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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
/ / 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)
DELAWARE 68-0070656
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) No.)
2320 MARINSHIP WAY, SUITE 300, SAUSALITO, 94965
CA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code (415) 331-5281
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS
COMMON STOCK
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. / /
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 26, 1999 was approximately $46,990,348 million (based on
a closing sale price of $15.9375 per share as reported on the NASDAQ National
Market).
The number of shares of the registrant's Common Stock outstanding as of
March 26, 1999 was 7,370,645.
The Company's proxy statement for the 1999 Annual Meeting of Stockholders is
incorporated by reference into Part III of this 10-K.
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WILLIS LEASE FINANCE CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
PAGE
-----
Item 1. Business.................................................................... 3
Item 2. Properties.................................................................. 9
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....... 10
Item 6. Selected Financial Data..................................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................ 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................. 21
Item 8. Financial Statements and Supplementary Data................................. 21
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................ 22
PART III
Item 10. Directors and Executives Officers of the Registrant......................... 22
Item 11. Executive Compensation...................................................... 22
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 22
Item 13. Certain Relationships and Related Transactions.............................. 22
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 22
2
PART I
ITEM 1. BUSINESS
INTRODUCTION
Willis Lease Finance Corporation and its subsidiaries (the "Company") is a
provider of aviation services including: (i) leasing aftermarket commercial
aircraft engines and other aircraft-related equipment, (ii) selling aftermarket
aircraft engines and aircraft spare parts, and (iii) maintaining, repairing and
overhauling aircraft engines. The Company provides these complementary services
on an integrated basis to passenger airlines, air cargo carriers, aircraft
maintenance, repair and overhaul ("MRO") facilities and to distributors of
aircraft spare parts worldwide. Aircraft operators require engines and parts
beyond those installed in the aircraft that they operate. These "spare" aircraft
engines and parts are required for various reasons including government
requirements that engines and parts be inspected and repaired at regular
intervals based on equipment utilization. Furthermore, unscheduled events such
as mechanical failure, and FAA directives or manufacturer recommended actions
for maintenance, repair and overhaul of engines and parts can give rise to
demand for spare engines and parts and maintenance, repair and overhaul
services.
The Company's primary focus has been on providing operating leases of
aftermarket commercial aircraft engines and other aircraft-related equipment. As
of December 31, 1998, the Company had 47 lessees in 26 countries and the
Company's lease portfolio consisted of 74 engines, five commuter aircraft and
seven spare parts packages with an aggregate net book value of $283.9 million.
The Company targets medium-term operating leases, typically with initial lease
terms of three to seven years, where the Company retains the risks and benefits
associated with the residual value of the leased asset. The Company actively
manages its portfolio and structures its leases in order to enhance these
residual values. The Company's leasing business focuses on popular Stage III
commercial jet aircraft engines manufactured by CFM, General Electric, Pratt &
Whitney and Rolls Royce. These engines are the most widely used aircraft engines
in the world, powering Boeing, McDonnell Douglas and Airbus aircraft.
In 1994, the Company began selling aircraft parts and components to its
customers through its subsidiary Willis Aeronautical Services Inc. ("WASI").
WASI's strategy is to focus on the acquisition of aviation equipment, such as
whole engines and aircraft, which can be dismantled and sold as parts at a
greater profit. WASI also supplies certain parts and components used in the
maintenance, repair and overhaul of the Company's portfolio of aircraft and
engines. Finally, WASI provides an alternate method for realizing the maximum
value from an engine in our lease portfolio through dismantling the engine and
selling the individual parts and components.
In 1998, the Company began disassembling large commercial jet engines and
providing parts cleaning, testing and classification services through Pacific
Gas Turbine Center ("PGTC"). PGTC received certification in November 1998 from
the FAA to perform maintenance, repair and overhaul services for Pratt & Whitney
JT8D and JT9D engines and has since commenced offering and performing
maintenance, repair and overhaul services for WASI and third parties. PGTC will
purchase parts from WASI for use during the maintenance, repair, and overhaul of
engines.
The Company is a Delaware corporation. Its executive offices are located at
2320 Marinship Way, Suite 300, Sausalito, California 94965. The Company
transacts business directly and through its subsidiaries unless otherwise
indicated.
AIRCRAFT EQUIPMENT LEASING
LEASES. The vast majority of the Company's current leases to air carriers,
manufacturers and overhaul/repair facilities are operating leases as opposed to
finance leases. Under an operating lease, the Company retains title to the
aircraft equipment thereby retaining the benefit and assuming the risk of the
3
residual value of the aircraft equipment. 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
equipment. Operating lease rates are generally priced higher than finance lease
rates, in part because of the risks associated with residual value. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Ownership Risks."
The Company targets the medium-term lease market, typically with initial
lease terms of three to seven years. All of the Company's lease transactions
with initial lease terms of three to seven years are triple-net leases. A
triple-net lease requires the lessee to make the full lease payment and pay any
other expenses associated with the use of the equipment, 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 equipment upon return at the end of
the lease. 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 may undertake a
portion of the maintenance and regulatory compliance risk.
The Company attempts to mitigate risk where possible. For example, the
Company typically makes an independent analysis of the credit risk associated
with each lessee before entering into a lease transaction. The Company's credit
analysis generally consists of evaluating the prospective lessee's financial
standing utilizing financial statements and trade and/or banking references. In
certain circumstances, where the Company or its lenders believe necessary, the
Company may require its lessees to obtain a partial letter of credit or a
guarantee from a bank or a third party. The Company also evaluates insurance and
expropriation risk and evaluates and monitors the political and legal climate of
the country in which a particular lessee is located in order to determine its
ability to repossess its equipment should the need arise.
The Company often collects maintenance reserves and security deposits from
engine lessees and security deposits from aircraft lessees and parts lessees.
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 repairs
associated with engine use or maintenance is required. In many 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. Parts leases generally require that the parts
be returned in the condition they were in at lease inception.
During the lease period, the Company's leases require that the leased
equipment undergo maintenance inspection at qualified maintenance facilities
certified by the FAA or its foreign equivalent. In addition, when equipment
comes off-lease, it undergoes inspection to verify compliance with lease return
conditions. Proscribed maintenance and thorough inspection during and after the
lease term help ensure that the Company's leased equipment maintains its
residual value.
As a result of these guidelines, the Company has not experienced any
material losses attributable to credit or collection problems. However, the
Company cannot assure you that it will not experience collection problems or
significant losses in the future. In addition, and while the Company cannot
assure you that its maintenance and inspection requirements will result in a
realized return upon termination of a lease, the Company believes that its
attention to its lessees and its emphasis on maintenance and inspection
contributes to residual values and generally helps the Company to recover its
investment in its leased equipment. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors That May Affect Future
Results."
Upon termination of a lease, the Company will re-lease or sell the aircraft
equipment or will dismantle or have equipment dismantled and will sell the
parts. The demand for aftermarket aircraft equipment for
4
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 equipment and technological
developments. In addition, the value of particular used aircraft, spare parts or
aircraft engines varies greatly depending upon their condition, the maintenance
services performed during the lease term and as applicable the number of hours
remaining until the next major maintenance is required. If the Company is unable
to re-lease or sell aircraft equipment 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".
AIRCRAFT EQUIPMENT HELD FOR LEASE. The Company's management frequently
reviews opportunities to acquire suitable aircraft equipment based on market
demand, customer airline requirements and in accordance with the Company's lease
portfolio mix criteria and planning strategies for leasing. Before committing to
purchase specific equipment, the Company generally 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 the
equipment and the anticipated obsolescence of the equipment. As a result,
certain types and configurations of equipment do not necessarily fit the profile
for inclusion in the Company's portfolio of equipment owned and used in its
leasing operation.
The Company focuses particularly on the noise compliant Stage III aircraft
engines manufactured by CFM International ("CFM"), General Electric ("CF"),
Pratt & Whitney ("JT" and "PW") and Rolls Royce ("RB"). As of December 31, 1998,
all but eight of the engines in the Company's lease portfolio were Stage III
engines and were generally suitable for use on one or more commonly used
aircraft. The Company's parts packages consist of rotable parts for use on
commercial aircraft or the engines appurtenant to such aircraft. The Company's
investments in aircraft have involved the purchase of five de Havilland DHC-8
commuter aircraft. These aircraft are Stage III compliant. The Company may make
further investments in aircraft for lease in the future.
As of December 31, 1998, the Company had 74 aircraft engines and related
equipment, seven spare parts packages and five aircraft with an aggregate
original cost of $290.1 million in its lease portfolio. As of December 31, 1997,
the Company had 44 aircraft engines and related equipment, eight spare parts
packages and three aircraft with an aggregate original cost of $163.9 million in
its lease portfolio.
As of December 31, 1998, minimum future rentals under the noncancelable
leases of these aircraft assets was as follows:
(IN
YEAR THOUSANDS)
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1999........................................................................... $ 35,542
2000........................................................................... 26,993
2001........................................................................... 21,609
2002........................................................................... 18,148
2003........................................................................... 10,997
Thereafter..................................................................... 13,633
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$ 126,922
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LESSEES. As of December 31, 1998, the Company had 47 lessees of commercial
aircraft engines and other aircraft-related equipment in 26 countries.
The following table displays the regional profile of the Company's lease
customer base by revenue for the years ended December 31, 1998 and December 31,
1997. No single country other than the United
5
States accounted for more than 12% and 13% of the Company's lease revenue for
the years ended December 31, 1998 and December 31, 1997, respectively.
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
1998 1997
------------------------ ------------------------
LEASE LEASE
(DOLLARS IN THOUSANDS) REVENUE PERCENTAGE REVENUE PERCENTAGE
--------- ------------- --------- -------------
United States.................................. $ 10,540 33% $ 6,718 35%
Europe......................................... 6,704 20 5,432 28
Mexico(1)...................................... 3,780 11 2,479 13
Canada......................................... 2,071 6 1,521 8
Australia/New Zealand.......................... 926 3 1,027 5
Asia........................................... 2,710 8 1,249 6
South America.................................. 5,399 16 778 4
Middle East.................................... 917 3 251 1
--------- --- --------- ---
Total.......................................... $ 33,047 100% $ 19,455 100%
--------- --- --------- ---
--------- --- --------- ---
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(1) For the years ended December 31, 1998 and 1997, Aerovias de Mexico, S.A. de
C.V., a lessee customer of the Company, contributed approximately 8% and 13%
respectively of operating lease revenue.
The Company generates a portion of its revenue from gain on sale of leased
assets. During 1998, gains associated with sales to the two most significant
purchasers of lease assets Kellstrom Industries, Inc. and TPI Aviation, Ltd.,
constituted 74% and 13% of gains on sale of leased assets, respectively.
