aircraft engines. Revenue consists primarily of lease revenue, income from the sale of spare parts and components and income from the sale of engines and equipment. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 1998: Revenue is summarized as follows: <TABLE> <CAPTION> Three Months Ended March 31, ---------------------------------------------------- 1999 1998 ------- ------- Amount % Amount % ------------ ------------- ------------ ------------ (dollars in thousands) <S> <C> <C> <C> <C> Lease revenue $10,569 36% $ 6,436 51% Gain on sale of leased equipment 3,411 12 3,108 24 Spare parts sales 8,971 31 3,016 24 Sale of equipment acquired for resale 5,775 20 -- -- Interest and other income 220 1 185 1 ------- ------- ------- ------- Total $28,946 100% $12,745 100% ======= ======= ======= ======= </TABLE> LEASING RELATED ACTIVITIES. Lease related revenue for the quarter ended March 31, 1999, increased 64% to $10.6 million from $6.4 million for the comparable period in 1998. This increase reflects lease related revenues from additional engines, aircraft and spare parts packages. The aggregate of net book value of leased equipment and net investment in direct finance lease at March 31, 1999 and 1998 was $289.8 million and $193.8 million, respectively, an increase of 50%. During the quarter ended March 31, 1999, 6 engines were added to the Company's lease portfolio at a total cost of $20.1 million. Eight engines from the lease portfolio were sold or transferred to inventory for sale. The engines sold from the lease portfolio had a total net book value of $11.2 million and were sold for a gain of $3.4 million. During the quarter ended March 31, 1998, the Company sold one engine from the lease portfolio. The engine had a net book value of $2.2 million and was sold for a gain of $3.1 million. During the quarter ended March 31, 1999, the Company sold two engines acquired for resale for $5.8 million which resulted in a gain of $1.0 million. The Company had no such sales during the comparable 1998 period. SPARE PARTS SALES. Revenues from spare parts sales increased 197% to $9.0 million as compared to $3.0 million in the quarter ended March 31, 1998. The gross margin decreased to 26% from 32% in the corresponding period in 1998. This decrease was due to a change in the mix of parts being sold during the past twelve months. 11
INTEREST AND OTHER INCOME. Interest and other income for the quarters ended March 31, 1999 and 1998, were $0.2 million. This is a result of interest earned on cash and deposits held. INTEREST EXPENSE AND RESIDUAL SHARING Interest expense related to all activities increased 88% to $4.9 million for the quarter ended March 31, 1999, from the comparable period in 1998, due to an increase in average debt outstanding during the period. This increase in debt was primarily related to debt associated with the increase in lease portfolio assets and to a lesser extent an increase in spare parts inventories. Residual sharing expense decreased 10% to $211,560 for the quarter ended March 31, 1999 from $232,512 for the comparable period in 1998. The decline was due to the repayment, in March 1998, of one of the Company's loans which had residual sharing provisions. Residual sharing arrangements apply to three of the Company's engines as of March 31, 1999. The Company accrues for its residual sharing obligations using net book value as a proxy for residual proceeds. DEPRECIATION EXPENSE. Depreciation expense increased 120% to $3.1 million for the quarter ended March 31, 1999, from the comparable period in 1998, due primarily to the increase in lease portfolio assets. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 47% to $4.7 million for the quarter ended March 31, 1999, from the comparable period in 1998. This increase reflects expenses, in all business segments, associated with staff additions, increased rent due to the expansion of the facilities, as well as an increase in professional fees and insurance expense. INCOME TAXES. Income taxes, exclusive of tax on extraordinary items, for the quarter ended March 31, 1999, increased to $1.9 million from $1.3 million for the comparable period in 1998. This increase reflects an increase in the Company's pre-tax earnings. The effective tax rate for the quarters ended March 31, 1999 and 1998 were 40%. EXTRAORDINARY ITEM. In March 1998, the Company repaid a loan that had residual sharing provisions and an interest rate of 10%. The repayment resulted in an extraordinary expense of $0.2 million, net of tax. The Company had no such transactions during the comparable 1999 period. ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. This statement is effective for all quarters of fiscal years beginning after June 15, 1999. The Company is reviewing the effect this standard will have on the Company's consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES Historically, the Company has financed its growth through borrowings secured by its equipment lease portfolio. Cash of approximately $30.9 million and $49.4 million, in the three month periods ended March 31, 1999 and 1998, respectively, was derived from this activity. In these same time periods $20.4 million and $8.0 million, respectively, was used to pay down related debt. Cash flow from operating activities used approximately $1.6 million and $0.8 million in the three month periods ended March 31, 1999 and 1998, respectively. The deficit cash flow from operations was primarily attributable to repayment of an account payable related to the purchase of an engine and an increase in WASI's accounts receivable due to increased sales. The Company's primary use of funds is for the purchase of equipment for lease. Approximately $23.0 million and $50.3 million of funds were used for this purpose in the three month periods ended March 31, 1999 and 1998, respectively. At March 31, 1999, the Company had a $150.0 million revolving credit facility to finance the acquisition of aircraft engines, aircraft and spare parts for sale or lease as well as for general working capital purposes. As of March 31, 1999, 12
