ITEM 1. BUSINESS
INTRODUCTION
Willis Lease Finance Corporation and its subsidiaries (the "Company") is a provider of aviation services focusing on leasing aftermarket commercial aircraft engines and other aircraft-related equipment. The Company provides this service to passenger airlines and air cargo carriers. 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 requirements that engines and parts be inspected and repaired at regular intervals based on equipment utilization. Furthermore, unscheduled events such as mechanical failure, and Federal Aviation Administration ("FAA") directives or manufacturer recommended actions for maintenance, repair and overhaul of engines and parts can give rise to demand for spare engines.
The Company's core focus has been on providing operating leases of aftermarket commercial aircraft engines and other aircraft-related equipment. As of December 31, 2000, the Company had a total lease portfolio (including 10 engines counted as discontinued operations) of 52 lessees in 23 countries and the Company's total lease portfolio (including net investments in direct finance leases) consisted of 110 engines, six aircraft and four spare parts packages with an aggregate net book value of $419.9 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 International, General Electric, Pratt & Whitney, Rolls Royce and International Aero Engines. 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 through a 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. WASI was sold in November 2000, as described below.
In 1998, the Company began disassembling commercial jet engines and providing parts cleaning, testing and classification services through Pacific Gas Turbine Center, Incorporated ("PGTC Inc."). PGTC Inc. received certification in November 1998 from the FAA to perform maintenance, repair and overhaul services for Pratt & Whitney JT8D and JT9D engines. PGTC Inc. commenced repair of JT8D engines shortly after receiving FAA certification. In May 1999, the Company contributed the operations and assets of PGTC Inc. to a newly formed joint venture with Chromalloy Gas Turbine Corporation, Pacific Gas Turbine Center, LLC ("PGTC LLC"). PGTC Inc. and its successor, PGTC LLC provide engine disassembly and maintenance, repair and overhaul services to the Company and third parties. The Company sold its interest in PGTC LLC in November 2000, as described below.
On November 7, 2000, the Company entered into agreements for a series of strategic transactions, each of which closed on November 30, 2000, with Flightlease AG, a corporation organized under the laws of Switzerland ("Flightlease"), SR Technics Group, a corporation organized under the laws of Switzerland ("SRT"), FlightTechnics, LLC, a Delaware limited liability company ("FlightTechnics") and SR Technics Group America, Inc., a Delaware corporation ("SRT Group America"), each of which are affiliated companies.
The Company sold its membership interests in its engine maintenance, repair and testing joint venture with Chromalloy Gas Turbine Corporation, Pacific Gas Turbine Center LLC ("PGTC LLC"), to SRT Group America for $13.1 million (subject to post-closing adjustments). Also, the Company sold its aircraft parts and components subsidiary, Willis Aeronautical Services, Inc. ("WASI"), to SRT Group America for $24.9 million. The Company acquired five aircraft engines from SRT for $43.0 million drawn from the proceeds of the sale of WASI and its membership interests in PGTC LLC and subsequently leased them back to SRT for periods of four and ten years.
The Company entered into a three year business cooperation period with Flightlease and SRT by which Flightlease and SRT have price discounts and lowest price guarantees on short term and long term engine leases from the Company. Flightlease and SRT in turn will provide the Company with access to spare engines, will promote the Company's engine leasing efforts and the development of other products, and will facilitate business opportunities among the Company and Flightlease's and SRT's other business partners. The Company has also entered into put option arrangements regarding certain engines scheduled to be run to the end of their useful lives to sell them at the Company's discretion, to SRT at pre-determined prices.
The Company sold 1,300,000 newly issued shares of its common stock to FlightTechnics and an option, exercisable within 18 months of the closing date, to purchase newly issued shares of its common stock in a private placement in an amount between 1,700,000 shares and up to an amount that would give FlightTechnics 34.9% of the Company's issued and outstanding common stock. The price per share for the first additional 1,700,000 shares purchased pursuant to this option will be $15.00, and the price per share for any shares purchased in excess of the first additional 1,700,000 shares will be $16.50. FlightTechnics has two demand registration rights which are exercisable beginning three years after the closing date. The Company amended its Rights Agreement dated September 24, 1999 between the Company and American Stock Transfer & Trust Company to include FlightTechnics and its affiliates under the definition of an "Exempt Person", subject to FlightTechnics and its affiliates owning a certain percentage of the Company's common stock.
FlightTechnics also may purchase more shares of the Company's common stock in the open market or from existing shareholders upon the occurrence of certain conditions, but in no event may FlightTechnics and its affiliates collectively own more than 49.9% of the Company's issued and outstanding common stock. Certain stockholders, including Charles F. Willis IV, and FlightTechnics have also agreed to certain voting provisions and to restrictions on their abilities to sell their shares of the Company's common stock.
As part of these transactions, Donald A. Nunemaker resigned as a member of the Company's board of directors, although he remains the Company's Executive Vice President and Chief Administrative Officer. In his place, the Company's board of directors appointed Hans Jorg Hunziker, President of Flightlease, to the board. FlightTechnics has the right to appoint an additional director to the Company's board of directors upon the exercise of its option, at which time the board membership will be increased from five directors to seven directors.
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 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 the residual value. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Results."
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 the Company's ability to repossess its equipment should the need arise.
The Company often collects maintenance reserves and security deposits from engine and aircraft lessees and security deposits from aircraft 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 are 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 the parts were in at lease inception.
During the lease period, the Company's leases require that the leased equipment undergo maintenance and 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.