SPARE PARTS SALES
In 1994, the Company began selling aircraft parts and components to
airlines, air cargo carriers, MRO facilities and other aircraft parts
distributors through WASI. WASI purchases and resells aftermarket engine parts,
engines, modules, airframes and rotable components. WASI purchases individual
engine parts from airlines and others in the aftermarket or acquires whole
engines and aircraft and contracts with PGTC to have the engines dismantled and
with third parties to have the aircraft dismantled into their component parts
for resale. Some of the parts are overhauled for WASI by FAA-authorized repair
agencies 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, PW 4000 and JT8D aircraft engines and
components. These engines are the most widely used aircraft engines in the
world, powering Boeing, McDonnell Douglas and Airbus aircraft, including the
Boeing 737, 747, 757 and 767, the McDonnell Douglas MD-80 series and the Airbus
A300, A310, A320, A330 and A340 aircraft. WASI has begun to expand into engine
components for the CFM-56, a high thrust engine used on the popular Boeing 737.
The Company believes that the operations of WASI complement the Company's
leasing and maintenance, repair, and overhaul businesses. To date, WASI's
operations have afforded the Company additional contacts and opportunities in
the aircraft engine market. WASI also supplies certain parts and components used
in the maintenance, repair and overhaul of the Company's portfolio of aircraft
and engines. In addition, WASI provides an alternate method for realizing the
maximum value from an engine in our lease portfolio through dismantling the
engine and selling the individual parts and components.
When procuring aircraft parts, WASI puts great emphasis on source and
traceability. At December 31, 1998, at least 95% of WASI's inventory on hand was
acquired from certified commercial air carriers or others operating under
recognized regulatory agencies accepted by the FAA. Less than 5% of the
inventory was acquired from trading companies and in all such cases the parts
are certified by the seller as to origin. WASI trades in life-limited parts that
have complete traceability back to the manufacturer or in some cases
traceability from a commercial air carrier back to the manufacturer. See,
"Management's
6
Discussion and Analysis of Financial Condition and Results of
Operations--Factors That May Affect Future Results."
ENGINE DISASSEMBLY, REPAIR AND RELATED ACTIVITIES
In 1998, the Company began disassembling large commercial jet engines and
providing parts cleaning, testing and classification services through PGTC. PGTC
was formed initially to provide engine disassembly services to WASI. In November
1998, PGTC received its FAR 145 Repair Station Air Agency Certification from the
FAA. The FAA certification allows PGTC to perform maintenance, repair and
overhaul services for the Pratt & Whitney JT8D and JT9D engines as well as
clean, perform non-destructive testing of and classify, as to condition, certain
Pratt & Whitney engine parts.
PGTC will provide services to WASI and to third party customers. PGTC will
purchase parts from WASI since spare parts are used extensively during the
maintenance, repair and overhaul of engines. PGTC's services have and will
continue to allow the Company to reduce the cost and improve the timeliness of
engine disassemblies, component overhaul services and parts classification.
During 1998, PGTC's primary source of revenue was the intercompany
disassembly of engines, which are eliminated on consolidation, and secondarily
the disassembly of engines for third parties. PGTC's primary expenses are
personnel costs for direct labor and management of its operations. During 1998,
PGTC made certain investments in leasehold improvements and equipment to allow
it to carry out its operations. In the later part of 1998, PGTC began purchasing
and contracting for additional equipment that will allow it to become a
full-service engine repair and overhaul facility.
EQUIPMENT ACQUIRED FOR RESALE
The Company engages in the selective purchase and resale of commercial
aircraft engines and engine components in the aftermarket to complement its
engine and parts leasing business. It is the Company's general policy to
minimize risk by not purchasing engines or components on speculation; however,
on occasion, the Company purchases engines and components without having a
commitment for their sale. The Company normally makes a contractual commitment
to purchase specific engines or components for its own account only after, or
concurrently with, obtaining a firm customer purchase commitment. Although the
Company usually has purchase commitments at delivery, it would have financial
exposure if it purchased an engine or components, which could not immediately be
resold. The Company assesses the supply and demand of target engines and
components through its sales force 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 inventories and engines on order.
FINANCING/SOURCE OF FUNDS
The Company typically acquires the engines it leases with a combination of
equity capital and funds borrowed from financial institutions. The Company can
typically borrow 80% to 100% of an engine purchase price and 60% to 80% of an
aircraft or spare parts purchase price on a recourse, non-recourse or partial
recourse basis. Under most of the Company's term loans, the lender is entitled
to receive most of the lease payments associated with the financed equipment to
apply to debt service. Under the Company's warehouse facilities, the lender is
paid interest only until such time as loans under the facilities become due.
Generally, lenders take a security interest in the equipment. The Company
retains ownership of the equipment, subject to such security interest. Loan
interest rates often reflect the financial condition of the underlying lessees,
the terms of the lease and percentage of purchase price advanced, and for full
or partial recourse loans, the financial condition of the Company. The Company
obtains the balance of the purchase price of the equipment, the "equity"
portion, from internally generated funds, cash-on-hand, and the net proceeds of
prior common stock offerings.
7
At December 31, 1998, the Company and its subsidiaries had outstanding
$240.3 million of full or partial recourse loans and $4.0 million of
non-recourse loans.
The loans available to the Company under recourse arrangements are secured
by the financed engines, aircraft or spare parts and the assignment of lease
payments due under the related leases. Borrowings to finance the acquisition of
aircraft and parts packages have generally been on a recourse basis. Upon
default under a loan covering equipment financed through recourse borrowings,
the lender providing the financing can foreclose on the equipment, repossess and
sell such equipment and seek any balance due on such financing from the Company
to the extent of the recourse.
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. Certain of the Company's engines are owned in
wholly-owned subsidiaries set up for financing purposes. Non-recourse loans
represent loans to the Company's subsidiaries which own only the assets securing
the loan and as to which the Company has not guaranteed the loan. 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.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations-- Liquidity and Capital Resources."
COMPETITION
The markets for the Company's products and services are very competitive,
and the Company faces competition from a number of sources. These include
aircraft, engine and aircraft parts manufacturers, aircraft and aircraft engine
lessors, airline and aircraft service and repair 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. The Company can give you no assurance that competitive pressures
will not materially and adversely affect the Company's business, financial
condition or results of operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-- Factors That May Affect Future
Results."
INSURANCE
The Company requires its lessees to carry the types of insurance customary
in the air transportation industry, including comprehensive third party
liability insurance and physical damage 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 Company or its lenders normally identified as the payee for
loss and damage to the equipment. All policies contain a breach of warranty
endorsement or a 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. The Company also carries
contingent physical damage and third party liability insurance as well as
product liability insurance.
GOVERNMENT REGULATION
The Company's customers are subject to a high degree of regulation in the
jurisdictions in which they operate. For example, the FAA regulates the
manufacture, repair and operation of all aircraft operated in the United States
and equivalent regulatory agencies in other countries regulate aircraft operated
in those
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countries. Such regulations also indirectly affect the Company's business
operations. All aircraft operated in the United States must be maintained under
a continuous condition monitoring program and must periodically undergo thorough
inspection and maintenance. The inspection, maintenance and repair procedures
for commercial aircraft are prescribed by regulatory authorities and can be
performed only by certified repair facilities utilizing certified technicians.
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.
While the Company's reselling business is not regulated, the aircraft,
engines and engine parts that the Company sells to its customers must be
accompanied by documentation that enables the customer to comply with applicable
regulatory requirements. Furthermore, 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.
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
marketability.
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. Aircraft engine manufacturers may also develop new engine
components to be used in lieu of engine components already contained in the
Company's inventory. In all such cases, to the extent the Company has such
engine components in its inventory, their value may be reduced.
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 FAA Regulations of the United States. As of December 31, 1998,
all but eight of the engines in the Company's lease portfolio were Stage III
engines.
The Company believes that the aviation industry will be subject to continued
regulatory activity. Increased oversight has and will continue to originate with
quality assurance departments at airline operators. The Company has been able to
meet all such requirements to date, and believes that it will be able meet any
additional requirements that may be imposed. The Company cannot assure you,
however, that new, more stringent government regulations will not be adopted in
the future or that any such new regulations, if enacted, would not have a
material adverse impact on the Company.
EMPLOYEES
As of December 31, 1998, the Company had 78 full-time employees and two
part-time employees (excluding consultants), including 33 employees in equipment
acquisition, leasing, sales and administration, 28 employees in airframe and
engine component sales and administration and 19 employees in engine
disassembly, repair services and administration. None of the Company's employees
is covered by a collective bargaining agreement and the Company believes its
employee relations are satisfactory.
ITEM 2. PROPERTIES
The Company's principal offices are located at 2320 Marinship Way, Suite
300, Sausalito, California 94965. The Company occupies space in Sausalito under
a lease that covers approximately 9,300 square feet of office space and expires
on May 31, 2003. Aircraft asset leasing, financing, sales and general
administrative activities are conducted from the Sausalito location. The Company
also leases approximately 125,000 square feet of office, warehouse and shop
space for WASI's and PGTC's operations at San Diego, California. This lease
expires on December 31, 2010. In addition, the Company leases approximately
9
10,730 square feet of warehouse and office space at 1769 West University Drive,
Suite 177, Tempe, Arizona 85821, which is used for parts storage and
distribution. This lease expires on July 31, 1999 and it is expected that the
Company will renew this lease. See Note 9 to the audited consolidated Financial
Statements.
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 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Effective June 8, 1998, the Company changed its state of incorporation from
California to Delaware. The change was accomplished through a merger (the
"Merger") of Willis Lease Finance Corporation, a California corporation
("Willis-California"), into its wholly-owned Delaware subsidiary of the same
name ("Willis-Delaware"). In connection with the reincorporation, the Company
adopted various features in its certificate of incorporation and bylaws which
are intended, among other things, to promote the stability of the Company's
shareholder base and to render more difficult certain unsolicited or hostile
attempts to take over the Company (the "Shareholder Protection Features")
including: (a) the division of the Board of Directors of the Company into three
classes to serve staggered terms of office as more fully set forth in the
Certificate of Incorporation; (b) the requirement that certain "Business
Combinations" (as defined in Article XIII of the Certificate of Incorporation)
be approved by the affirmative vote of the holders of not less than 80% of the
total voting power of all outstanding shares of voting stock of the Company; (c)
the provision that Bylaws may be amended or repealed only by the Board of
Directors or with the approval of the holders of 80% of the total voting power
of the outstanding shares of voting stock of the Company; and (d) the provision
that special meetings of shareholders of the Company may be called only by the
Board of Directors, the Chairman of the Board or the President.
The reincorporation proposal and each of the Shareholder Protection Features
were approved by the Company's shareholders at the Company's annual meeting of
shareholders on May 12, 1998. As a result of the Merger, each outstanding share
of Willis-California's common stock, no par value per share, was converted into
one share of Willis-Delaware common stock, par value $0.01 per share. Each stock
certificate representing issued and outstanding shares of Willis-California
common stock will continue to represent the same number of shares of
Willis-Delaware common stock. Shareholders were not required to undertake a
mandatory exchange of shares. The common stock continued and continues to trade
on the NASDAQ National Market under the symbol WLFC.
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 26,
1999, there were approximately 1,349 stockholders of record of the Company's
Common Stock. The foregoing number does not include beneficial holders of the
Company's common stock.