$9.3 million was available under this facility, subject to the Company providing sufficient collateral. The facility has a two-year revolving period followed by a four-year term-out period. The facility is renewable annually. At March 31, 1999, the Company had an $80.0 million debt warehouse facility, to a wholly-owned special purpose finance subsidiary of the Company, WLFC Funding Corporation, for the financing of jet aircraft engines transferred by the Company to such finance subsidiary. This transaction's structure facilitates future public or private securitized note issuances by the special purpose finance subsidiary. The subsidiary is consolidated for financial statement presentation purposes. The facility has an eight-year initial term. The Company has guaranteed the obligations under the facility on a limited basis, up to an amount equal to the greater of (i) the lesser of $5 million and 20% of the outstanding obligations or (ii) 10% of the outstanding obligations. Assuming compliance with the facility's terms, including sufficiency of collateral, as of March 31, 1999, $15.0 million was available under this facility. Approximately $10.1 million of the Company's debt is repayable during 1999. Such repayments consist of scheduled installments due under term loans. The Company believes that its current equity base, internally generated funds and existing and contemplated debt facilities are sufficient to fund the Company's anticipated operations into the third quarter of 1999, at which time additional capital will be required to fund projected growth. The Company is currently discussing, with its commercial and investment banks, additions to its debt and equity capital bases. As of March 31, 1999, the Company had two engines and four spare parts packages which had not been financed. The Company may seek financing for this equipment, although no assurance can be given that such financing will be available on favorable terms, if at all. In addition, certain of the Company's engines have been financed under floating rate facilities. Until fixed rate financing for these assets is in place, the Company is subject to interest rate risk, since the underlying lease revenue is fixed. See "Management - Interest Rate Exposure" below. The Company has committed to purchase, during 1999, additional used aircraft and used and new engines for its operations. Certain deposits were made, in 1998, in connection with a portion of these commitments. As of March 31, 1999, the Company's current commitment to such purchases is not more than $31.1 million, which includes $1.4 million of deposits in other assets. 13
MANAGEMENT OF INTEREST RATE EXPOSURE At March 31, 1999, $207.7 million of the Company's borrowings were on a variable rate basis at various interest rates tied to either LIBOR or the prime rate. The Company's equipment leases are generally structured at fixed rental rates for specified terms. 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 borrowings. In September 1996, the Company purchased an amortizing interest rate cap in order to limit its exposure to increases in interest rates on a portion of its variable rate borrowings. Pursuant to this cap, the counter party will make payments to the Company, based on the notional amount of the cap, if the three month LIBOR rate is in excess of 7.66%. As of March 31, 1999, the notional principal amount of the cap was $34.3 million, which will decline to $26.0 million at the end of its term. The cost of the cap is being amortized as an expense over its remaining term. To further mitigate exposure to interest rate changes, the Company entered into an interest rate swap agreement in December 1998, which has a notional outstanding amount of $15.0 million, a duration of two years and a fixed rate of 4.95%. Under its borrowing agreement, WLFC Funding Corporation is required to hedge a certain portion of its $80 million warehouse facility against changes in interest rates. WLFC has entered into interest rate swap agreements in order to meet such hedging requirements and to manage the variable interest rate risk related to its debt. As of March 31, 1999, such swap agreements had notional outstanding amounts of $40 million, a weighted average remaining duration of 36 months and a weighted average fixed rate of 5.88%. The Company will be exposed to risk in the event of non-performance of the interest rate hedge counter parties. The Company anticipates that it will hedge additional amounts of its floating rate debt during the next several months. FACTORS THAT MAY AFFECT FUTURE RESULTS 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 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 and in the Company's report on Form 10-K for the year ended December 31, 1998. 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 or in other written or oral statements by the Company. The businesses in which the Company is engaged are capital intensive businesses. Accordingly, the Company's ability to successfully execute its business strategy and to sustain its operations is dependent, in large 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 is not successful in obtaining sufficient capital, the Company's ability to: (i) add new aircraft engines, aircraft and spare parts packages to its portfolio, (ii) add inventory to support its spare parts sales, (iii) fund its working capital needs, (iv) develop the business of PGTC, and (v) finance possible future acquisitions, would be impaired. The Company's inability to obtain sufficient capital would have a material adverse effect on the Company's business, financial condition and/or results of operations. The Company retains title to the aircraft engines, aircraft and parts packages that it leases to third parties. Upon termination of a lease, the Company will seek to