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 that it will not experience collection problems or significant losses in the future. In addition, while the Company cannot assure 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. The demand for aftermarket aircraft equipment for either sale or re-lease may be affected by a number of variables including general market conditions, regulatory changes (particularly those imposing environmental, maintenance and other requirements on the operation of aircraft engines), changes in the supply and cost of aircraft 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, Pratt & Whitney ("PW"), Rolls Royce and International Aero Engines. As of December 31, 2000, all but 20 (10 of which are classified as discontinued operations) of the engines in the Company's lease portfolio were Stage III or Stage II engines that have been fitted with "hush-kits" 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 primarily involved the purchase of de Havilland DHC-8 commuter aircraft which are Stage III compliant. The Company may make further investments in aircraft for lease in the future.
As of December 31, 2000, the Company had a total portfolio of 110 aircraft engines and related equipment (including 10 engines counted as discontinued operations), four spare parts packages and six aircraft with an aggregate original cost of $451.9 million in its lease portfolio. As of December 31, 1999, the Company had a total portfolio (including 14 engines counted as discontinued operations) of 101 aircraft engines and related equipment, four spare parts packages and eight aircraft with an aggregate original cost of $370.5 million in its lease portfolio.
As of December 31, 2000, minimum future rentals for continuing operations under the noncancelable leases (both operating and direct finance leases) of these engines, parts and aircraft assets was as follows:
LESSEES. As of December 31, 2000, for continuing operations, the Company had 45 lessees of commercial aircraft engines and other aircraft-related equipment in 23 countries.
The following table displays the regional profile of the Company's lease customer base for continuing operations for the years ended December 31, 2000, 1999 and 1998. No single country other than the United States accounted for more than 7%, 10% and 11% of the Company's lease revenue for the years ended December 31, 2000, 1999 and 1998, respectively.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors that May Affect Future Results."
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. The Company may purchase engines and components without having a commitment for their sale. 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.
DISCONTINUED OPERATIONS
EQUIPMENT HELD FOR LEASE
As part of the transaction with SRT and affiliates, the Company agreed to retain a lease portfolio of 10 engines maintained and managed by WASI. Certain of these engines are subject to put option arrangements where, at the option of the Company, these engines can be sold to SRT Group America. In addition, other additional engines have been identified as likely to be sold during the next year.
To the extent that the engines in the portfolio retained are subject to put options and do not fit within the Company's main portfolio or are identified as likely to be sold, the assets and the results of operation are included in discontinued operations.
As of December 31, 2000, for discontinued operations, the Company had three lessees of commercial aircraft engines in two countries, the USA and Mexico.
SPARE PARTS SALES
In 1994, the Company began selling aircraft parts and components to airlines, air cargo carriers, Maintenance, Repair and Overhaul (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. WASI has contracted with PGTC Inc. and currently contracts with PGTC LLC as well as third parties 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 JT8D, JT9D and PW4000 aircraft engines and components. These engines are amongst the most widely used aircraft engines in the world, powering Boeing, McDonnell Douglas and Airbus aircraft, including the Boeing 727, 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 sold its shares in WASI on November 30, 2000.
ENGINE REPAIR, DISASSEMBLY, AND RELATED ACTIVITIES
In 1998, the Company began disassembling large commercial jet engines and providing parts cleaning, testing and classification services through PGTC Inc. PGTC Inc. was formed initially to provide such disassembly services to WASI. In November 1998, PGTC Inc. received its FAR 145 Repair Station Air Agency Certification from the FAA. The FAA certification allows PGTC Inc. and its successor PGTC LLC 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 Inc. commenced repair of JT8D engines shortly after receiving FAA certification.
In May 1999, the Company entered into an agreement with Chromalloy Gas Turbine Corporation, a subsidiary of Sequa Corporation ("Chromalloy"), to operate a joint venture to perform maintenance, repair and overhaul of commercial jet engines. Under the terms of the joint venture agreement, the Company and Chromalloy formed a new company, PGTC LLC. The Company contributed the operations and assets of its wholly owned subsidiary PGTC Inc. and Chromalloy contributed working capital to the joint venture giving each a 50% interest in the joint venture.
The Company sold its 50% interest in the PGTC LLC joint venture on November 30, 2000.
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 50% to 80% of an aircraft or spare parts purchase price on a recourse, non-recourse or partial recourse basis. Under several 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. 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 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. 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 and more diverse inventories, complementary lines of business and greater financial, marketing, information systems 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 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. 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 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 leasing and reselling business is not regulated, the aircraft, engines and engine parts that the Company leases and 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.
Effective January 1, 2000, federal regulations 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 if the engines are to be used in the continental United States. Additionally, much of Europe has adopted similar regulations. As of December 31, 2000, all but 20 (10 of which are classified as discontinued operations) of the engines in the Company's lease portfolio were Stage III engines. The 20 engines that do not meet Stage III noise level requirements (Stage II engines) are on-lease or available for lease to customers located in countries which have not adopted Stage III noise regulations such as Mexico and the countries of South America. Additionally, Stage II engines may be "hush-kitted" so as to meet Stage III noise regulations.
The Company believes that the aviation industry will be subject to continued regulatory activity. Additionally, increased oversight has and will continue to originate from the quality assurance departments of 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, 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, 2000, the Company had 33 full-time employees and 1 part-time employee (excluding consultants), in equipment acquisition, leasing, sales 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.
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 sub-leases from WASI on a month-to-month basis approximately 2,800 square feet of office and warehouse space for the Company's operations at San Diego, California.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4.
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 2000.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following information relates to the Company's Common Stock, which is listed on the NASDAQ National Market under the symbol WLFC. As of March 19, 2001 there were approximately 917 stockholders of record of the Company's Common Stock.
The high and low sales price of the Common Stock for each quarter of 2000 and 1999, as reported by NASDAQ, are set forth below:
2000 1999 ---- ---- HIGH LOW HIGH LOW First Quarter $ 9.13 $5.00 $19.25 $14.87 Second Quarter 8.56 6.00 18.25 14.50 Third Quarter 8.00 5.81 17.37 13.19 Fourth Quarter 10.00 5.06 7.31 3.81
During the years ended December 31, 2000 and 1999 the Company did not pay cash dividends to Company stockholders.