10
The high and low sales price of the Common Stock for each quarter of 1998
and 1997, as reported by NASDAQ, are set forth below:
1998 1997
-------------------- --------------------
HIGH LOW HIGH LOW
--------- --------- --------- ---------
First Quarter.......................................... $ 22.62 $ 16.25 $ 14.50 $ 12.25
Second Quarter......................................... 24.37 19.25 12.63 10.31
Third Quarter.......................................... 25.25 13.75 23.50 12.25
Fourth Quarter......................................... 19.50 14.62 24.13 15.25
During the years ended December 31, 1998, 1997 and 1996 the Company paid
dividends totaling $0, $0 and $951,475 to Company shareholder(s) respectively
The dividend paid in 1996 was paid prior to the Company's initial public
offering.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes selected consolidated financial data and
operating information of the Company. The selected consolidated financial and
operating 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.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
--------- ---------- ---------- --------- ---------
(DOLLARS IN THOUSANDS)
REVENUE:
Lease revenue......................................... $ 33,046 $ 19,456 $ 13,740 $ 13,771 $ 13,636
Gain (loss) on sale of leased equipment............... 13,413 4,165 2 (483) 633
Spare parts sales..................................... 24,088 14,110 5,843 3,859 795
Sale of equipment acquired for resale................. 4,094 12,748 12,105 5,472 2,184
Interest and other income............................. 1,439 728 618 119 542
--------- ---------- ---------- --------- ---------
Total Revenue......................................... $ 76,080 $ 51,207 $ 32,308 $ 22,738 $ 17,790
EXPENSES:
Cost of spare parts sales............................. $ 17,298 $ 9,469 $ 3,308 $ 2,546 $ 659
Cost of equipment acquired for resale................. 3,573 10,678 10,789 2,742 1,863
All other expenses.................................... 39,448 22,245 13,351 14,168 13,295
Gain on modification of credit facility............... -- -- -- 2,203 --
--------- ---------- ---------- --------- ---------
Income before income taxes, minority interest and
extra ordinary item................................. $ 15,761 $ 8,815 $ 4,860 $ 5,485 $ 1,973
Net income............................................ $ 9,251 $ 7,338 $ 2,804 $ 3,216 $ 1,172
BALANCE SHEET DATA:
Total assets.......................................... 360,005 $ 198,430 $ 124,933 $ 91,437 $ 83,542
Debt (includes capital lease obligation).............. 248,232 104,235 76,146 69,911 69,456
Shareholders' equity.................................. 65,842 54,601 23,202 4,812 1,959
LEASE PORTFOLIO:
Engine portfolio at the end of the period............. 74 44 32 31 26
Spare parts package portfolio at the end of the
period.............................................. 7 7 2 -- --
Aircraft portfolio at the end of the period........... 5 3 -- -- --
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
GENERAL. The Company's primary focus has been on providing operating leases
of aftermarket commercial aircraft engines and other aircraft-related equipment.
As of December 31, 1998, the Company had 47 lessees in 26 countries and its
lease portfolio consisted of 74 engines, five commuter aircraft and seven spare
parts packages with an aggregate net book value of $283.9 million. The Company
targets medium-term operating leases, typically with initial lease terms of
three to seven years, where the Company retains the risks and benefits
associated with the residual value of the leased asset. The Company actively
manages its portfolio and structures its leases in order to enhance these
residual values. The Company's leasing business focuses on popular Stage III
commercial jet aircraft engines manufactured by CFM, General Electric, Pratt &
Whitney and Rolls Royce. These engines are the most widely used aircraft engines
in the world, powering Boeing, McDonnell Douglas and Airbus aircraft.
In 1994, the Company began selling aircraft parts and components to its
customers through WASI. WASI's strategy is to focus on the acquisition of
aviation equipment, such as whole engines and aircraft, which can be dismantled
and sold as parts at a greater profit. WASI also supplies certain parts and
components used in the maintenance, repair and overhaul of the Company's
portfolio of aircraft and engines. Finally, WASI provides an alternate method
for realizing the maximum value from an engine in our lease portfolio through
dismantling the engine and selling the individual parts and components.
In 1998, the Company began disassembling large commercial jet engines and
providing parts cleaning, testing and classification services through PGTC. PGTC
received certification in November 1998 from the FAA to perform maintenance,
repair and overhaul services for Pratt & Whitney JT8D and JT9D engines and has
since commenced offering and performing and offering maintenance, repair and
overhaul services to and for WASI and third parties. PGTC will purchase parts
from WASI for use during the maintenance, repair and overhaul of engines. PGTC
had no material third party revenues in 1998 and is therefore not presented as a
separate business segment herein.
LEASING RELATED ACTIVITIES. Revenue from leasing of aircraft equipment is
recognized as operating lease or finance lease revenue over the terms of the
applicable lease agreements. The vast majority of the Company's leases are
accounted for as operating leases. Under an operating lease, the Company retains
title to the leased equipment, thereby retaining the potential benefit and
assuming the risk of the residual value of the leased equipment.
The Company generally depreciates engines on a straight-line basis over 15
years to a 55% residual value. Spare parts packages are generally depreciated on
a straight-line basis over 15 years to a 25% residual value. Aircraft are
generally depreciated on a straight-line basis over 15 years to a 17% residual
value.
At the commencement of each lease, the Company typically collects security
deposits (normally equal to at least one month's lease payment) and maintenance
reserves (normally equal to one month's estimated maintenance expenses) from the
lessee. 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 the Company's lenders and are used when normal
repair associated with engine use or maintenance is required. In many 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.
For equipment sold out of the Company's lease portfolio, the Company
recognizes the gain associated with the sale as revenue. Gain consists of sales
proceeds less the net book value of the equipment sold and any direct costs
associated with the sale. Additionally, to the extent that any deposits or
reserves are not
12
included in the sale and the purchaser of the equipment assumes any liabilities
associated therewith, such deposits and reserves are included in the gain on
sale.
The Company engages in the selective purchase and sale of commercial
aircraft engines and engine components. Assets acquired for resale are recorded
at the lower of cost or net realizable value. Gross revenue from the sale of
equipment is reflected as sale of equipment acquired for resale with the
corresponding cost of the equipment shown as an expense item.
SPARE PARTS SALES. WASI acquires aviation equipment, such as whole engines
and aircraft, which can be dismantled and sold as parts at a greater profit. The
Company records the purchases at cost and capitalizes additional costs relating
to acquisition, overhaul, insurance and other direct costs. Gross revenue from
the sale of parts is reflected as spare parts sales. WASI may also engage in the
short term leasing of engines destined for disassembly and sale of parts.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
Revenue is summarized as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1997
-------------------- --------------------
AMOUNT % AMOUNT %
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Lease revenue.......................................... $ 33,046 43.4% $ 19,456 38.0%
Gain on sale of leased equipment....................... 13,413 17.6 4,165 8.1
Spare parts sales...................................... 24,088 31.7 14,110 27.6
Sale of equipment acquired for resale.................. 4,094 5.4 12,748 24.9
Interest and other income.............................. 1,439 1.9 728 1.4
--------- --------- --------- ---------
Total.................................................. $ 76,080 100.0% $ 51,207 100.0%
--------- --------- --------- ---------
--------- --------- --------- ---------
LEASING RELATED ACTIVITIES. Lease related revenue for the year ended
December 31, 1998, increased 70% to $33.0 million from $19.5 million for the
comparable period in 1997. 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 December
31, 1998 and 1997 was $283.9 million and $148.4 million, respectively, an
increase of 91%.
During 1998, 40 engines, three aircraft, and one spare parts package were
added to the Company's lease portfolio at a total cost of $171.1 million. Ten
engines, one spare parts package and one aircraft from the lease portfolio were
sold or transferred to WASI for sale as parts. The engines and the aircraft had
a total net book value of $27.1 million and were sold for a gain of $13.4
million.
During the year ended December 31, 1997, the Company sold six engines from
the lease portfolio. These engines had a net book value of $11.5 million and
were sold for a gain of $4.2 million.
During the year ended December 31, 1998, the Company sold one engine
acquired for resale for $4.1 million which resulted in a gain of $0.5 million,
compared to the year ended December 31, 1997, during which the Company sold ten
engines acquired for resale for $12.7 million resulting in a gain of $2.1
million. Included in the 1997 sales was one transaction involving the sale of
four engines acquired at a cost of $600,000 and sold for a gain of $100,000.
Equipment sales opportunities and profitability may vary materially from
period to period.
13
SPARE PARTS SALES. Revenues from spare parts sales increased 71% to $24.1
million compared to the year ended December 31, 1997. The gross margin,
decreased to 28% in 1998, from 33% in the corresponding period in 1997. This
decrease was due to increased provisions for write-downs of inventory, the
Company's decision to sell, shortly after their acquisition, certain of the
engines acquired under its agreement with United Airlines, thus avoiding
carrying costs and a change in the mix of engine type parts sold.
INTEREST AND OTHER INCOME. Interest and other income for the year ended
December 31, 1998, increased to $1.4 million from $0.7 million for the year
ended December 31, 1997. This is a result of interest earned on cash and
deposits held.
INTEREST EXPENSE AND RESIDUAL SHARING. Interest expense related to all
activities increased 95% to $15.2 million for the year ended December 31, 1998,
from the comparable period in 1997, 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. We accrue for our residual
sharing obligations using net book value as a proxy for residual proceeds.
Residual sharing expense decreased 10% to $803,328 for the year ended December
31, 1998 from $892,861 for the comparable period in 1997. 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 December 31, 1998.
DEPRECIATION EXPENSE. Depreciation expense increased 95% to $8.3 million
for the year ended December 31, 1998, from the comparable period in 1997, due
primarily to the increase in lease portfolio assets in 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 63% to $15.2 million for the year ended December 31, 1998, from the
comparable period in 1997. 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 year ended December 31, 1998, increased to $6.3 million from $3.5 million
for the comparable period in 1997. This increase reflects an increase in the
Company's pre-tax earnings.
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. In February 1997, the
Company obtained a new loan agreement for $41.5 million to replace an existing
loan of $44.2 million. The transaction resulted in an extraordinary gain of $2.0
million, net of tax.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
Revenue is summarized as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996
-------------------- --------------------
AMOUNT % AMOUNT %
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Lease revenue.......................................... $ 19,456 38.0% $ 13,740 42.5%
Gain on sale of leased equipment....................... 4,165 8.1 2 0.0
Spare parts sales...................................... 14,110 27.6 5,843 18.1
Sale of equipment acquired for resale.................. 12,748 24.9 12,105 37.5
Interest and other income.............................. 728 1.4 618 1.9
--------- --------- --------- ---------
Total.................................................. $ 51,207 100.0% $ 32,308 100.0%
--------- --------- --------- ---------
--------- --------- --------- ---------
14
LEASING RELATED ACTIVITIES. Lease related revenue for the year ended
December 31, 1997, increased 42% to $19.5 million from $13.7 million for the
comparable period in 1996. This increase reflects lease revenues from additional
engines and spare parts packages. The aggregate of net book value of leased
equipment and net investment in direct finance lease at December 31, 1997 and
1996 was $148.4 million and $96.1 million, respectively, an increase of 54%.