re-lease or sell the aircraft equipment or will dismantle the equipment and will sell the parts. The Company also engages in the selective purchase and resale of commercial aircraft engines and engine components. On occasion, the Company purchases engines or components without having a firm commitment for their sale. Numerous factors, many of which are beyond the Company's control, may have an impact on the Company's ability to re-lease or sell aircraft equipment on a timely basis, including the following: (i) general market conditions, (ii) the condition of the aircraft equipment upon termination of the lease, (iii) the maintenance services performed during the lease term and, as applicable, the number of hours remaining until the next major maintenance is required, (iv) regulatory changes (particularly those imposing environmental, maintenance and other requirements on the operation of aircraft engines), (v) changes in the supply or cost of aircraft engines, and (vi) technological developments. There is no 14
assurance that the Company will be able to re-lease or sell aircraft equipment on a timely basis or on favorable terms. The failure to re-lease or sell aircraft equipment on a timely basis or on favorable terms re-lease or sell aircraft equipment on a timely basis or on favorable terms could have a material adverse effect on the Company's business, financial condition and/or results of operations. The Company experiences fluctuations in its operating results. Such fluctuations may be due to a number of factors, including: (i) general economic conditions, (ii) the timing of sales of engines and spare parts, (iii) financial difficulties experienced by airlines, (iv) interest rates, (v) fuel costs, (vi) downturns in the air transportation industry, (vii) increased fare competition, (viii) decreases in growth of air traffic, (ix) unanticipated early lease termination or a default by a lessee, (x) the timing of engine acquisitions, (xi) engine marketing activities, (xii) fluctuations in market prices for the Company's assets. The Company anticipates that fluctuations from period to period will continue in the future. As a result, the Company believes that comparisons to results of operations for preceding periods are not necessarily meaningful and that results of prior periods should not be relied upon as an indication of future performance. A lessee may default in performance of its lease obligations and the Company may be unable to enforce its remedies under a lease. The Company's inability to collect receivables due under a lease or to repossess aircraft equipment in the event of a default by a lessee could have a material adverse effect on the Company's business, financial condition and/or results of operations. Various airlines have experienced financial difficulties in the past, 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 Title 11 of the United States Code, creditors are automatically stayed from enforcing their rights. In the case of United States certified airlines, Section 1110 of the Bankruptcy Code provides certain relief to lessors of aircraft equipment. The scope of Section 1110 has been the subject of significant litigation and there is no assurance that the provisions of Section 1110 will protect the Company's investment in an aircraft, aircraft engines or parts 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. Leases of spare parts may involve additional risks. For example, it is likely to be more difficult to recover parts in the event of a lessee default and the residual value of parts may be less ascertainable than an engine. The Company's leases are generally structured at fixed rental rates for specified terms while many of the Company's borrowings are at a floating rate. 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 the Company pays under its borrowings, and have a material adverse effect on the Company's business, financial condition and/or results of operations. During the three month period ended March 31, 1999, 76% of the Company's lease revenue was generated by leases to foreign customers, including 7% from Asian customers and 18% from South American customers. Such international 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. 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 risk of expropriation of the Company's leased engines. Furthermore, many foreign countries have currency and exchange laws regulating the international transfer of currencies. The Company generates a portion of its revenue from sale of leased assets. The inability to execute transactions for gain on sale or a change in the accounting guidelines related to such sales could have a material impact on the Company's business, financial condition and/or results of operations. The Company has recently experienced significant growth in revenues. The Company's growth has placed, and is expected to continue to place, a significant strain on the Company's managerial, operational and financial resources. There is 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, in which event the Company's business, financial condition and/or results of operations could be adversely affected. The Company may also acquire businesses that would complement or expand the Company's existing businesses. Any acquisition or expansion made by the Company may result in one or more of the following events: (i) the incurrence of additional debt, (ii) future 15
