Willis Lease Finance Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Unaudited consolidated financial statements; dollar amounts below are in millions unless stated otherwise. The company acquires and leases aircraft engines and related equipment and also sells spare parts and equipment.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $51.5 | $57.7 | $151.8 | $142.9 |
| Earnings from operations | $5.9 | $4.1 | $18.5 | $4.9 |
| Net income | $4.0 | $2.6 | $11.4 | $3.4 |
| Diluted EPS | $0.62 | $0.32 | $1.66 | $0.43 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $68.9 | $67.6 |
Q3 revenue declined about 11% year over year, while nine-month revenue rose about 6%. Net income increased in both comparisons. Nine-month results benefited from higher utilization and maintenance reserve revenue; lower gains on equipment sales and lower spare-parts and equipment sales partly offset these trends. Q3 lease rent revenue increased 11.5%, but maintenance reserve revenue fell 11.7%, and equipment-sale gains declined to $0.2 million from $3.8 million. Nine-month lease rent revenue rose 12.0% and maintenance reserve revenue rose 16.7%.
For the first nine months, average portfolio utilization was 90%, versus 85% in 2015; 92% of equipment held for lease by book value was on lease at September 30. Parts-sales gross margin was 25.2%, compared with 25.3% in the prior-year period. Equipment write-downs were $5.9 million versus $8.6 million.
Financial position, debt and liquidity
- At September 30, 2016, total assets were $1,291.3 million, notes payable net of issuance costs were $885.6 million, and shareholders’ equity was $196.5 million. At December 31, 2015, the comparable figures were $1,294.3 million, $866.1 million and $209.2 million.
- Cash and cash equivalents were $10.7 million; restricted cash was $28.2 million and is not generally available for unrestricted use. The filing reports $5.6 million of cash and restricted cash in foreign subsidiaries, which the company does not intend to repatriate.
- Nine-month investing cash outflow was $60.7 million and financing cash outflow was $7.2 million. Equipment purchases were $113.2 million; proceeds from equipment sales were $61.8 million. The company repurchased $25.0 million of common stock during the period.
- The revolving credit facility was increased from $700 million to $890 million and extended to April 2021; an accordion feature could increase it to $1 billion. The facility bears interest initially at LIBOR plus 2.75%, adjusted quarterly based on leverage. About $600.1 million of borrowings were variable-rate at September 30.
- Scheduled debt obligations due within one year were $23.5 million. The company reported compliance with its revolving-credit and WEST II covenants. It said equity, internally generated funds and existing facilities should support operations for the next 12 months, while warning that weaker cash generation or reduced facility availability could impair operations and growth.
Material changes, outlook and risks
- Drivers and costs: Management attributed stronger lease revenue primarily to higher portfolio utilization and lease-portfolio value. Nine-month G&A expense rose 12.5%, mainly due to higher bonus accruals, legal costs and salaries. Technical expense fell 37.3% as engine shop visits and returns declined. Interest expense was pressured by higher average debt and rising LIBOR.
- Interest-rate exposure: The company estimates a 1 percentage-point change in rates would change annual interest expense by approximately $6.0 million. Leases are generally at fixed rates while some debt is floating-rate; the company had no interest-rate swaps in place. It cautions that higher rates may compress spreads and operating cash flows.
- Other risks: Lease revenue and cash flow are sensitive to off-lease equipment and lease rates. The company also noted currency-devaluation risk among lessees; 90% of nine-month lease rent revenue came from non-U.S.-domiciled lessees. No customer accounted for more than 10% of lease rent revenue.
- Accounting correction: The company corrected errors involving equipment acquired with in-place leases because maintenance rights had not previously been identified and accounted for. Management deemed the errors immaterial to individual prior periods. The corrections reduced nine-month 2015 net income by $1.0 million and diluted and basic EPS by $0.12; the filing also describes other immaterial out-of-period adjustments. Prior-period figures shown include adjustments.
- Estimates and unusual items: A change to depreciation estimates for certain older engine types increased expense by $0.7 million in the first nine months of 2016. Write-downs reflected consignment and part-out decisions, changed market expectations for parts, and an impaired engine. The company recognized a $0.6 million China operating subsidy in the period.
- Subsequent events: In October 2016, the company issued 1 million shares of 6.5% Series A preferred stock to Development Bank of Japan at $20 per share, for net proceeds of $19.8 million. It also announced the purchase of Total Engine Support Limited’s business and assets; TES had about 500 engines under management. The filing says the acquisition was not material to consolidated results.
- Controls: Management concluded disclosure controls were effective as of quarter-end and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether improved utilization and lease revenue can continue, and how off-lease levels and lease rates affect cash generation.
- Exposure to variable-rate debt, covenant requirements and the availability of borrowing capacity under the asset-secured facilities.
- The assumptions behind equipment residual values, impairment write-downs and the maintenance-right accounting correction.
- The effect of the preferred-stock dividend and the TES acquisition on future cash flows, leverage and earnings; the filing provides no formal earnings guidance.
- The restriction and intended non-repatriation of foreign cash, and the potential impact of lessee currency weakness.