During 1997, 21 engines, three aircraft, and five spare parts packages were
added to the Company's lease portfolio at a total cost of $68.1 million. Nine
engines from the lease portfolio were sold or transferred to WASI for sale as
parts.
During the year ended December 31, 1997, the Company sold six engines from
the lease portfolio. These engines had a net book value of $11.5 million and
they were sold for a gain of $4.2 million.
During the year ended December 31, 1997, the Company sold ten engines
acquired for resale for $12.7 million which resulted in a gain of $2.1 million,
compared to the year ended December 31, 1996, during which the Company sold four
engines acquired for resale for $12.1 million resulting in a gain of $1.3
million. Included in the 1997 sales was one transaction involving the sale of
four engines acquired at a cost of $600,000 and sold for a gain of $100,000.
Equipment sales opportunities and profitability may vary materially from
period to period.
SPARE PARTS SALES. Revenues from spare parts sales increased 142% to $14.1
million compared to the year ended December 31, 1996. The gross margin,
decreased to 33% in 1997, from 43% in the corresponding period in 1996.
INTEREST AND OTHER INCOME. Interest and other income for the year ended
December 31, 1997, increased to $0.7 million from $0.6 million for the year
ended December 31, 1996. This is a result of interest earned on deposits held,
primarily the proceeds from the Initial Public Offering.
INTEREST EXPENSE AND RESIDUAL SHARING. Interest expense related to all
activities increased 80% to $7.8 million for the year ended December 31, 1997,
from the comparable period in 1996, due primarily to an increased loan base and
the replacement of an existing facility with a new loan agreement in the first
quarter of 1997 bearing a higher interest rate. Residual sharing expense
increased 24% to $0.9 million for the year ended December 31, 1997, from the
$0.7 million for the comparable period in 1996.
DEPRECIATION EXPENSE. Depreciation expense increased 33% to $4.2 million
for the year ended December 31, 1997, from the comparable period in 1996, due to
the larger asset base in 1997.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 82% to $9.3 million for the year ended December 31, 1997, from the
comparable period in 1996. This increase reflects expenses associated with staff
additions, increased rent due to the expansion of the WASI facility, as well as
an increase in professional fees, insurance expense and public company costs.
INCOME TAXES. Income taxes, exclusive of tax on extraordinary items, for
the year ended December 31, 1997, increased to $3.5 million from $2.0 million
for the comparable period in 1996. This increase reflects an increase in the
Company's pre-tax earnings.
EXTRAORDINARY ITEM. In February 1997, the Company obtained a new loan
agreement for $41.5 million to replace an existing loan of $44.2 million. The
transaction resulted in an extraordinary gain of $2.0 million, net of tax.
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
15
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 $194.7 million, $165.6
million and $16.1 million, in the years ended December 31, 1998, 1997 and 1996,
respectively, was derived from this activity. In these same time periods $51.3
million, $137.1 million and $13.5 million, respectively, was used to pay down
related debt or capital lease. In December 1997, net proceeds from a follow-on
common stock offering were approximately $23.8 million. In September 1996, net
proceeds from the initial public offering were approximately $15.9 million. Cash
flow from operating activities used approximately $18.9 million in the year
ended December 31, 1998 and cash flows from operating activities generated $6.5
million and $9.6 million in the years ended December 31, 1997 and 1996,
respectively. The deficit cash flow from operations in 1998 was primarily
attributable to the acquisition of used aircraft assets for WASI's inventory and
deposits made in connection with future, committed inventory purchases. Such
deposits are carried as other assets on the Company's consolidated balance
sheet.
The Company's primary use of funds is for the purchase of equipment for
lease. Approximately $171.1 million, $68.1 million and $25.3 million of funds
were used for this purpose in the years ended December 31, 1998, 1997 and 1996,
respectively.
At December 31, 1998, 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
December 31, 1998, $20.9 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.
The Company has an $80.0 million debt warehouse facility, to a fully-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
and (ii) 10% of the outstanding obligations. The facility requires the Company
to hedge a certain portion of the debt against interest rate changes. In May
1998, a three year $15 million interest rate swap was executed to hedge a
portion of the interest expense under this facility. Additionally, in August
1998, a five year $10.0 million interest rate swap was executed. Assuming
compliance with the facility's terms, including sufficiency of collateral, as of
December 31, 1998, $15.5 million was available under this facility.
Approximately $11.6 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 debt facilities are sufficient to fund the Company's anticipated
operations into the second 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 facilities.
As of December 31, 1998, the Company had four 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
16
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, in 1998, were
made in connection with these commitments. As of December 31, 1998, the
Company's current commitment to such purchases is not more than $13.2 million,
which includes $1.9 million of deposits in other assets.
MANAGEMENT OF INTEREST RATE EXPOSURE
At December 31, 1998, $196.2 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 December 31, 1998, the notional
principal amount of the cap was $33.3 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 December 31, 1998, such
swap agreements had notional outstanding amounts of $25 million, a weighted
average remaining duration of 39 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 Forms 10-K and 10-KA for the year ended December 31,
1997. 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
17
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 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 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.
In 1998, 67% of the Company's lease revenue was generated by leases to
foreign customers, including 8% from Asian customers and 16% from South American
customers. Such international leases may
18
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 amount of such revenue, as a percentage of overall revenue, increased
between 1997 and 1998. During 1998, gains associated with sales to the two most
significant purchasers of leased assets, Kellstrom Industries, Inc. and TPI
Aviation, Ltd., constituted 74% and 13% of gains on sale of leased assets,
respectively. 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 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
19
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 business, financial condition and/or
results of operations. As is the case with most companies, the Year 2000
computer problem creates risks for the Company.
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 of the Company's computer systems and
information technology not being 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 plans to circulate to significant
third parties with whom the Company does business a written request for their
plans and progress in addressing the Year 2000 issue; evaluate the responses;
and develop contingency plans to address risks of non-compliance by such third
parties. The Company intends to complete this process by June 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
20
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 7A. 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 $1.3 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 $2.6 million per
annum. The foregoing effect of interest rate changes 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.
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 1998, 67%
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is submitted as a separate section of
this report.
21
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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.
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 25.
(a) (3) and (c): EXHIBITS:
EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------------ ------------------------------------------------------------
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 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.
10.2 Employment Agreement between the Company and Edwin Dibble.
Incorporated by reference to Exhibit 10.9 to Registration
Statement No. 333-39865 filed on December 11, 1997.
10.3 Employment Agreement between the Company and Donald
Nunemaker dated July 16, 1997. Incorporated by reference
to Exhibit 10.10 to the Company's Report on Form 10-K for
the year ended December 31, 1997.
10.4 Employment Agreement between the Company and James D.
McBride dated September 9, 1997.
22
EXHIBIT
NUMBER DESCRIPTION
- ------------ ------------------------------------------------------------
10.5* Indenture dated as of September 1, 1997, between WLFC
Funding Corporation and The Bank of New York, as Indenture
Trustee. Incorporated by reference to Exhibit 10.16 to the
Company's Report on Form 10-K for the year ended December
31, 1997.
10.6* Series 1997-1 Supplement dated as of September 1, 1997
between WLFC Funding Corporation and the Bank of New York,
as Indenture Trustee. Incorporated by reference to Exhibit
10.17 to the Company's Report on Form 10-K for the year
ended December 31, 1997.
10.7 Class A Note Purchase Agreement dated as of September 1,
1997 between the Company, WLFC Funding Corporation and
First Union National Bank of North Carolina. Incorporated
by reference to Exhibit 10.18 to the Company's Report on
Form 10-K for the year ended December 31, 1997.
10.8* Administration Agreement dated as of September 1, 1997
between WLFC Funding Corporation, the Company, First Union
Capital Markets Corp. and The Bank of New York.
Incorporated by reference to Exhibit 10.19 to the
Company's Report on Form 10-K for the year ended December
31, 1997.
10.9* Aircraft Purchase and Sale Agreement dated as of March 24,
1998 between the Company and United Air Lines, Inc.
Incorporated by reference to Exhibit 10.1 to the Company's
Report on Form 10-Q for the quarter ended March 31, 1998.
10.10* Amended and Restated Credit Agreement dated September
30,1998. Incorporated by reference to Exhibit 10.1 to the
Company's Report on Form 10-Q for the quarter ended
September 30, 1998.
11.1 Statement regarding computation of per share earnings.
21.1 Subsidiaries of the Company
27.1 Financial Data Schedule.
- ------------------------
* Portions of these exhibits 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
The Company filed no reports on Form 8-K during the fourth quarter of 1998.
23
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 30, 1999
WILLIS LEASE FINANCE CORPORATION
By: /s/ CHARLES F. WILLIS, IV
-----------------------------------------
Charles F. Willis, IV
CHAIRMAN OF THE BOARD, PRESIDENT, AND
CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
DATE TITLE SIGNATURE
----------------------- -------------------------- ------------------------------
Chief Executive Officer /s/ CHARLES F. WILLIS, IV
Date: March 30, 1999 (Principal Executive ------------------------------
Officer) Charles F. Willis, IV
Chief Financial Officer /s/ JAMES D. MCBRIDE
Date: March 30, 1999 (Principal Financial and ------------------------------
Accounting Officer) James D. McBride
/s/ WILLIAM M. LEROY
Date: March 30, 1999 Director ------------------------------
William M. LeRoy
/s/ DONALD E. MOFFITT
Date: March 30, 1999 Director ------------------------------
Donald E. Moffitt
/s/ ROBERT H. RAU
Date: March 30, 1999 Director ------------------------------
Robert H. Rau
/s/ WILLARD H. SMITH, JR.
Date: March 30, 1999 Director ------------------------------
Willard H. Smith, Jr.
24
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants.................................................. Page 26
Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997.......... Page 27
Consolidated Statements of Income for the years ended December 31, 1998, December
31, 1997 and December 31, 1996................................................... Page 28
Consolidated Statements of Shareholders' Equity for the years ended December 31,
1998, December 31, 1997 and December 31, 1996.................................... Page 29
Consolidated Statements of Cash Flows for the years ended December 31, 1998,
December 31, 1997 and December 31, 1996.......................................... Page 30
Notes to Consolidated Financial Statements......................................... Page 31
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.
25
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS OF WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES:
We have audited the accompanying consolidated financial statements of Willis
Lease Finance Corporation and subsidiaries (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 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 as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.
