WILLIS LEASE FINANCE CORP annual report, FY2018

Willis Lease Finance Corporation — 2018 Form 10-K

Business context and reporting period. This annual report covers the year ended December 31, 2018, with unaudited fourth-quarter results also disclosed. Willis Lease Finance leases commercial aircraft engines, aircraft and related equipment, and provides asset-management and spare-parts services. At year-end, its owned lease portfolio comprised 244 engines and related equipment, 17 aircraft and 10 other items, with a net book value of $1.673 billion; it also managed 440 engines and related equipment for other parties. The company reported Leasing and Related Operations and Spare Parts Sales segments.

Financial and operating performance

Metric	2018	2017
Total revenue	$348.3 million	$274.8 million
Operating earnings	$52.5 million	$28.9 million
Net income	$43.2 million	$62.2 million
Net income attributable to common shareholders	$39.9 million	$60.3 million
Diluted earnings per common share	$6.60	$9.69
Cash provided by operating activities	$188.7 million	$137.1 million
Capital purchases of equipment and related costs	$441.4 million	$373.5 million
Debt obligations, net of issuance costs	$1.337 billion	$1.085 billion

Revenue increased 26.7%. Lease rent rose 34.7% to $175.6 million, principally reflecting higher lease rates and a larger leased-asset base. Maintenance-reserve revenue rose 8.5% to $87.0 million.
Spare-parts and equipment sales increased to $71.1 million from $51.4 million. Adoption of ASC 606 changed the presentation of certain part-out sales to gross revenue and cost; the company said this presentation change did not affect 2018 net income.
Operating earnings improved, while net income and diluted EPS fell from 2017. The prior-year result included a $43.6 million tax benefit from remeasurement of deferred taxes following the 2017 Tax Act. 2018 income-tax expense was $13.0 million.
Depreciation and amortization was $76.8 million; equipment write-downs were $10.7 million, down from $24.9 million in 2017. General and administrative expense rose 29.2% to $72.0 million, including facility-transition costs and higher bonus accruals. Net finance costs rose 31.8% to $64.2 million as debt balances and borrowing costs increased.
Annual operating margin was approximately 15.1% (operating earnings divided by total revenue); net margin was approximately 12.4%. These are calculated from reported figures and are affected by the revenue-presentation change and unusual 2017 tax benefit.
At year-end, cash and cash equivalents were $11.7 million and restricted cash was $70.3 million. The combined $81.9 million includes restricted funds that are not generally available for corporate use. The revolving credit facility had $463.0 million available.
Approximately 88% of assets were on lease at year-end; average utilization during 2018 was about 89%. Cash flows used in investing activities were $380.5 million; financing activities provided $226.4 million.

Material changes versus the prior comparable period

The net book value of the owned lease portfolio grew 24.6% to $1.673 billion. The company added 38 engines and seven aircraft during 2018 at a total cost of $421.9 million, including capitalized costs.
Lease rent rose substantially, while maintenance-reserve revenue growth was more modest. Short-term maintenance revenue increased, but long-term maintenance revenue declined as fewer long-term leases ended in 2018.
Debt increased by approximately $252 million, and interest expense rose alongside higher LIBOR and additional securitization financing. The company closed WEST IV with $373.4 million of fixed-rate notes in August 2018.
ASC 606 increased reported 2018 spare-parts and equipment sales by $16.4 million and reduced reported gain on sale of leased equipment by $0.7 million, with no net-income effect. Comparatives were not restated.
The company repurchased 471,595 common shares for approximately $16.2 million. The board renewed the buyback authorization through December 31, 2020, for up to $60 million. No common dividends have been paid, and management reported no plan to pay them in the foreseeable future.

Outlook, commentary, risks and unusual items

Management stated that equity, internally generated funds and existing debt facilities were sufficient to maintain operations through 2019, while warning that weaker lease revenue, higher borrowing costs or reduced credit availability could constrain operations and growth.
Equipment purchase commitments totaled $160.2 million, due within one year. The company separately disclosed commitments to purchase new engines in 2019 with an aggregate value of up to $66.8 million and noted risks if it cannot lease the engines favorably or meet purchase obligations.
Interest-rate exposure is material: $427.0 million of debt was variable-rate at year-end. Management estimated that a one-percentage-point rate change would alter annual interest expense by about $3.3 million. A $100 million interest-rate swap was outstanding.
Lease rent and maintenance-reserve payments more than 30 days past due totaled approximately $4.8 million and $5.6 million, respectively. The company cautions that customer distress may lead to defaults, repossession costs, downtime and losses.
Other key risks include residual-value and obsolescence risk, maintenance shortfalls, competition, foreign legal and political exposure, U.S.-dollar payment risk for foreign lessees, and restrictive debt covenants. About 77% of lease rent revenue came from foreign lessees; Europe represented 40% of lease rent revenue.
Substantially all assets secure debt. Restricted cash and securitized-entity assets are subject to financing terms and are not freely available to the parent. The company reported covenant compliance at December 31, 2018.
The company adopted ASC 842 on January 1, 2019 and expected to recognize approximately $4–$5 million of operating lease liabilities and corresponding right-of-use assets, with no material overall financial-statement effect expected.
Fourth-quarter 2018 revenue was $118.2 million and net income attributable to common shareholders was $17.3 million, or $2.99 diluted EPS. Fourth-quarter 2017 common-shareholder income was $41.9 million, or $6.75 diluted EPS; the full-year 2017 tax benefit is important context for that comparison.
After year-end, the company completed the sale and leaseback of the remaining four of ten Airbus A319 aircraft under its easyJet agreement on January 8, 2019; six had been completed by year-end.

Important facts for investors to verify

Reconcile underlying sales and margins across periods given ASC 606’s gross-versus-net presentation change; do not treat reported revenue growth as fully comparable without adjustment.
Monitor past-due lease rent and maintenance reserves, customer credit quality, asset utilization, and the cost and timing of repossessions or maintenance.
Assess debt maturities, revolving-credit availability, covenant headroom, variable-rate exposure and whether cash classified as restricted can support planned purchases and obligations.
Evaluate the $160.2 million purchase commitments, including the 2019 engine orders, against lease placements, funding capacity and expected returns.
Review asset appraisals, impairment assumptions and residual values, particularly for older engines and aircraft, and the effect of evolving technology and regulation.
Consider the preferred shares’ 6.5% dividend and redemption provisions, the renewed $60 million buyback authorization, and the CEO’s approximately 45% beneficial ownership when assessing capital allocation and governance.