ITEM 6.
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.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
GENERAL. The Company's core focus has been on providing operating leases of aftermarket commercial aircraft engines and other aircraft-related equipment. As of December 31, 2000, the Company had a total portfolio (including engines counted as discontinued operations) of 52 lessees in 23 countries and its total lease portfolio consisted of 110 engines, six commuter aircraft and four spare parts packages with an aggregate net book value of $419.9 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, Rolls Royce and International Aero Engines. 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 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. WASI was sold on November 30, 2000.
In 1998, the Company began disassembling commercial jet engines and providing parts cleaning, testing and classification services through Pacific Gas Turbine Center, Incorporated ("PGTC Inc."). PGTC Inc. received certification in November 1998 from the FAA to perform maintenance, repair and overhaul services for Pratt & Whitney JT8D and JT9D engines. PGTC Inc. commenced repair of JT8D engines shortly after receiving FAA certification. In May 1999, the Company contributed the operations and assets of PGTC Inc. to a newly formed joint venture, Pacific Gas Turbine Center, LLC ("PGTC LLC"). PGTC Inc. provided and its successor, PGTC LLC provides engine disassembly and maintenance, repair and overhaul services to the Company and third parties. The Company sold its interest in PGTC LLC on November 30, 2000.
With the sale of these two businesses, the Company no longer engages in the business of parts sales or in dissembling repair and maintenance of aircraft engine, and its core focus is its leasing portfolio.
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 13-20 years to a 15%-17% residual value. For assets that are leased with an intent to disassemble upon lease termination, the Company depreciates the assets over their estimated lease term to a residual value based on an estimate of the wholesale value of the parts after disassembly.
At the commencement of a lease, the Company often 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 lease 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.
SALES RELATED ACTIVITIES. 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 costs directly associated with the sale. Additionally, to the extent that any deposits or reserves are not 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.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR ENDED DECEMBER 31, 1999
Revenue from continuing operations is summarized as follows:
LEASING RELATED ACTIVITIES. Lease related revenue for the year ended December 31, 2000, increased 11% to $49.0 million from $44.1 million for the comparable period in 1999. This increase reflects lease related revenues from additional engines. The aggregate of net book value of leased equipment and net investment in direct finance lease at December 31, 2000 and 1999 was $416.7 million and $338.6 million, respectively, an increase of 23%.
During the year ended December 31, 2000, 27 engines and three aircraft were added to the Company's lease portfolio at a total cost of $137.9 million. Eighteen engines from the lease portfolio were sold or transferred to WASI for sale as parts. The engines sold had a total net book value of $36.5 million and were sold for a gain of $8.1 million.
During the year ended December 31, 1999, 24 engines and three spare parts packages, from the lease portfolio were sold or transferred to WASI for sale as parts. These engines and the parts packages had a total net book value of $39.2 million and were sold for a gain of $11.4 million.
During the year ended December 31, 1999, the Company sold three engines acquired for resale for $9.8 million resulting in a gain of $1.4 million.
OTHER INCOME. Other income relates to a one-time event associated with assignment of a lease for office and warehouse space.
INTEREST EXPENSE AND RESIDUAL SHARING. Interest expense related to continuing activities increased 22% to $24.6 million for the year ended December 31, 2000, from the comparable period in 1999, due to an increase in average debt outstanding and interest rates during the period. This increase in debt was primarily related to debt associated with the increase in lease portfolio assets. Residual sharing expense decreased 25% to $0.6 million for the year ended December 31, 2000 from $0.8 million for the comparable period in 1999. Residual sharing arrangements apply to two of the Company's engines as of December 31, 2000 and are a function of the difference between the debt associated with the residual sharing arrangement and estimated residual proceeds. The Company accrues for its residual sharing obligations using net book value as an estimate for residual proceeds.
INTEREST INCOME. Interest income for the year ended December 31, 2000, decreased to $0.9 million from $1.0 million for the year ended December 31, 1999.
DEPRECIATION EXPENSE. Depreciation expense increased 8% to $12.4 million for the year ended December 31, 2000, from the comparable period in 1999, due primarily to the increase in lease portfolio assets in 2000.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses decreased 1% to $11.9 million for the year ended December 31, 2000, from the comparable period in 1999. Five months of expenses related to PGTC Inc. are included in the year ended December 31, 1999.
INCOME TAXES. Income taxes, exclusive of tax on discontinued operations for the year ended December 31, 2000, increased to $3.5 million from $3.2 million for the comparable period in 1999. This increase reflects an increase in the Company's effective tax rate for the year ended December 31, 2000 to approximately 39% on continuing operations from approximately 24% in 1999 due to adjustments of state tax apportionment. The Company's tax rate is subject to change based on changes in the mix of domestic and foreign leased assets, the proportions of revenue generated within and outside of California and numerous other factors, including changes in tax law.
DISCONTINUED OPERATIONS. In November 2000, the Company agreed to sell its engine parts and components subsidiary (WASI) and its membership interest in its joint venture (PGTC LLC). The sale was completed on November 30, 2000.
Accordingly, the Company's parts operations and its equity share of the results of the joint venture are accounted for as discontinued operations and prior periods financial statements have been reclassified accordingly.
Net earnings/(loss) from discontinued operations for the years ended December 31, 2000 and 1999 are as follows (in thousands of dollars):
The gain on disposal of discontinued operations for the year ended December 31, 2000 is as follows (in thousands of dollars):
YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE YEAR ENDED DECEMBER 31, 1998
Revenue from continuing operations is summarized as follows:
LEASING RELATED ACTIVITIES. Lease related revenue for the year ended December 31, 1999, increased 39% to $44.1 million from $31.6 million for the comparable period in 1998. This increase reflects lease related revenues from additional engines and aircraft. The aggregate of net book value of leased equipment and net investment in direct finance lease at December 31, 1999 and 1998 was $338.6 million and $283.4 million, respectively, an increase of 19%.