KPMG LLP
SAN FRANCISCO, CALIFORNIA
FEBRUARY 16, 1999
26
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
1998 1997
-------------- --------------
ASSETS
Cash and cash equivalents........................................................ $ 5,278,548 $ 13,095,303
Deposits......................................................................... 18,764,222 18,461,456
Equipment held for operating lease, less accumulated depreciation of $15,455,685
at December 31, 1998 and $15,193,313 at December 31, 1997...................... 274,618,347 138,535,643
Net investment in direct finance lease........................................... 9,249,212 9,821,854
Property, equipment and furnishings, less accumulated depreciation of $576,848 at
December 31, 1998 and $275,109 at December 31, 1997............................ 2,479,977 540,856
Spare parts inventory............................................................ 35,857,852 10,334,113
Operating lease rentals receivable............................................... 2,491,722 2,068,231
Receivables from spare parts sales............................................... 5,310,039 2,908,175
Other receivables................................................................ 756,751 375,878
Other assets..................................................................... 5,198,141 2,288,547
-------------- --------------
Total assets..................................................................... $ 360,004,811 $ 198,430,056
-------------- --------------
-------------- --------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses............................................ $ 9,619,453 $ 4,010,976
Salaries and commissions payable................................................. 976,738 1,070,051
Deferred income taxes............................................................ 11,684,449 8,476,040
Deferred gain.................................................................... 156,782 183,278
Notes payable and accrued interest............................................... 245,580,598 101,433,200
Capital lease obligation......................................................... 2,652,205 2,802,119
Residual share payable........................................................... 2,618,351 2,092,140
Maintenance reserves............................................................. 13,273,247 20,018,195
Security deposits................................................................ 4,560,751 2,435,987
Unearned lease revenue........................................................... 3,040,189 1,306,613
-------------- --------------
Total liabilities................................................................ $ 294,162,763 $ 143,828,599
-------------- --------------
Shareholders' equity:
Preferred stock ($0.01 par value, 5,000,000 shares authorized; 0 issued and
outstanding as of December 31, 1998 and December 31, 1997)..................... -- --
Common stock, ($0.01 par value and no par value, 20,000,000 shares authorized;
7,360,813 and 7,177,320 shares issued and outstanding as of December 31, 1998
and December 31, 1997, respectively)........................................... 73,608 40,117,223
Paid-in capital in excess of par................................................. 42,033,371 --
Retained earnings................................................................ 23,735,069 14,484,234
-------------- --------------
Total shareholders' equity....................................................... 65,842,048 54,601,457
-------------- --------------
Total liabilities and shareholders' equity....................................... $ 360,004,811 $ 198,430,056
-------------- --------------
-------------- --------------
See accompanying notes to the consolidated financial statements
27
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-------------------------------------------
1998 1997 1996
------------- ------------- -------------
REVENUE
Lease revenue....................................................... $ 33,046,567 $ 19,455,364 $ 13,740,438
Gain on sale of leased equipment.................................... 13,412,890 4,165,443 2,208
Spare part sales.................................................... 24,088,360 14,110,102 5,842,607
Sale of equipment acquired for resale............................... 4,093,641 12,747,840 12,105,315
Interest and other income........................................... 1,438,983 727,995 617,144
------------- ------------- -------------
Total revenue....................................................... 76,080,441 51,206,744 32,307,712
EXPENSES
Interest expense.................................................... 15,208,796 7,797,446 4,323,276
Depreciation expense................................................ 8,250,853 4,223,286 3,181,216
Residual share...................................................... 803,328 892,861 722,753
Cost of spare part sales............................................ 17,298,434 9,468,953 3,307,928
Cost of equipment acquired for resale............................... 3,573,499 10,677,716 10,788,730
General and administrative.......................................... 15,184,329 9,331,972 5,123,813
------------- ------------- -------------
Total expenses...................................................... 60,319,239 42,392,234 27,447,716
------------- ------------- -------------
Income before income taxes, minority interest and extraordinary
item.............................................................. 15,761,202 8,814,510 4,859,996
Income taxes........................................................ (6,309,883) (3,484,768) (1,976,471)
------------- ------------- -------------
Income before minority interest and extraordinary item.............. 9,451,319 5,329,742 2,883,525
Less: minority interest in net income of subsidiary................. -- -- (79,053)
------------- ------------- -------------
Income before extraordinary item.................................... 9,451,319 5,329,742 2,804,472
Extraordinary item net of applicable income taxes................... (200,480) 2,007,929 --
------------- ------------- -------------
Net income.......................................................... $ 9,250,839 $ 7,337,671 $ 2,804,472
------------- ------------- -------------
------------- ------------- -------------
Basic earnings per common share:
Income before extraordinary item.................................... $ 1.30 $ 0.97 $ 0.75
Extraordinary item.................................................. (0.03) 0.36 --
------------- ------------- -------------
Net income.......................................................... $ 1.27 $ 1.33 $ 0.75
------------- ------------- -------------
------------- ------------- -------------
Diluted earnings per common share:
Income before extraordinary item.................................... $ 1.27 $ 0.94 $ 0.74
Extraordinary item.................................................. (0.03) 0.35 --
------------- ------------- -------------
Net income.......................................................... $ 1.24 $ 1.29 $ 0.74
------------- ------------- -------------
------------- ------------- -------------
Average common shares outstanding................................... 7,266,002 5,497,358 3,756,040
Diluted average common shares outstanding........................... 7,460,872 5,673,425 3,787,788
See accompanying notes to the consolidated financial statements
28
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
ISSUED AND PAID-IN
OUTSTANDING CAPITAL TOTAL
SHARES OF COMMON IN EXCESS RETAINED ADVANCES TO SHAREHOLDERS'
COMMON STOCK STOCK OF PAR EARNINGS SHAREHOLDERS EQUITY
------------- ----------- ---------- ---------- ------------ ------------
Balances at December 31,
1995........................ 1,500 $ 500 $ -- $5,293,566 $ (481,789) $4,812,277
Common stock issued and
proceeds from IPO, net...... 5,425,293 16,055,189 -- -- -- 16,055,189
Repayments to shareholders,
net......................... -- -- -- -- 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
Shares issued................. 25,527 221,244 -- -- -- 221,244
Common stock issued and
proceeds from follow-on
offering, net............... 1,725,000 23,840,290 -- -- -- 23,840,290
Net income.................... -- -- -- 7,337,667 -- 7,337,667
------------- ----------- ---------- ---------- ------------ ------------
Balances at December 31,
1997........................ 7,177,320 $40,117,223 $ -- $14,484,230 $ -- $54,601,453
Shares issued................. 183,493 587,240 737,098 -- -- 1,324,338
Tax benefit from disqualified
dispositions of qualified
shares...................... -- -- 665,418 -- -- 665,418
Conversion to par value
stock....................... -- (40,630,855) 40,630,855 -- -- --
Net income.................... -- -- -- 9,250,839 -- 9,250,839
------------- ----------- ---------- ---------- ------------ ------------
Balances at December 31,
1998........................ 7,360,813 $ 73,608 $42,033,371 $23,735,069 $ -- $65,842,048
------------- ----------- ---------- ---------- ------------ ------------
------------- ----------- ---------- ---------- ------------ ------------
See accompanying notes to the consolidated financial statements
29
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
------------ ------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................. $ 9,250,839 $ 7,337,671 $ 2,804,472
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation of equipment held for lease............................... 7,945,184 4,098,348 3,103,601
Depreciation of property, equipment and furnishings.................... 305,669 124,938 77,615
Loss on sale of property, equipment and furnishings.................... 23,661 (45,122) 5,701
Gain on sale of leased equipment....................................... (13,412,890) (4,165,443) (2,208)
Increase in residual share payable..................................... 526,211 892,861 722,753
Minority interest in net income of subsidiary.......................... -- -- 79,053
Changes in assets and liabilities:
Deposits............................................................. (302,766) (4,861,252) (2,279,587)
Spare parts inventory................................................ (25,523,739) (6,276,465) (1,176,384)
Receivables.......................................................... (3,206,228) (2,155,312) (1,931,905)
Other assets......................................................... (986,434) (1,335,128) (745,525)
Accounts payable and accrued expenses................................ 5,608,477 1,257,335 1,701,186
Salaries and commission payable...................................... (93,313) 531,393 374,697
Deferred income taxes................................................ 3,208,409 2,526,364 1,857,351
Deferred gain........................................................ (26,496) (26,496) 209,774
Accrued interest..................................................... 704,166 (247,821) 666,571
Maintenance reserves................................................. (6,744,948) 8,337,670 2,963,355
Security deposits.................................................... 2,124,764 457,482 708,484
Unearned lease revenue............................................... 1,733,576 32,344 417,182
------------ ------------ -----------
Net cash (used in) provided by operating activities.................... (18,865,858) 6,483,367 9,556,186
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of equipment held for operating lease (net of
selling expenses).................................................... 40,486,239 15,672,655 3,748,035
Proceeds from sale of property, equipment and furnishings.............. 16,300 80,500 28,198
Purchase of equipment held for operating lease......................... (171,101,237) (68,143,774) (25,277,021)
Deposits made in connection with inventory purchases................... (1,923,160) -- --
Purchase of property, equipment and furnishings........................ (2,284,755) (242,392) (362,510)
Principal payments received on direct finance lease.................... 572,642 273,146 --
------------ ------------ -----------
Net cash used in investing activities.................................. (134,233,971) (52,359,865) (21,863,298)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments from shareholder, net....................................... -- -- 481,789
Proceeds from issuance of notes payable................................ 194,703,146 165,590,908 16,086,621
Proceeds from issuance of common stock................................. 1,989,756 24,061,534 15,926,101
Principal payments on notes payable.................................... (51,259,914) (137,095,544) (13,478,332)
Principal payments on capital lease obligation......................... (149,914) (158,338) --
Cash dividends paid on common stock.................................... -- -- (951,475)
------------ ------------ -----------
Net cash provided by financing activities.............................. 145,283,074 52,398,560 18,064,704
(Decrease) increase in cash and cash equivalents....................... (7,816,755) 6,522,062 5,757,592
Cash and cash equivalents at beginning of period....................... 13,095,303 6,573,241 815,649
------------ ------------ -----------
Cash and cash equivalents at end of period............................. $ 5,278,548 $ 13,095,303 $ 6,573,241
------------ ------------ -----------
------------ ------------ -----------
Supplemental information:
Net cash paid for: Interest........................................... $ 14,504,630 $ 7,951,352 $ 3,656,707
------------ ------------ -----------
Income Taxes.......................................... $ 4,838,522 $ 196,850 $ 31,552
------------ ------------ -----------
See accompanying notes to the consolidated financial statements
30
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 ("Willis") is a provider of aviation
services whose primary focus has been on providing operating leases of
aftermarket commercial aircraft engines and other aircraft-related equipment to
air carriers, manufacturers and overhaul/repair facilities worldwide. Willis
also engages in the selective purchase and resale of commercial aircraft
engines.
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), T-10 Inc. (T-10), T-11 Inc. (T-11),
and T-12 Inc. (T-12) are wholly-owned subsidiaries of Willis. They are all
California corporations and were established to purchase and lease and resell
commercial aircraft engines and parts.
Willis Aeronautical Services, Inc. ("WASI") is a wholly owned subsidiary of
Willis. WASI is a California corporation established in 1994 for the purpose of
marketing and selling aircraft parts and components. WLFC Funding Corporation
("WLFC-FC") is a wholly owned subsidiary of Willis. WLFC-FC is a Delaware
corporation and was established in 1997 for the purpose of financing aircraft
engines. WLFC Engine Pooling Company ("WLFC-Pooling") is a wholly-owned
subsidiary of Willis. WLFC-Pooling is a California Corporation and was
established in 1997 for the purpose of acquiring and leasing aircraft engines.