charges to earnings related to the amortization of goodwill and other intangible assets, (iii) difficulties in the assimilation of operations, services, products and personnel, (iv) an inability to sustain or improve historical revenue levels, (v) diversion of management's attention from ongoing business operations, and (vi) potential loss of key employees. Any of the foregoing factors could have a material adverse effect on the Company's business, financial condition and/or results of operations. The markets for the Company's products and services are extremely competitive, and the Company faces competition from a number of sources. These include aircraft and aircraft part manufacturers, aircraft and aircraft engine lessors, airline and aircraft service companies and aircraft spare parts redistributors. 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, equipment manufacturers, aircraft maintenance providers, FAA certified repair facilities and other aviation aftermarket suppliers may vertically integrate into the markets that the Company serves, thereby significantly increasing industry competition. There can be no assurance that competitive pressures will not materially and adversely affect the Company's business, financial condition and/or results of operations. 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 or affect the Company's recognition of revenue or expense would have a material impact on the Company's business, financial condition and/or results of operations. Before parts may be installed in an aircraft, they must meet certain standards of condition established by the FAA and/or the equivalent regulatory agencies in other countries. Specific regulations vary from country to country, although regulatory requirements in other countries are generally satisfied by compliance with FAA requirements. Parts must also be traceable to sources deemed acceptable by the FAA or such equivalent regulatory agencies. Such standards may change in the future, requiring engine components already contained in the Company's inventory to be scrapped or modified. In all such cases, to the extent the Company has such engine components in its inventory, their value may be reduced and the Company's business, financial condition and/or results of operations could be adversely affected The Company obtains a substantial portion of its inventories of aircraft, engines and engine parts from airlines, overhaul facilities and other suppliers. There is no organized market for aircraft, engines and engine parts, and the Company must rely on field representatives and personnel, advertisements and its reputation as a buyer of surplus inventory in order to generate opportunities to purchase such equipment. The market for bulk sales of surplus aircraft, engines and engine parts is highly competitive, in some instances involving a bidding process. While the Company has been able to purchase surplus inventory in this manner successfully in the past, there is no assurance that surplus aircraft, engines and engine parts of the type required by the Company's customers will be available on acceptable terms when needed in the future or that the Company will continue to compete effectively in the purchase of such surplus equipment. A change in the market for aircraft and engine parts could result in the Company's inventory being overvalued and could require the Company to write-down its inventory valuations in order to bring them into line with the revised fair market value. Furthermore, when the Company purchases and dismantles used aircraft, engines and parts, the Company assigns a value to the parts based on market price. Airline manufacturers may also develop new parts to be used in lieu of parts already contained in the Company's inventory. There is no assurance that a write-down would not adversely affect the Company's business, operating results or financial condition. The Company uses computer systems in many areas of its operations. In addition, various third parties that are important to the Company's business (including lessees, customers, vendors and financial institutions) use computer systems in their areas of operations. Should the Company or certain of such third parties not be "Year 2000 compliant," certain of the Company's operations could be disrupted for an indeterminate period of time, potentially having a material adverse impact on the Company's results, business, financial condition and/or of operations. As is the case with most companies, the Year 2000 computer problem creates risks for the Company. 16
The Company has assessed the Year 2000 computer problem as it affects the Company's computer systems and information technology. As a result of the Company's assessment, the Company does not expect any material interruption of internal operations arising from the Company's computer systems and information technology not being Year 2000 compliant. The mission critical systems of the Company identified during the assessment are all off the shelf software packages with unmodified source codes which have been certified by the manufacturer as Year 2000 compliant. The Company is not aware of any significant Year 2000 issues with respect to the airworthiness of the Company's aircraft, aircraft engines or spare parts; however, should such issues result in Airworthiness Directives or other manufacturer recommended maintenance for leased assets, the implementation and the majority of the cost of such implementation would generally be the responsibility of the lessee. Any resulting costs to the Company cannot be estimated at this time. Significant uncertainties remain about the effect on the Company's operations of third parties that may not be Year 2000 compliant and with whom the Company does business (including lessees, customers, vendors and financial institutions). The Company is in the process of assessing Year 2000 issues relating to such third parties and certain of the Company's officers have oversight of these assessments. The Company has circulated to significant third parties with whom the Company does business a written request for their plans and progress in addressing the Year 2000 issue. The Company intends to evaluate the responses and develop contingency plans to address risks of non-compliance by such third parties. The Company expects to complete this process by July 1999. The costs associated with assessing the Year 2000 issue, including developing and implementing