During the year ended December 31, 1999, 51 engines and three aircraft were added to the Company's lease portfolio at a total cost of $119.8 million. Twenty-four engines and three spare parts packages from the lease portfolio were sold or transferred to WASI for sale as parts. The engines sold had a total net book value of $39.2 million and were sold for a gain of $11.4 million.
During the year ended December 31, 1998, 10 engines, one spare parts package and one aircraft from the lease portfolio were sold or transferred to WASI for sale as parts. These engines and the aircraft had a total net book value of $25.3 million and were sold for a gain of $12.6 million.
During the year ended December 31, 1999, the Company sold three engines acquired for resale for $9.8 million which resulted in a gain of $1.4 million, compared to the year ended December 31, 1998, during which the Company sold one engine acquired for resale for $4.1 million resulting in a gain of $0.5 million.
INTEREST EXPENSE AND RESIDUAL SHARING. Interest expense increased 44% to $20.1 million for the year ended December 31, 1999, from the comparable period in 1998, due to an increase in average debt outstanding during the period. This increase in debt was primarily related to debt associated with the increase in lease portfolio assets. Residual sharing expense increased 5% to $846,000 for the year ended December 31, 1999 from $803,000 for the comparable period in 1998. Residual sharing arrangements apply to three of the Company's engines as of December 31, 1999 and are a function of the difference between the debt associated with the residual sharing arrangement and estimated residual proceeds. The Company accrues for its residual sharing obligations using net book value as an estimate for residual proceeds.
INTEREST INCOME. Interest and other income for the year ended December 31, 1999, decreased to $1.0 million from $1.4 million for the year ended December 31, 1998. The decrease was primarily due to ancillary fees generated in connection with a lease arrangement during the year ended December 31, 1998. The Company had no such fee activity during the comparable 1999 period.
DEPRECIATION EXPENSE. Depreciation expense increased 56% to $11.5 million for the year ended December 31, 1999, from the comparable period in 1998, due primarily to the increase in lease portfolio assets in 1999.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 19% to $12.1 million for the year ended December 31, 1999, from the comparable period in 1998. This change reflects increased expenses, in all business segments, associated with staff additions, increased non-capitalizable engine maintenance related expenses, as well as an increase in professional fees. Five months of expenses related to PGTC Inc. are included in the year ended December 31, 1999.
INCOME TAXES. Income taxes, exclusive of tax on discontinued operations and extraordinary items, for the year ended December 31, 1999, decreased to $3.2 million from $5.6 million for the comparable period in 1998. This decrease mainly reflects a decrease in the Company's effective tax rate for the year ended December 31, 1999. The decrease in the effective tax rate was related to state taxes. The Company's tax rate is subject to change based on changes in the mix of domestic and foreign leased assets, the proportions of revenue generated within and outside of California and numerous other factors, including changes in tax law.
DISCONTINUED OPERATIONS. In November 2000, the Company agreed to sell its engine parts and components subsidiary (WASI) and its membership interest in its joint venture (PGTC LLC). The sale was completed on November 30, 2000.
Accordingly, the Company's parts operations and its equity share of the results of the joint venture are accounted for as discontinued operations and prior periods financial statements have been reclassified accordingly.
Net earnings/(loss) from discontinued operations for the years ended December 31, 1999 and 1998 are as follows (in thousands of dollars):
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.
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) 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.
SFAS No. 137, "Accounting for Derivatives, Instruments, and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB Statement No. 133," issued in June 1999, defers the effective date of SFAS No. 133. SFAS No. 133, as amended, is now effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. The Statement requires the recognition of derivative instruments at their fair value and that changes in the fair value are recorded as components of other Comprehensive Income and/or Earnings for the period. The Company has a limited number of interest rate swaps which will be accounted for under this Statement. Transition arrangements under this Statement mean that the fair value of the swaps, estimated at $0.7 million as of December 31, 2000, would be recorded to Other Comprehensive Income. Future changes in fair value are not estimable at this time.
In September 2000, FASB issued SFAS 140 "Accounting for transfers and servicing of financial assets and extinguishment of liabilities, an amendment of FASB Statement No. 125." Statement 140 provides guidance on the following topics: securitization transactions involving financial assets, sales of financial assets such as receivables, loans and securities, collateralized borrowing arrangements, repurchase agreements, and extinguishments of liabilities. The provisions of Statement 140 will become effective for transactions entered into after March 31, 2001. The Company is currently evaluating the impact of SFAS140 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 $104.4 million, $118.2 million and $194.7 million, in the years ended December 31, 2000, 1999 and 1998, respectively, was derived from this activity. In these same time periods $95.3 million, $73.0 million and $51.4 million, respectively, was used to pay down related debt or capital lease obligations. On November 30, 2000, net proceeds from a private placement of common stock and options were approximately $18.2 million. Cash flow from operating activities generated $26.5 million and $24.3 million in the years ended December 31, 2000 and 1999 respectively, and cash flows from operating activities used approximately $20.5 million in the year ended December 31, 1998. 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.
The Company's primary use of funds is for the purchase of equipment for lease. Approximately $137.9 million, $119.8 million and $171.1 million of funds were used for this purpose in the years ended December 31, 2000, 1999 and 1998, respectively.
At December 31, 2000, the Company had a $150.0 million revolving credit facility to finance the acquisition of aircraft engines, aircraft and spare parts for lease as well as for general working capital purposes. As of December 31, 2000, this facility was fully drawn. The facility had a revolving period which ended September 2000 and was extended to January 29, 2001, followed by a term-out period ending September 2004. The interest rate on this facility at December 31, 2000 is LIBOR plus 1.75%.