Pacific Gas Turbine Center Incorporated ("PGTC") is a wholly owned subsidiary of
Willis. PGTC was formed in 1998 to provide, among other things, engine
disassembly services. WLFC (Ireland) Limited is a wholly-owned subsidiary of
Willis. WLFC (Ireland) Limited was formed in 1998 to facilitate certain of
Willis' international leasing activities.
(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, T-11, T-12, WASI, WLFC-FC,
WLFC-Pooling, PGTC and WLFC (Ireland) Limited (together, the "Company"). All
significant intercompany balances and transactions have been eliminated in
consolidation.
(c) REVENUE RECOGNITION
Revenue from leasing of aircraft equipment is recognized as operating lease
or finance 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.
The Company records an allowance for estimated returns of spare parts based
on recent experience. Such returns occur in the ordinary course of the Company's
business.
(d) EQUIPMENT HELD FOR OPERATING LEASE
Aircraft assets held for operating lease are stated at cost, less
accumulated depreciation. Certain professional fees incurred in connection with
the acquisition and leasing of aircraft assets are capitalized as part of the
cost of such assets.
The Company generally depreciates engines 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 accurately reflects
31
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the Company's typical holding period for the assets and, further, that the
residual value assumption reasonably approximates the selling price of the
assets 15 years from date of acquisition.
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 estimated remaining in-service life.
The spare parts packages owned by the Company are depreciated on a
straight-line basis over an estimated useful life of 15 years to a 25% residual
value.
The aircraft owned by the Company are depreciated on a straight-line basis
over an estimated useful life of 13 years to a 17% residual value.
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 reviews at
least quarterly the carrying value of long-lived assets. Such reviews resulted
in no losses on revaluation in 1998, 1997 or 1996.
(e) 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: (i) specifically identified based on actual
purchase price; or (ii) the cost of parts purchased in a pool or from dismantled
engines or aircraft based on estimated relative sales price.
(f) LOAN COMMITMENT AND RELATED FEES
To the extent that the Company is required to pay fees in order to secure
debt, such fees are amortized over the life of the related loan on a
straight-line basis.
(g) 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
lease revenue. Major overhauls paid for by the Company, which add economic
value, are capitalized and depreciated over the estimated remaining useful life
of the engine.
(h) INTEREST RATE HEDGING
In 1996, the Company purchased an interest rate cap in order to mitigate 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.
32
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Additionally, the Company has entered into interest rate swap agreements to
mitigate its exposure on its variable rate borrowings. The durations of the swap
agreements are set consistent with the duration of the Company's leases. The
differential to be paid or received under the swap agreements is charged or
credited to interest expense.
(i) 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.
(j) 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. Leasehold improvements are recorded at
cost and depreciated by the straight-line method over the lease term.
(k) ADVANCES TO SHAREHOLDER
The advances to the sole shareholder were noninterest bearing (except for a
$10,000 interest bearing note). All such notes were repaid in 1996.
(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 $2.6 million and $2.1 million as of December
31, 1998 and 1997, respectively. As of December 31, 1998 and 1997, a total of
three and five engines, respectively, with a net book value of $11.0 million and
$15.3 million, respectively, were subject to residual sharing arrangements
(notes 4 and 5).
(m) SALE OF LEASED EQUIPMENT AND EQUIPMENT ACQUIRED FOR RESALE
The Company regularly sells equipment from its lease portfolio. This
equipment may or may not be subject to lease at time of sale. The gain on such
sales is recognized as revenue and consists of proceeds associated with the sale
less the net book value of the asset sold and any direct costs associated with
the sale. To the extent that deposits or maintenance reserves are not included
in the sale and the liability associated with such items is transferred to the
purchaser of the equipment, the Company includes such items in its calculation
of gain.
The Company periodically engages in transactions involving the purchase and
resale of aircraft equipment. Assets acquired for resale are recorded at the
lower of cost or net realizable value. Gross
33
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
revenue from the sale of equipment is reflected as sale of equipment acquired
for resale with the corresponding cost of the equipment shown as an expense
item.
(n) CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments readily convertible into
known amounts of cash, with original maturities of 90 days or less, as cash
equivalents.
(o) RECLASSIFICATIONS
Certain items in the consolidated financial statements of prior years have
been reclassified to conform to the current year's presentation.
(p) 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.
(q) PER SHARE INFORMATION
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share," which
required the Company to replace its presentation of primary earnings per share
with a presentation of basic and fully diluted earnings per share on the face of
the income statement, effective December 15, 1997. The principal difference
between primary earnings per share and basic earnings per share under the new
statement is that basic earnings per share does not consider common stock
equivalents such as stock options and warrants. Basic earnings per common share
is computed by dividing net income to common shares by weighted-average number
of shares outstanding during the period. The computation of fully diluted
earnings per share is similar to the computation of basic earnings per share,
except for the inclusion of all potentially dilutive common shares. The
statement required restatement of all prior periods presented. Basic and fully
diluted earnings per share are presented below:
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Basic:
Net Income......................................................................... $ 9,251 $ 7,338 $ 2,804
Weighted-average number of common shares outstanding............................... 7,266 5,497 3,756
Basic earnings per common share.................................................... $ 1.27 $ 1.33 $ 0.75
--------- --------- ---------
Fully diluted:
Net income......................................................................... $ 9,251 $ 7,338 $ 2,804
Shares:
Weighted-average number of common shares outstanding............................... 7,266 5,497 3,756
Potentially dilutive common shares................................................. 195 176 32
--------- --------- ---------
Total Shares..................................................................... 7,461 5,673 3,788
Fully diluted earnings per weighted-average common share......................... $ 1.24 $ 1.29 $ 0.74
34
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(r) 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 December 31, 1998 and December 31, 1997, 7,360,813 and
7,177,320 shares of common stock were issued and outstanding. No preferred stock
was issued or outstanding as of December 31, 1998 or December 31, 1997.
The rights and preferences of preferred stock are established by the
Company's Board of Directors upon issuance.
(s) ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued a new
statement: SFAS No. 130, "Reporting Comprehensive Income," which requires
enterprises to report, by major component and in total, all changes in equity
from nonowner sources: The Company does not have any comprehensive income other
than the revenue and expense items included in the Consolidated Statements of
Income. As a result, comprehensive income equals net income for the years ended
December 31, 1998, 1997 and 1996.
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.
(2) EQUIPMENT HELD FOR LEASE
At December 31, 1998, the Company had 74 aircraft engines and related
equipment with an aggregate original cost of $250.1 million, seven spare parts
packages with an aggregate original cost of $17.8 million and five commuter
aircraft with an aggregate original cost of $22.2 million in its lease
portfolio. At December 31, 1997, the Company had 44 aircraft engines and related
equipment with an aggregate original cost of $146.3 million, seven spare parts
packages with an aggregate original cost of $7.1 million and three commuter
aircraft with an aggregate original cost of $10.5 million in its lease
portfolio.
Certain of the Company's aircraft equipment is leased and operated
internationally. All leases relating to this equipment are denominated and
payable in U.S. dollars.
35
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) EQUIPMENT HELD FOR LEASE (CONTINUED)
The Company leases its aircraft equipment to lessees domiciled in eight
geographic regions: The tables below set forth geographic information about the
Company's operating leased aircraft equipment grouped by domicile of the lessee:
YEARS ENDED DECEMBER 31,
-------------------------------
REGION 1998 1997 1996
- ------------------------------------------------------------- --------- --------- ---------
(IN THOUSANDS)
Operating lease revenue:
United States.............................................. $ 10,540 $ 6,718 $ 5,295
Canada..................................................... 2,071 1,521 1,291
Mexico..................................................... 3,780 2,479 1,865
Australia/New Zealand...................................... 926 1,027 1,030
Europe..................................................... 6,704 5,432 2,840
South America.............................................. 5,399 778 530
Asia....................................................... 1,862 807 889
Middle East................................................ 917 251 --
--------- --------- ---------
Totals....................................................... $ 32,199 $ 19,013 $ 13,740
--------- --------- ---------
--------- --------- ---------
YEARS ENDED DECEMBER 31,
-------------------------------
REGION 1998 1997 1996
- ---------------------------------------------------------------- --------- --------- ---------
(IN THOUSANDS)
Operating lease revenue less applicable depreciation, interest
and residual share:
United States................................................. $ 3,801 $ 2,751 $ 2,405
Canada........................................................ 517 580 549
Mexico........................................................ 1,954 554 306
Australia/New Zealand......................................... 276 402 471
Europe........................................................ 1,824 2,076 1,410
South America................................................. 2,198 267 185
Asia.......................................................... 755 123 340
Middle East................................................... 321 100 --
Off-lease and other........................................... (419) (70) (61)
--------- --------- ---------
Totals.......................................................... $ 11,227 $ 6,783 $ 5,606
--------- --------- ---------
--------- --------- ---------
36
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) EQUIPMENT HELD FOR LEASE (CONTINUED)
YEARS ENDED DECEMBER 31,
---------------------------------
REGION 1998 1997 1996
- ----------------------------------------------------------- ---------- ---------- ---------
(IN THOUSANDS)
Net book value of operating leased assets:
United States............................................ $ 61,267 $ 46,853 $ 31,332
Canada................................................... 17,753 11,167 7,116
Mexico................................................... 30,366 13,032 13,441
Australia/New Zealand.................................... 6,281 5,312 5,509
Europe................................................... 75,179 35,964 30,052
South America............................................ 44,169 11,205 2,034
Asia..................................................... 15,348 7,437 4,109
Middle East.............................................. 4,188 4,833 --
Off-lease................................................ 20,068 2,733 2,499
---------- ---------- ---------
Totals..................................................... $ 274,619 $ 138,536 $ 96,092
---------- ---------- ---------
---------- ---------- ---------
Finance leased assets, generated $847,570 and $442,542 of revenue in 1998
and 1997, respectively. After interest expense such assets generated $480,224
and $171,684, respectively. The net investment in direct finance leases on
December 31, 1998 and 1997 was as follows:
1998 1997
--------- ---------
(IN THOUSANDS)
Minimum payments receivable.............................................. $ 7,852 $ 9,280
Estimated residual value of leased assets................................ 4,950 4,950
Unearned income.......................................................... (3,553) (4,408)
--------- ---------
Net investment in finance lease.......................................... $ 9,249 $ 9,822
--------- ---------
--------- ---------
As of December 31, 1998, minimum future payments under noncancelable leases
were as follows:
YEAR OPERATING FINANCE
- ------------------------------------------------------------------------ ---------- ---------
(IN THOUSANDS)
1999.................................................................... $ 34,128 $ 1,414
2000.................................................................... 25,579 1,414
2001.................................................................... 20,195 1,414
2002.................................................................... 16,734 1,414
2003.................................................................... 9,583 1,414
Thereafter.............................................................. 12,928 705
---------- ---------
$ 119,147 $ 7,775
---------- ---------
---------- ---------
37
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,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS)
Vehicles.................................................................... $ 156 $ 156
Computer equipment.......................................................... 526 259
Furniture and equipment..................................................... 1,450 401
Leasehold improvements...................................................... 925 --
--------- ---------
3,057 816
Accumulated depreciation.................................................... (577) (275)
--------- ---------
Net book value.............................................................. $ 2,480 $ 541
--------- ---------
--------- ---------
(4) EXTRAORDINARY EXPENSE/GAIN
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.
