WILLIS LEASE FINANCE CORP quarterly report, Q2 FY2014

Willis Lease Finance Corporation — Q2 2014 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2014. The company acquires and leases commercial aircraft engines and related equipment, and also selectively sells equipment and aircraft parts. Financial amounts below are in millions of dollars unless noted.

Financial performance

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Total revenue	$42.3	$38.0	$85.3	$73.3
Operating earnings (loss)	$3.3	($1.5)	$9.7	$1.0
Income before taxes	$3.6	$1.9	$10.3	$4.5
Net income	$2.2	$9.7	$6.5	$11.3
Diluted EPS	$0.27	$1.17	$0.80	$1.36
Net cash from operations	Not provided for quarter	Not provided for quarter	$34.4	$38.6

Q2 revenue increased 11.3%; first-half revenue increased 16.4%. Lease rent revenue rose 5.0% for the half, while maintenance reserve revenue rose 36.0%, mainly reflecting greater revenue recognized on long-term lease terminations.
Operating margin was approximately 7.8% in Q2 versus negative 3.9% a year earlier; first-half operating margin was 11.4% versus 1.4%. Net margin was approximately 5.2% in Q2 and 7.7% for the half; year-ago comparisons were elevated by a substantial tax benefit.
Q2 net income fell despite improved operating results because Q2 2013 included an $8.6 million extraterritorial income tax benefit. The company recorded tax expense of $1.3 million in Q2 2014; the prior-year quarter recorded a $7.8 million benefit.
At June 30, assets were $1,179.3 million, down from $1,199.2 million at year-end 2013. Cash and cash equivalents were $12.4 million and restricted cash was $44.5 million. Notes payable totaled $753.8 million, down from $787.6 million; shareholders’ equity was $218.8 million.
First-half investing cash flow was positive $2.6 million, versus negative $90.7 million in 2013, reflecting substantially lower equipment purchases ($23.2 million versus $92.1 million). Financing cash outflow was $37.4 million, including $43.8 million of principal payments. Cash declined $0.4 million to $12.4 million.

Changes and operating drivers

Q2 lease rent revenue was essentially flat, while average utilization declined to 81% from 83%. For the first half, average utilization improved to 84% from 83%; approximately 82% of equipment by book value was on lease at period-end.
Lower engine repair activity reduced technical expense by $1.8 million in Q2 and $2.0 million for the first half. Net finance costs also declined modestly year over year.
Depreciation and amortization increased 10.9% in Q2 and 13.1% for the half, reflecting portfolio growth and revised useful-life and residual-value estimates for certain older engines. The estimate change added $2.1 million to Q2 depreciation and reduced Q2 net income by an estimated $1.3 million, or $0.16 per diluted share.
Equipment write-downs were $2.2 million in Q2 and $2.5 million for the half, associated with engines designated for part-out where carrying values exceeded expected proceeds.
The spare-parts business, launched in late 2013, generated $1.5 million in first-half revenue and $0.1 million of operating earnings. The company also entered a 50/50 China-based engine-leasing joint venture in June; its expected initial company contribution is $15 million, not yet funded at quarter-end.

Liquidity, debt and outlook

On June 4, the company expanded its revolving credit facility from $450 million to $700 million and extended maturity to June 2019. Availability was $357 million at June 30, compared with $88 million at December 31, 2013. Initial pricing is LIBOR plus 2.50%, subject to quarterly leverage-based adjustments.
Debt rates ranged from approximately 2.4% to 5.5%. Of outstanding borrowings, $384.1 million was variable-rate debt tied to one-month LIBOR; management estimated a one-percentage-point rate move would change annual interest expense by about $3.8 million. No interest-rate swaps were in place at quarter-end.
Management said equity, internally generated funds and existing facilities should support operations for the next 12 months. It cautioned that increased off-lease equipment, reduced facility availability, or inability to access additional capital could constrain operations and growth. Fixed-rate lease revenues may not adjust quickly enough to offset rising variable borrowing costs.
The company reported compliance with revolving-facility and WEST II covenants at June 30. Approximately $30.9 million of debt was due within 12 months. Contractual commitments included $28.0 million of equipment purchase obligations, within a stated gross commitment of $29.8 million for three engines, one aircraft and related equipment scheduled for 2014.
WEST II had $361.5 million of term notes outstanding, secured by 71 engines and related leases; associated assets and restricted cash are not generally available for other company obligations. Lease security deposits and some maintenance reserves are restricted. The company reported $7.8 million of cash and cash equivalents plus restricted cash held in foreign subsidiaries, with no current intent to repatriate it.
No quantitative earnings or revenue guidance was provided. Results for the first half are not necessarily indicative of the remainder of 2014.

Risks, contingencies and other notable items

Interest-rate risk is material: higher LIBOR may compress lease spreads or reduce lease demand. Currency devaluation could impair lessees’ ability to pay, although leases are denominated in U.S. dollars; 86% of first-half lease revenue came from non-U.S.-domiciled lessees.
Asset residual values, useful lives and impairment estimates rely on management judgment; differing assumptions or market conditions could result in additional write-downs or losses on sale.
The company disclosed settlement discussions with the SEC concerning late public filings of stock ownership by the company and three current officers. It did not expect the matter to materially affect business or operations.
A $13.4 million aircraft loan closed July 16, 2014, after quarter-end, at a fixed 2.75% for its first five years.
Management reported disclosure controls and procedures were effective, and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether maintenance-reserve revenue tied to lease terminations and equipment-sale gains are sustainable.
Current utilization, off-lease asset levels, and the assumptions behind engine residual values, depreciation estimates and impairment charges.
Available revolving-credit capacity, covenant headroom, debt maturities, and sensitivity to LIBOR changes.
Funding and expected returns for the new China joint venture, and execution of the 2014 equipment purchase commitments.
Subsequent developments in the SEC settlement discussions and any associated costs or consequences.