At December 31, 2000, the Company had a $125.0 debt warehouse facility. The facility is available to a wholly-owned special purpose finance subsidiary of the Company, WLFC Funding Corporation, for the financing of jet aircraft engines acquired by or transferred to such finance subsidiary by the Company. The facility is renewable annually. This facility's structure facilitates 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 with a revolving period to February 2001 as of December 31, 2000 followed by a seven-year amortization period. At December 31, 2000, the interest rate was a commercial paper based rate plus a spread of 1.55%. 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 $5.0 million and 20% of the outstanding obligations or (ii) 10% of the outstanding obligations. Assuming compliance with the facility's terms, including sufficiency of collateral, as of December 31, 2000, $34.6 million was available under this facility. In February 2001, this facility was increased to $180.0 million and its revolving period was extended to February 2002.
At December 31, 2000 the Company had a $28.7 million term loan facility available to a wholly-owned consolidated special purpose subsidiary of the Company, WLFC AC1 Corporation, for the financing of jet aircraft engines transferred by the Company to such subsidiary. The facility is a five year term loan with final maturity of June 30, 2005. The interest rate is currently LIBOR plus 2.05%. This facility is fully drawn.
Approximately $35.6 million of the Company's debt is repayable during 2001. Such repayments consist of scheduled installments due under term loans.
The Company believes that its current equity base, internally generated funds and existing debt facilities are sufficient to maintain the Company's current level of operations. A decline in the level of internally generated funds or the availability under the Company's existing debt facilities would impair the Company's ability to sustain its current level of operations. The Company is currently discussing additions to its debt base with its commercial and investment banks. If the Company is not able to access additional debt, its ability to continue to grow its asset base consistent with historical trends will be impaired and its future growth limited to that which can be funded from internally generated capital.
The Company has committed to purchase, during 2001, additional used aircraft and used engines for its operations. As of December 31, 2000, the Company's current commitment to such purchases is not more than $4.5 million.
MANAGEMENT OF INTEREST RATE EXPOSURE
To mitigate exposure to interest rate changes, the Company has entered into interest rate swap agreements which have notional outstanding amounts of $30.0 million, a weighted average remaining term of 19 months and a weighted average fixed rate of 6.2%. Under its borrowing agreement, WLFC Funding Corporation is required to hedge a certain portion of its $125.0 million warehouse facility against changes in interest rates. WLFC Funding Corporation 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, 2000, such swap agreements had notional outstanding amounts totaling $65.0 million, a weighted average remaining term of 26 months and a weighted average fixed rate of 6.02%. The effect of the hedge instruments was to reduce interest expense by $0.5 million for the year ended December 31, 2000.
The Company will be exposed to risk in the event of non-performance of the interest rate hedge counter parties. The Company may hedge additional amounts of its floating rate debt during the next year.
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 herein. Factors that could cause or contribute to such differences include those discussed below. 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. The Company is currently in the process of negotiating a new revolving credit facility. There can be no assurance that the necessary amount of capital will continue to be available to the Company on favorable terms or at all or that the new credit facility will be completed on favorable terms or at all. The Company's inability to obtain sufficient capital, or to complete its new credit facility could result in increased funding costs and would limit the Company's ability to: (i) add new aircraft engines, aircraft and spare parts packages to its portfolio, (ii) fund its working capital needs, and (iii) finance possible future acquisitions. 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. The Company also engages in the selective purchase and resale of commercial aircraft engines. On occasion, the Company purchases engines 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, (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 2000, 74% of the Company's lease revenue was generated by leases to foreign customers. Such international leases may present greater risks to the Company because certain foreign laws, regulations and judicial procedures may not be as protective of lessor rights as those which apply in the United States. The Company is subject to the timing and access to courts and the remedies local laws impose in order to collect its lease payments and recover its assets. In addition, political instability abroad and changes in international policy also present risk of expropriation of the Company's leased engines. Furthermore, many foreign countries have currency and exchange laws regulating the international transfer of currencies.
The Company has experienced significant growth in lease revenues during the past year. 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 manufacturers, aircraft and aircraft engine lessors and airline and aircraft service companies. Certain of the Company's competitors have substantially greater resources than the Company, including greater name recognition, a broader range of material, complementary lines of business and greater financial, marketing and other resources. In addition, equipment manufacturers, 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.
The Company obtains a substantial portion of its inventories of aircraft and engines from airlines, overhaul facilities and other suppliers. There is no organized market for aircraft and engines, 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 and engines 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 and engines 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.
California is in the midst of an energy crisis that could disrupt the Company's operations and increase its expenses. In the event of an acute power shortage, that is, when power reserves for the State of California fall below 1.5%, California has on some occasions implemented, and may in the future continue to implement, rolling blackouts throughout California. The Company currently does not have backup generators or alternate sources of power in the event of a blackout, and its current insurance may not provide coverage for any damages it or its customers may suffer as a result of any interruption in its power supply. If blackouts interrupt its power supply, the Company would be temporarily unable to continue operations. Any such
interruption in its ability to continue operations could damage its reputation, harm its ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm its business and results of operations.
ITEM 7A.
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 (net of hedges) would result in an increase or decrease, respectively, in interest expense of $1.6 million per annum. The Company estimates a two percent increase or decrease in the Company's variable rate debt (net of hedges) would result in an increase or decrease, respectively, in interest expense of $3.3 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 2000, 74% 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is submitted as a separate section of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
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.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the Company's Proxy Statement.
ITEM 12.
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.
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.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements The response to this portion of Item 14 is submitted as a separate section of this report beginning on page 24.