In February 1997, the Company obtained a new loan agreement for $41.5
million to replace an existing loan of $44.2 million. The transaction resulted
in an extraordinary gain of $2.0 million, net of tax.
38
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE AND ACCRUED INTEREST
Notes payable consisted of the following:
AS OF DECEMBER 31,
----------------------
1998 1997
---------- ----------
(IN THOUSANDS)
Note payable at a fixed interest rate of 8.05%. Secured by an aircraft engine and the
proceeds thereof. The note matures in May 2003.......................................... $ 2,600 $ 2,732
Note payable at a fixed interest rate of 10%. Secured by an aircraft engine and proceeds
thereof. This note was repaid in March 1998............................................. -- 2,531
Note payable at a floating interest rate of LIBOR plus 5%. Secured by aircraft engines and
the proceeds thereof. The note matures in 2001 or upon sale of such engines............. 2,661 3,016
Note payable at a floating interest rate of LIBOR plus 1.625% secured by engines, the
proceeds thereof and certain deposits. This facility has committed amount of $80
million. At December 31, 1998, $15.5 million was available under this facility subject
to the Company providing additional collateral. The facility matures in February
2006.................................................................................... 64,479 34,400
Notes payable at a floating rate of interest of LIBOR plus 1.75%. Secured by engines,
parts and the proceeds thereof. This facility has a committed amount of $150 million At
December 31, 1998, $20.9 million was available under this facility. The facility has a
two-year revolving period followed by a four-year term-out period. The facility is
renewable annually, subject to the Company providing additional collateral.............. 129,100 --
Note payable at a floating interest rate of LIBOR plus 2.5%. Secured by aircraft engines
and the proceeds thereof. The note matured in June 1998................................. -- 13,433
Notes payable at fixed interest rates ranging from 10.23% to 10.77%. Secured by aircraft
engines and parts and the proceeds thereof. The notes mature between December 2001 and
February 2002........................................................................... 17,288 18,748
Notes payable at fixed interest rates of 11.03%. Secured by aircraft engines and the
proceeds thereof. The notes mature on December 2000..................................... 1,339 2,893
Note payable at a fixed interest rate of 11.68%. Secured by an aircraft engine and the
proceeds thereof. The note matures on December 2001..................................... 1,980 2,189
Note payable at a fixed interest rate of 8.18% secured by aircraft and the proceeds
thereof. The note matures January 2003.................................................. 9,545 10,500
Notes payable at fixed interest rates of 10% and 8.89%. Secured by aircraft engines and
the proceeds thereof. The notes mature May 1998 and August 2002......................... 4,128 6,179
Notes payable under a line of credit in the amount of $3,000,000 at a variable rate of
prime plus 1%. The loan was secured by the assets of WASI. This facility expired on
April 30, 1998.......................................................................... -- 2,627
Subordinated note payable at a fixed interest rate of 7%. Secured by aircraft engines,
spare parts and the proceeds thereof. The note matures June 2004........................ 1,342 1,586
Note payable at a fixed interest rate of 6.95% secured by aircraft and the proceeds
thereof. The note matures September 2005................................................ 9,813 --
---------- ----------
Total notes payable....................................................................... $ 244,275 $ 100,834
---------- ----------
---------- ----------
39
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE AND ACCRUED INTEREST (CONTINUED)
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 $246.0 million at December 31,
1998.
The fair value of the interest rate cap as estimated by the financial
institution providing the instrument, was $4,902 at December 31, 1998. The fair
value of the interest rate swaps, as estimated by the financial institutions
providing the swaps, was $(562,990) at December 31, 1998.
Principal outstanding at December 31, 1998 is repayable as follows:
(IN
YEAR THOUSANDS)
- -------------------------------------------------------------------------------
1999........................................................................... $ 11,629
2000........................................................................... 16,313
2001........................................................................... 36,046
2002........................................................................... 44,247
2003........................................................................... 31,796
Thereafter..................................................................... 104,246
-------------
$ 244,277
-------------
-------------
As of December 31, 1998 and 1997, accrued interest in the amounts of $1.3
million and $0.6 million respectively, is included in notes payable and accrued
interest. At December 31, 1998 and 1997, the Company held deposits in the amount
of $18.8 million and $18.5 million, respectively, consisting of bank accounts
that are subject to withdrawal restrictions as per lease or loan agreements.
Included in these amounts are prepayments to the Company required by certain
lease agreements for periodic engine maintenance. These accounts also include
security deposits held. Substantially all of the deposits bear interest for the
Company's benefit.
40
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAXES
The components of income tax expense (net of tax benefit or expense related
to the extraordinary items of $134,160 and (1,329,408) for the years ended
December 31, 1998 and 1997, respectively, included in the accompanying statement
of income were as follows:
FEDERAL STATE TOTAL
--------- --------- ---------
(IN THOUSANDS)
December 31, 1998
Current......................................................... 2,118 850 2,968
Deferred........................................................ 2,850 358 3,208
--------- --------- ---------
4,968 1,208 6,176
--------- --------- ---------
--------- --------- ---------
December 31, 1997
Current......................................................... $ 1,683 $ 604 $ 2,288
Deferred........................................................ 2,252 274 2,526
--------- --------- ---------
$ 3,935 $ 878 $ 4,814
--------- --------- ---------
--------- --------- ---------
December 31, 1996
Current......................................................... $ 94 $ 25 $ 119
Deferred........................................................ 1,580 277 1,857
--------- --------- ---------
$ 1,674 $ 302 $ 1,976
--------- --------- ---------
--------- --------- ---------
The following is a reconciliation of the statutory federal income tax
expense (net of income tax benefit related to the extraordinary item) to the
effective income tax expense:
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
Statutory federal income tax expense............................. 5,245 $ 4,132 $ 1,652
State taxes, net of federal benefit.............................. 901 710 298
Other............................................................ 30 (28) 26
--------- --------- ---------
Effective income tax expense................................... $ 6,176 $ 4,814 $ 1,976
--------- --------- ---------
--------- --------- ---------
41
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,
----------------------
1998 1997
---------- ----------
(IN THOUSANDS)
Deferred tax assets:
Prepaid rent........................................................ 1,211 $ 520
Residual sharing expenses........................................... 1,043 833
Uniform capitalization expenses..................................... 945 95
State Taxes......................................................... 235 201
Reserves............................................................ 390 76
Alternative minimum tax credit...................................... 2,803 1,441
Passive activity loss carryforwards................................. 286 2,440
---------- ----------
Total gross deferred tax assets................................... 6,913 5,606
Less valuation allowances......................................... -- --
---------- ----------
Net deferred tax assets........................................... 6,913 5,606
Deferred tax liabilities:
Depreciation on aircraft equipment.................................. (18,597) (14,082)
---------- ----------
Net deferred tax liability........................................ $ (11,684) $ (8,476)
---------- ----------
---------- ----------
As of December 31, 1998, the Company had passive activity loss carryforwards
of approximately $840,000 for federal income tax purposes which have no
expiration date and which should be available to offset future passive and
active revenue. As of December 31, 1998, the Company also had alternative
minimum tax credits of approximately $2.8 million for federal income tax
purposes which have no expiration date and which should be available to offset
future tax liabilities. Management believes that no valuation allowance is
required on deferred tax assets as it is more likely than not that all amounts
are recoverable through future operations.
(7) DIVIDENDS AND ADVANCES TO SHAREHOLDERS
During the years ended December 31, 1998, 1997, and 1996, the Company paid
dividends totaling $0, $0 and $951,475 to Company shareholder(s), respectively.
During the years ended December 31, 1998, 1997 and 1996, the Company made
loans of, $0, $0 and $265,478 to a Company shareholder. Repayments on such loans
and loans made in prior periods, for the years ended December 31, 1998, 1997 and
1996 were, $0, $0 and $747,267, respectively. There were no outstanding balances
on such loans, as of December 31, 1998 and 1997.
(8) RISK MANAGEMENT ISSUES
RISK CONCENTRATIONS
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash deposits and
receivables.
42
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) RISK MANAGEMENT ISSUES (CONTINUED)
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, 1998 and 1997, management believes the Company had no
significant concentrations of credit risk.
For the year ended December 31, 1998, the Company had one significant
customer, Kellstrom Industries, Inc., ("Kellstrom") which accounted for
approximately 13% of total revenue and 74% of gain on sale of leased equipment.
The gross sales proceeds associated with lease equipment sales to Kellstrom
during the year ended December 31, 1998 were $25.4 million. The Company
purchased engines from Kellstrom for total consideration of $18.5 million during
the year ended December 31, 1998. For the year ended December 31, 1998, lease
equipment sales to TPI Aviation, Ltd. accounted for 2% of total revenue and 14%
of gain on sale of leased equipment.. The gross sales proceeds associated with
lease equipment sales to TPI Aviation, Ltd. during the year ended December 31,
1998 were $5.8 million.
For the years ended December 31, 1997 and 1996, the Company had one
significant customer, Aerovias Mexico, S.A. de C.V., which accounted for
approximately 13% and 14% of lease revenue, respectively.
INTEREST RATE RISK MANAGEMENT
In September 1996, Willis Lease Finance Corporation 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 December 31,
1998, the notional principal amount of the cap was $33.3 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, Willis Lease Finance Corporation entered into an interest
rate swap agreement in December 1998 which has a notional amount of $15 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 debt warehouse facility against changes in
interest rates. WLFC Funding Corporation has entered into interest rate swap
agreements in order to meet the hedging requirements and to manage the variable
rate interest risk related to WLFC Funding Corporation's debt. As of December
31, 1998, such swap agreements had notional outstanding amounts of $25 million,
a weighted average remaining duration of 39 months and a weighted average fixed
rate of 5.88%. As a result of these swap arrangements, interest expense was
increased by $28,234, $0 and $0 in 1998, 1997 and 1996, respectively.
(9) COMMITMENTS
The Company has three leases for its office and warehouse space. The annual
lease rental commitments are $309,481, $420,000, and $45,175 and the leases
expire on May 31, 2003, December 31, 2010 and July 31, 1999, respectively.
43
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) COMMITMENTS (CONTINUED)
The Company finances one of its engines under a capital lease. The
maturities of the capital lease obligation as of December 31, 1998 are as
follows:
(IN
THOUSANDS)
1999........................................................................... $ 376
2000........................................................................... 377
2001........................................................................... 376
2002........................................................................... 377
2003........................................................................... 376
Thereafter..................................................................... 1,816
-------------
Net Minimum Lease Payment...................................................... 3,698
Less: Amount Representing Interest............................................. (1,046)
-------------
Present Value of Net Minimum Lease Payment..................................... $ 2,652
-------------
-------------
In March 1998, the Company committed, subject to documentation, to purchase,
during 1998 and 1999, certain aircraft and engines for its WASI parts operation.