the above plan, are expected to be nominal. Non-compliance on the part of a third party could result in lost revenue and an inability to make lease or other payments to the Company. Non-compliance by the third party's financial institution could also affect the ability to process payments. A reasonable worst case scenario would be that a large number of third parties (including lessees and spare parts customers) will be unable to operate and generate revenues and as a result will be unable to make lease payments or purchase parts. The Company is unable to estimate the likelihood or the magnitude of the resulting lost revenue at this time. However, should this occur, the Company would attempt to repossess leased engines, aircraft and spare parts from non-compliant third parties and place such assets with compliant third parties. The Company cannot assure you that it would be able to re-lease such assets at favorable terms or at all. Similarly, the Company would attempt to find compliant customers for the Company's spare parts sales. If a significant number of leased assets could not be re-leased on favorable terms or at all, or their re-lease is delayed, or if compliant customers for spare parts sales were unavailable, the Company's business, financial condition and/or results of operations would be adversely affected. Providers of casualty and liability insurance to the aviation industry have indicated that they may exclude coverage for Year 2000 related risks and/or may require aviation equipment operators to answer, to the insurance provider's satisfaction, a questionnaire regarding the Year 2000 preparedness of aviation equipment operators, in order to provide coverage for Year 2000 risks. The inability of a lessee to obtain or maintain coverage for Year 2000 related losses and/or the Company's inability to obtain or maintain any contingent insurance for Year 2000 related risks would expose the Company to material risk of loss. The Company is in the process of informing its lessees of Year 2000 related insurance issues and will be monitoring its lessees' ability to obtain insurance coverage for Year 2000 related risks. ITEM 2A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposure is that of interest rate risk. A change in the U.S. prime interest rate, LIBOR rate, or cost of funds based on commercial paper market rates, would affect the rate at which the Company could borrow funds under its various borrowing facilities. Increases in interest rates to the Company, which may cause the Company to raise the implicit rates charged to its customers, could result in a reduction in demand for the Company's leases. Certain of the Company's warehouse credit facilities are variable rate debt. The Company estimates a one percent increase or decrease in the Company's variable rate debt would result in an increase or decrease, respectively, in interest expense of $1.4 million per annum. The Company estimates a two percent increase or decrease in the Company's variable rate debt would result in an increase or decrease, respectively, in interest expense of $2.9 million per annum. The foregoing effect of interest rate changes, net of interest rate hedges, on per annum interest expense is estimated as constant due to the terms of the Company's variable rate borrowings, which generally provide for the maintenance of borrowing levels given adequacy of collateral and compliance with other loan conditions. 17
The Company hedges a portion of its borrowings, effectively fixing the rate of these borrowings. The Company is currently required to hedge a portion of debt of the WLFC Funding Corporation Facility. Such hedging activities may limit the Company's ability to participate in the benefits of any decrease in interest rates, but may also protect the Company from increases in interest rates. A portion of the Company's leases provide that lease payments be adjusted based on changes in interest rates. Furthermore, since lease rates tend to vary with interest rate levels, it is likely that the Company can adjust lease rates for the effect of change in interest rates at the termination of leases. Other financial assets and liabilities are at fixed rates. The Company is also exposed to currency devaluation risk. During the three month period ended March 31, 1999, 76% of the Company's total lease revenues came from non-United States domiciled lessees. All of the leases require payment in United States (U.S.) currency. If these lessees' currency devalues against the U.S. dollar, the lessees could potentially encounter difficulty in making the U.S. dollar denominated lease payments. 18
PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits <TABLE> <CAPTION> EXHIBIT DESCRIPTION NUMBER <S> <C> 3.1 Certificate of Incorporation, filed on March 12, 1998 together with Certificate of Amendment of Certificate of Incorporation filed on May 6, 1998. Incorporated by reference to Exhibits 4.01 and 4.02 of the Company's report on Form 8-K filed on June 23, 1998. 3.2 Bylaws. Incorporated by reference to Exhibit 4.03 of the Company's report on Form 8-K filed on June 23, 1998. 4.1 Specimen of Common Stock Certificate incorporated by reference to Exhibit 4.1 of the Company's report on form 10-Q for the quarter ended June 30, 1998. 10.1 Note Purchase Agreement (Series 1997-1 Notes) dated February 11, 1999. 10.2* Amended and Restated Series 1997-1 Supplement dated February 11, 1999 11.1 Statement regarding computation of per share earnings. 27.1 Financial Data Schedule. </TABLE> - ------------------------ * Portions of this exhibit have been omitted pursuant to a request for confidential treatment and the redacted material has been filed separately with the Commission. (b) Reports on Form 8-K None 19
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. Date: May 17, 1999 Willis Lease Finance Corporation By: /s/ James D. McBride --------------------------------- James D. McBride Chief Financial Officer 20