(a) (2) Financial Statement Schedules Schedule II Valuation Accounts 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.
(a) (3) and (c): Exhibits: The response to this portion of Item 14 is submitted as a separate section of this report beginning on page 51.
EXHIBITS
(b) Reports on Form 8-K
The Company filed two reports on Form 8-K during the fourth quarter of 2001. The first report was filed on November 13, 2000 announcing the signing of agreements with SAirGroup and the second report was filed on December 15, 2000 and reported the fact that the Company had issued additional shares in a private placement and sold its interests in Willis Aeronautical Services Inc. and Pacific Gas Turbine LLC. Proforma financial statements were included in the Report on Form 8-K filed on December 15, 2000.
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.
Dated: March 21, 2001
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.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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 auditing standards generally accepted in the United States of America. 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, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP SAN FRANCISCO, CALIFORNIA MARCH 21, 2001
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to the consolidated financial statements
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to the consolidated financial statements
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000 (IN THOUSANDS)
See accompanying notes to the consolidated financial statements
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes to the consolidated financial statements
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) and T-11 Inc. (T-11) 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.
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. 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. WLFC AC1 Incorporated is a wholly owned subsidiary of Willis Lease Finance Corp. WLFC AC1 Incorporated is a Delaware corporation and was established in 2000 for the purpose of acquiring and leasing aircraft engines.
Willis Aeronautical Services, Inc. ("WASI") was 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 and was sold in November 2000. Pacific Gas Turbine Center Incorporated ("PGTC Inc.") was a wholly owned subsidiary of Willis. PGTC Inc. was formed in 1998 to provide, among other things, engine disassembly services and was dissolved in May 1999 upon the Company contributing the operations and assets to a newly formed joint venture, Pacific Gas Turbine Center, LLC ("PGTC LLC"). The Company sold its interest in PGTC LLC in November 2000.
Management considers the continuing operations of the Company to operate in one reportable segment.
(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, WASI (11 months ended November 2000), WLFC-FC, WLFC-Pooling, PGTC Inc. (five months ended May 1999), WLFC AC1 Incorporated 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 sold for dismantling.
(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. Major overhauls paid for by the Company which add economic value are capitalized and depreciated over the estimated remaining useful life of the engine.
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 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.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For engines or aircraft that are leased with an intent to disassemble upon lease termination, the Company depreciates the engines or aircraft over their estimated lease term to a residual value based on an estimate of the wholesale value of the parts after disassembly.
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 to 20 years to a 15% to 17% residual value.
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) 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 reviews at least quarterly the carrying value of long-lived assets. Such reviews resulted in a write-down of assets of $147,000 in continuing operations (disclosed under depreciation in the Income Statement) and $471,000 in discontinued operations in 2000 (disclosed under Gain on Disposal of Discontinued Operations in the Income Statement). There were no such losses on revaluation in 1999 or 1998.
(e) 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 which approximates the interest method.
(f) MAINTENANCE COSTS
Maintenance costs under the Company's long-term leases are generally the responsibility of the lessees. Additionally, under many of the Company's long-term leases, lessees pay fees to the Company based on the usage of the asset. Upon the completion of approved maintenance of an asset, such fees are returned to the lessee. The Company records a Maintenance Reserve liability in connection with the obligation to reimburse lessees for approved maintenance. Under certain of the Company's leases, the lessee is not obligated to perform maintenance on the asset. To the extent that such leases require the lessee to make payments to the Company based on the usage of the asset and the Company does not plan to apply such payments to the repair of the asset, the usage payments are included in lease revenue.
(g) INTEREST RATE HEDGING
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.
(h) 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.
(i) 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 and are included as other assets in the balance sheets.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(j) 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 $3.5 million as of December 31, 2000 and 1999, respectively. As of December 31, 2000 and 1999, two engines (1999 three engines), with a total net book value of $7.4 million and $10.6 million, respectively, were subject to residual sharing arrangements.
(k) 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 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.
(l) 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.
(m) RECLASSIFICATIONS
Certain items in the consolidated financial statements of prior years have been reclassified to conform to the current year's presentation.
(n) 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.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(o) PER SHARE INFORMATION
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 reconciliation between basic common shares and fully diluted common shares is presented below:
(p) ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) 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.
SFAS No. 137, "Accounting for Derivatives, Instruments, and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB Statement No. 133," issued in June 1999, defers the effective date of SFAS No. 133. SFAS No. 133, as amended, is now effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. The Statement requires the recognition of derivative instruments at their fair value and that changes in the fair value are recorded as components of other Comprehensive Income and/or Earnings for the period. The Company has a limited number of interest rate swaps which will be accounted for under this Statement. Transition arrangements under this Statement mean that the fair value of the swaps, estimated at $0.7 million as of December 31, 2000, would be recorded to Other Comprehensive Income. Future changes in fair value are not estimable at this time.
In September 2000 FASB issued SFAS 140 "Accounting for transfers and servicing of financial assets and extinguishment of liabilities, an amendment of FASB Statement No. 125." Statement 140 provides guidance on the following topics: securitization transactions involving financial assets, sales of financial assets such as receivables, loans and securities, collateralized borrowing arrangements, repurchase agreements, and extinguishments of liabilities. The provisions of Statement 140 will become effective for transactions entered into after March 31, 2001. The Company is currently evaluating the impact of SFAS 140 on the Company's consolidated financial statements.
(q) COMPREHENSIVE INCOME
The Company's net income is equal to comprehensive income for the years ended December 31, 2000, 1999 and 1998.