A $1.9 million deposit is held by the seller of the aircraft and engines in
connection with this commitment and the total commitment as of December 31, 1998
to purchase over the course of 1999 is not more than $13.2 million. This deposit
is included in other assets as of December 31, 1998.
(10) 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 note payable
was repaid in September of 1996. There were no related party transactions in
1997 or 1998.
(11) EMPLOYEE BENEFIT PLANS
EMPLOYEE STOCK PURCHASE PLAN
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 was 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 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 of the common stock on the date of entry into an offering
period. In fiscal 1998 and 1997, 15,755 and 10,527 shares of common stock,
respectively were issued under the Purchase Plan.
The weighted average per share fair value of the employee's purchase rights
under the Purchase Plan for the rights granted in 1998 and 1997 were $6.37 and
$3.47 respectively.
44
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) EMPLOYEE BENEFIT PLANS (CONTINUED)
1996 STOCK OPTION/STOCK ISSUANCE PLAN
In June 1996, the Board of Directors approved the 1996 Stock Option/Stock
Issuance Plan (the "Plan"). The Plan was amended by the Shareholders and
restated in February 1998, to provide for an increase in the number of shares
reserved for issuance under the Plan from 525,000 shares to 1,025,000 shares.
The plan includes a Discretionary Option Grant Program, a Stock issuance
Program, and an Automatic Option Grant Program for eligible non-employee Board
members.
A summary of the activity under the plan is as follows:
OPTIONS OUTSTANDING
--------------------------------------
WEIGHTED
OPTIONS AVERAGE WEIGHTED
AVAILABLE EXERCISE AVERAGE
FOR GRANT OPTIONS PRICE FAIR VALUE
---------- ---------- ------------- -----------
Balances at June 21, 1996 (Inception).......................... 525,000 -- --
Options Granted.............................................. (315,000) 315,000 $ 8.00 $ 4.19
Options Exercised............................................ -- -- --
Options Canceled............................................. -- -- --
---------- ---------- ------
Balances at December 31, 1996.................................. 210,000 315,000 $ 8.00
Options Granted.............................................. (191,000) 191,000 $ 13.99 $ 5.83
Options Exercised............................................ -- (15,000) $ 8.00
Options Canceled............................................. 52,500 (52,500) $ 10.86
---------- ---------- ------
Balances at December 31, 1997.................................. 71,500 438,500 $ 10.27
Additional Options Made Available............................ 500,000 -- --
Options Granted.............................................. (302,000) 302,000 $ 14.98 $ 5.32
Options Exercised............................................ -- (150,000) $ 8.28
Options Canceled............................................. 70,000 (70,000) $ 10.47
---------- ---------- ------
Balances at December 31, 1998.................................. 339,500 520,500 $ 13.51
In connection with the exercise of a portion of these options during the year
ended December 31, 1998, the Company recognized a $665,418 tax benefit.
A summary of the outstanding, exercisable options and their weighted average
exercise prices is as follows:
WEIGHTED
AVERAGE
EXERCISE
OPTIONS PRICE
--------- -------------
At December 31, 1996................................................ 90,000 $ 8.00
At December 31, 1997................................................ 192,500 $ 9.33
At December 31, 1998................................................ 162,500 $ 11.76
45
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) EMPLOYEE BENEFIT PLANS (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable options at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- ------------------------------
WEIGHTED AVERAGE
NUMBER REMAINING WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE OUTSTANDING EXERCISE PRICE
- -------------------------------- ----------- ------------------- ----------------- ----------- -----------------
$ 8.00.......................... 97,500 7.71 $ 8.00 75,000 $ 8.00
$10.63 to $14.75................ 342,000 9.29 $ 13.58 60,500 $ 12.69
$19.50 to $22.13................ 81,000 9.17 $ 19.90 27,000 $ 20.14
----------- --- ------ ----------- ------
$ 8.00 to $22.13................ 520,500 8.98 $ 13.51 162,500 $ 11.76
----------- --- ------ ----------- ------
----------- --- ------ ----------- ------
WARRANTS
In conjunction with the initial public 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 than 12 months after
the initial public offering, if and when the Company files a registration
statement 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 secondary offering
in December 1997 constituted such a registration. 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. On February 26, 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.
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 15, 1995.
At December 31, 1998, 1997 and 1996 the Company had two stock-based
compensation plans, as described above. The Company applies APB 25 in accounting
for its plans. Accordingly, no compensation cost has been recognized for its
fixed stock option plans and its stock purchase plan. Had compensation
46
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) EMPLOYEE BENEFIT PLANS (CONTINUED)
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 as follows:
1998 1997 1996
------------ ------------ ------------
Net Income as reported.................................................. $ 9,250,839 $ 7,337,671 $ 2,804,472
Net Income pro forma.................................................... $ 8,644,432 $ 6,900,477 $ 2,393,485
Basic Earnings per Common Share as reported............................. $ 1.27 $ 1.33 $ 0.75
Basic Earnings per Common Share pro forma............................... $ 1.19 $ 1.25 $ 0.64
Diluted Earnings per Common Share as reported........................... $ 1.24 $ 1.29 $ 0.74
Diluted Earnings per Common Share pro forma............................. $ 1.16 $ 1.22 $ 0.63
The fair value of the purchase rights under the Purchase Plan, the options
and the warrants is estimated using the Black-Scholes option pricing model with
the following weighted average assumptions:
1996 STOCK OPTION/ EMPLOYEE STOCK
STOCK ISSUANCE PLAN PURCHASE PLAN
------------------------------- -------------------------------
1998 1997 1996 1998 1997 1996
--------- --------- --------- --------- --------- ---------
Expected Dividend Yield........................... 0% 0% 0% 0% 0% 0%
Risk-free Interest Rate........................... 4.51% 6.05% 6.22% 5.36% 5.12% 5.96%
Expected Volatility............................... 48% 54% 84% 48% 54% 84%
Expected Life (in years).......................... 2.86 3.0 2.4 .05-2.0 0.5-2.0 1.3
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion the existing models do not necessarily provide a reliable single measure
of the fair value of the Company's options.
EMPLOYEE 401(k) PLAN
The Company adopted The Willis 401(k) Plan (the "401(k) Plan") effective as
of January 1997. The 401(k) Plan provides for deferred compensation as described
in Section 401(k) of the Internal Revenue Code. The 401(k) Plan is a
contributory plan available to essentially all full-time and part-time employees
of the Company in the United States. In 1998, employees who participated in the
401(k) Plan could elect to defer and contribute to the 401(k) Plan up to 20% of
pretax salary or wages up to $10,000. The Company made no 401(k) contributions
during the years ended December 31, 1998 and 1997.
(12) OPERATING SEGMENTS
The Company's 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
47
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) OPERATING SEGMENTS (CONTINUED)
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 repair services. Because PGTC had no material
third party revenues and because it was managed and accounted for as part of the
Spare Parts Sales business segment for much of 1998, PGTC is not presented as a
separate business segment.
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):
LEASING AND SPARE
FOR THE YEAR ENDED DECEMBER 31, 1998 RELATED OPERATIONS PARTS SALES TOTAL
------------------ -------------- ---------
REVENUE
Lease revenue........................... $ 31,607 $ 1,439 $ 33,046
Gain on sale of leased equipment........ 12,628 785 13,413
Spare parts sales....................... -- 24,088 24,088
Sale of equipment acquired for resale... 4,094 -- 4,094
Interest and other income............... 1,393 46 1,439
-------- -------------- ---------
Total Revenue........................... 49,722 26,358 76,080
EXPENSES
Interest expense........................ 13,535 1,674 15,209
Depreciation expense.................... 7,377 874 8,251
Residual share.......................... 803 -- 803
Cost of spare parts..................... -- 17,298 17,298
Cost of equipment acquired for resale... 3,574 -- 3,574
General and administrative.............. 9,772 5,412 15,184
-------- -------------- ---------
Total Expenses.......................... 35,061 25,258 60,319
-------- -------------- ---------
Income before income tax and
extraordinary item.................... $ 14,661 $ 1,100(1) $ 15,761
-------- -------------- ---------
-------- -------------- ---------
Total assets as of December 31, 1998.... $316,855 $ 43,150 $ 360,005
-------- -------------- ---------
-------- -------------- ---------
- ------------------------
(1) The Company estimates that income before income tax and extraordinary item
would have been $2.5 million if the effect of PGTC's operations, after
intercompany eliminations, were eliminated from the results of the Spare
Parts Sales segment.
48
WILLIS LEASE FINANCE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) OPERATING SEGMENTS (CONTINUED)
LEASING AND
RELATED SPARE
FOR THE YEAR ENDED DECEMBER 31, 1997 OPERATIONS PARTS SALES TOTAL
--------------- ----------- ---------
REVENUE
Lease revenue........................................... $ 19,304 $ 151 $ 19,455
Gain on sale of leased equipment........................ 4,166 -- 4,166
Spare parts sales....................................... -- 14,110 14,110
Sale of equipment acquired for resale................... 12,748 -- 12,748
Interest and other income............................... 612 116 728
--------------- ----------- ---------
Total Revenue........................................... 36,830 14,377 51,207
EXPENSES
Interest expense........................................ 7,508 289 7,797
Depreciation expense.................................... 4,123 100 4,223
Residual share.......................................... 893 -- 893
Cost of spare parts..................................... -- 9,469 9,469
Cost of equipment acquired for resale................... 10,678 -- 10,678
General and administrative.............................. 7,057 2,275 9,332
--------------- ----------- ---------
Total Expenses.......................................... 30,259 12,133 42,392
--------------- ----------- ---------
Income before income tax and extraordinary item......... $ 6,571 $ 2,244 $ 8,815
--------------- ----------- ---------
--------------- ----------- ---------
Total assets as of December 31, 1997.................... $ 189,701 $ 8,729 $ 198,430
--------------- ----------- ---------
--------------- ----------- ---------
LEASING AND
RELATED SPARE
FOR THE YEAR ENDED DECEMBER 31, 1996 OPERATIONS PARTS SALES TOTAL
--------------- ----------- ---------
REVENUE
Lease revenue........................................... $ 13,741 $ -- $ 13,741
Gain on sale of leased equipment........................ 2 -- 2
Spare parts sales....................................... -- 5,843 5,843
Sale of equipment acquired for resale................... 12,105 -- 12,105
Interest and other income............................... 588 29 617
--------------- ----------- ---------
Total Revenue........................................... 26,436 5,872 32,308
EXPENSES
Interest expense........................................ 4,289 34 4,323
Depreciation expense.................................... 3,152 29 3,181
Residual share.......................................... 723 -- 723
Cost of spare parts..................................... -- 3,308 3,308
Cost of equipment acquired for resale................... 10,789 -- 10,789
General and administrative.............................. 3,918 1,206 5,124
--------------- ----------- ---------
Total Expenses.......................................... 22,871 4,577 27,448
--------------- ----------- ---------
Income before income tax and extraordinary item......... $ 3,565 $ 1,295 $ 4,860
--------------- ----------- ---------
--------------- ----------- ---------
Total assets as of December 31, 1996.................... $ 121,336 $ 3,597 $ 124,933
--------------- ----------- ---------
--------------- ----------- ---------
49