(r) INVESTMENTS
Investments are in non-marketable securities where management does not have significant influence and are recorded at cost. Management evaluates the investments for impairment quarterly and at December 31, 2000, no adjustment to the carrying value was required.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) DISCONTINUED OPERATIONS
On November 7, 2000, the Company entered into agreements for a series of strategic transactions, each of which closed on November 30, 2000, with Flightlease AG, a corporation organized under the laws of Switzerland ("Flightlease"), SR Technics Group, a corporation organized under the laws of Switzerland ("SRT"), FlightTechnics, LLC, a Delaware limited liability company ("FlightTechnics") and SR Technics Group America, Inc., a Delaware corporation ("SRT Group America"), each of which are affiliated companies.
The Company sold its membership interests in its engine maintenance, repair and testing joint venture with Chromalloy Gas Turbine Corporation, Pacific Gas Turbine Center LLC ("PGTC"), to SRT Group America for $13,066,000, subject to post-closing adjustments which have not yet been finalized. Also, the Company sold its aircraft parts and components subsidiary, Willis Aeronautical Services, Inc. ("WASI"), to SRT Group America for $24,919,222.
As part of the transaction, the Company agreed to retain the lease portfolio of engines maintained and managed by WASI. Certain of these engines are subject to put option arrangements where, at the option of the Company, these engines can be sold to SRT Group America for part-out. In addition, further engines have been identified as likely to be sold during the next year.
To the extent that the engines in the portfolio retained are subject to put options or are identified as likely to be sold, the assets and the results of operation are included in discontinued operations.
Net earnings/(loss) from discontinued operations for the years ended December 31, 2000, 1999 and 1998 are as follows (in thousands of dollars):
The gain on disposal of discontinued operations for the year ended December 31, 2000 is as follows (in thousands of dollars):
Net assets of discontinued operations on the balance sheet as of December 31, 2000 and 1999 are as follows (in thousands of dollars):
INTEREST EXPENSE. To the extent that engines and inventory have been financed, interest expense has been allocated based on the principal outstanding during the year.
EQUIPMENT HELD FOR OPERATING LEASE. During 2000 WASI acquired or received by transfer from WLFC, 4 engines at a cost of $3.4 million and transferred into inventory 12 engines at a cost of $5.3 million. No gain or loss was recognized on the transfers. Future minimum rentals receivable for equipment under non-cancelable leases as of December 31, 2000 are approximately $600,000 in 2001 and $120,000 in 2002.
At December 31, 2000, discontinued operations had 10 engines with an aggregate original cost of $5.7 million in its operating and lease portfolio. At December 31, 1999, discontinued operations had 14 engines with an aggregate original cost of $10.3 million in its operating and lease portfolio.
INVESTMENT IN UNCONSOLIDATED AFFILIATE. In May 1999, the Company entered into an agreement with Chromalloy Gas Turbine Corporation ("Chromalloy"), a subsidiary of Sequa Corporation, to operate a joint venture to perform maintenance, repair and overhaul of commercial jet engines. Under the terms of the joint venture agreement, the Company and Chromalloy formed a new company, PGTC LLC. The Company contributed the operations and assets of its wholly owned subsidiary PGTC Inc. (with a book value of $5.7 million) and Chromalloy contributed working capital to the joint venture. The Company and Chromalloy had a 50% interest in the joint venture. The equity method of accounting is used for the Company's 50% ownership in PGTC LLC. Under the equity method, the original contribution was recorded at cost and is adjusted periodically to recognize the Company's share of the earnings or losses of PGTC LLC after the date of formation. For the year ended December 31, 2000 up to the sale of the Company's interest, the Company and WASI purchased $1.3 million (1999 $1.1 million) of services from PGTC LLC and PGTC LLC purchased $4.8 million (1999 $1.0 million) of engine parts from WASI. All intercompany profits or losses have been eliminated. The Company had no such activity during the comparable 1998 period. The Company sold its interest in PGTC LLC in November 2000.
STOCK COMPENSATION. In conjunction with the sale of its shares in WASI, the Company accelerated the vesting of options granted to employees of WASI and recognized an expense of approximately $144,000.
CONCENTRATIONS AND CREDIT RISK. During the 11 months prior to November 30, 2000 the top 5 customers of the spare parts business accounted for approximately 52% of total parts revenue (1999 37%, 1998 49%).
(3) EQUIPMENT HELD FOR LEASE
At December 31, 2000 for continuing operations, the Company had 100 aircraft engines and related equipment with an aggregate original cost of $407.9 million, 4 spare parts packages with an aggregate original cost of $14.8 million and 6 aircraft with an aggregate original cost of $23.5 million in its operating and lease portfolio. At December 31, 1999, the Company had 87 aircraft engines and related equipment with an aggregate original cost of $319.2 million, four spare parts packages with an aggregate original cost of $14.8 million and eight aircraft with an aggregate original cost of $26.2 million in its operating and finance 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.
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 for continuing operations grouped by domicile of the lessee:
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Finance leased assets, generated $739,000 and $797,000 of revenue in 2000 and 1999, respectively. After estimated interest expense such assets generated $53,000 and $127,000, respectively. The net investment in direct finance leases on December 31, 2000 and 1999 was as follows:
As of December 31, 2000, minimum future payments under noncancelable leases were as follows:
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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.
(5) NOTES PAYABLE
Notes payable consisted of the following:
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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 $301.3 million at December 31, 2000.
Principal outstanding at December 31, 2000 is repayable as follows:
Certain of the debt instruments above also have covenant requirements such as a minimum tangible net worth. As of December 31, 2000, the Company was in compliance with all covenant requirements.
Although it is the intention of the Company to hold the interest rate swaps until their maturity, at December 31, 2000 the Company estimated it would have to pay a net settlement of $743,000 to terminate the agreements.
At December 31, 2000 and 1999, the Company held deposits in the amount of $16.7 million and $16.0 million, respectively, consisting of bank accounts that are subject to withdrawal restrictions as per lease or loan agreements. Included in these amounts are payments 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.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAXES
The components of income tax for continuing operations for the years ended December 31, 2000, 1999 and 1998, respectively, included in the accompanying statement of income were as follows:
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 on continuing operations:
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, 2000, the Company had net operating loss carryforwards of approximately $23.1 million for federal tax purposes and $4.2 million for state tax purposes. The federal net operating loss carryforwards will expire in the year 2020 and the state net operating loss carry forwards will expire in 2005. Net operating losses can be used as a deduction against future income arising from any source. As of December 31, 2000, 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 previously paid taxes and/or future taxable income.
(7) RISK MANAGEMENT ISSUES
RISK CONCENTRATIONS
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash deposits and receivables.
The Company places its cash deposits with financial institutions and other creditworthy issuers and limits the amount of credit exposure to any one party. Concentrations of credit risk with respect to lease receivables are limited due to the large number of customers comprising the Company's customer base, and their dispersion across different geographic areas.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 2000 and 1999, 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., which accounted for approximately 13% of total revenue and 74% of gain on sale of leased equipment. The Company had no such customer concentrations during the comparable 2000 and 1999 periods.
INTEREST RATE RISK MANAGEMENT
To mitigate exposure to interest rate changes, Willis Lease Finance Corporation has entered into interest rate swap agreements. As of December 31, 2000, such swap agreements had notional outstanding amounts of $30 million, a weighted average remaining duration of 19 months and a weighted average fixed rate of 6.2%.
Under its borrowing agreement, WLFC Funding Corporation is required to hedge a certain portion of its $125 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, 2000, such swap agreements had notional outstanding amounts of $65 million, a weighted average remaining duration of 26 months and a weighted average fixed rate of 6.02%. As a result of these swap arrangements, interest expense was decreased by $484,000 in 2000 and increased in 1999 and 1998 by $307,000 and $28,000, respectively.
(8) COMMITMENTS AND CONTINGENCIES
The Company has one lease for its office space. The annual lease rental commitments are $325,000 and the lease expires on May 31, 2003.
The Company has committed to purchase one additional used engine for its operations for not more than $4.5 million.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In July 1999, the Company entered into an agreement to participate in a joint venture - Sichuan Snecma Aero-engine Maintenance Co. Ltd. Sichuan Snecma will focus on providing maintenance services for CFM56 series engines. Other participants in the joint venture are China Southwest Airlines, Snecma Services and Beijing Kailan Aviation Technology Development and Services Corporation. As of the year ended December 31, 2000, $0.8 million has been contributed. Under the terms of the agreement, the Company contributed an additional $0.7 million in January 2001 and not more than an additional $1.5 million is expected to be contributed to the joint venture over the next three years.
In January 2000, a suit was filed against the Company in connection with the sale by the Company of an aircraft engine for cash consideration. The buyer of the engine alleges that the sale was not validly consummated and amongst other things requests that the purchase price of the engine, $3.2 million, be returned to the buyer. This suit was dismissed in December 2000.
(9) INVESTMENTS
In July 1999, the Company entered into an agreement to participate in a joint venture formed as a limited company - Sichuan Snecma Aero-engine Maintenance Co. Ltd. The Company's investment is 7% in the venture. Sichuan Snecma will focus on providing maintenance services for CFM56 series engines. Other participants in the joint venture are China Southwest Airlines, Snecma Services and Beijing Kailan Aviation Technology Development and Services Corporation. As of the year ended December 31, 2000, $0.8 million has been contributed. This investment is recorded at cost.
(10) 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 2000 and 1999, 6,761 and 6,864 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 2000 and 1999 were $3.55 and $7.36, respectively.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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 May 2000, to provide for an increase in the number of shares reserved for issuance under the Plan from 1,025,000 shares to 1,525,000 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:
A summary of the outstanding, exercisable options and their weighted average exercise prices is as follows:
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information concerning outstanding and exercisable options at December 31, 2000:
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, 1999, 1998 and 1997, 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 for continuing operations has been recognized for its fixed stock option plans and its stock purchase plan. Had compensation cost for the Company's two stock-based compensation plans and warrants been determined consistent with SFAS 123, the Company's net income and earnings per share would have been as follows:
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.
The assumptions underlying the estimates derived using the Black-Scholes model are as follows:
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 2000, 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 $10,500. The Company made no 401(k) contributions during the years ended December 31, 2000 and 1999.
(11) 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.
(12) EQUITY
In addition to stock issued under the Employee Stock Purchase Plan described in note 10, the Company sold 1,300,000 newly issued shares of its common stock to FlightTechnics and an option, exercisable within 18 months of the closing date, to purchase newly issued shares of its common stock in a private placement in an amount between 1,700,000 shares and up to an amount that would give FlightTechnics 34.9% of the Company's issued and outstanding common stock. The price per share for the first additional 1,700,000 shares purchased pursuant to this option will be $15.00, and the price per share for any shares purchased in excess of the first additional 1,700,000 shares will be $16.50. Total proceeds of the transaction were $19.5 million before transaction costs of $1.3 million. Proceeds are allocated $14.8 million to shares and $3.3 million to options based upon the relative fair values at the issuance date, November 30, 2000.
WILLIS LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2000 and 1999 (in thousands, except per share data):
During the fourth quarter of 1999, WLFC recorded a reduction to its income tax expense of approximately $756,000 related to state taxes. The adjustment lowered the Company's effective tax rate for 1999 to 24%. The reduction in the income tax expense arose from a review of the Company's sources of revenue during 1998 and 1999. Based on this review, the effective tax rate applicable for deferred tax liability recognition during 1998 and 1999 was reduced.
SCHEDULE II Valuation Accounts (in thousands)
WILLIS LEASE FINANCE CORPORATION Valuation Accounts (in thousands)
INDEX OF EXHIBITS