UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

 

 

Commission File Number:

 

WILLIS LEASE FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.       Yes  ý   No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Registration S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  o

 

The aggregate market value of voting stock held by non-affiliates of the registrant as of March 4, 2002 was approximately $19.7 million (based on a closing sale price of $4.45 per share as reported on the NASDAQ National Market).

 

The number of shares of the registrant’s Common Stock outstanding as of  March 4, 2002 was 8,830,181.

 

The Company’s Proxy Statement for the 2002 Annual Meeting of Stockholders is incorporated by reference into Part III of this 10-K.

 

 

WILLIS LEASE FINANCE CORPORATION

2001 FORM 10-K ANNUAL REPORT

 

TABLE OF CONTENTS

 

		PART I
Item 1.		Business
Item 2.		Properties
Item 3.		Legal Proceedings
Item 4.		Submission of Matters to a Vote of Security Holders
		PART II
Item 5.		Market for Registrant’s Common Equity and Related Stockholder Matters
Item 6.		Selected Financial Data
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk
Item 8.		Financial Statements and Supplementary Data
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
		PART III
Item 10.		Directors and Executives Officers of the Registrant
Item 11.		Executive Compensation
Item 12.		Security Ownership of Certain Beneficial Owners and Management
Item 13.		Certain Relationships and Related Transactions
		PART IV
Item 14.		Exhibits, Financial Schedules and Reports on Form 8-K

 

 

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PART I

 

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, air cargo carriers and Maintenance and Repair Organizations (“MROs”).  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, 2001, the Company had a total lease portfolio (including 4 engines classified as discontinued operations) of 57 lessees in 28 countries and the Company’s total lease portfolio (including net investments in direct finance leases) consisted of 114 engines, six aircraft and four spare parts packages with an aggregate net book value of $495.3 million.  The Company actively manages its portfolio and structures its leases in order to enhance residual values of leased assets.  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 was to focus on the acquisition of aviation equipment, such as whole engines and aircraft, which could be dismantled and sold as parts at a greater profit.  WASI also supplied 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 provided 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 WASI and its membership interest in its engine repair joint venture with Chromalloy Gas Turbine Corporation, PGTC LLC and the Company sold its aircraft parts and components subsidiary, WASI, to SRT Group America for $37.6 million (as adjusted).  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 business cooperation period with Flightlease and SRT ending on November 30, 2003, by which Flightlease and SRT have price discounts and lowest price guarantees on engine leases from the Company.  Flightlease and SRT in turn provide the Company with access to spare engines, 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 (including SRT Group America). During the year ended December 31, 2001 there were no transactions completed by either party under the cooperation agreement. 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 Group America at pre-determined prices.  At December 31, 2001 there were five remaining engines (three in discontinued operation) with put options having a book value of $1.2 million.  The Company gave notice of its intention to exercise two of these put options in January 2002 and intends to close the puts during the second quarter.

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The Company sold 1,300,000 newly issued shares of its common stock to FlightTechnics and an option, exercisable within 18 months of November 30, 2000 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 stockholders 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 before the fifth anniversary of the closing date.  Certain stockholders, including Charles F. Willis IV, and FlightTechnics have also agreed to certain voting provisions and to  certain 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 Operating 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.

 

SAir Group, the parent company of SRT Flightlease and FlightTechnics, filed for bankruptcy in Switzerland in October, 2001. SRT is not subject to the bankruptcy filing and as of the date of this report is current on all rental obligations to the Company.  See “Managements Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Results."

 

The terrorist attacks of September 11, 2001 and the general economic slowdown has resulted in an increase in the number of engines off-lease with an associated impact on revenue and has also led to the bankruptcy of one of the Company’s largest customers, Canada 3000 in November 2001.  See “Managements Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Results."

 

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.

 

Management considers the continuing operation of the Company to operate in one reportable segment.

 

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.”

 

All of the Company’s lease transactions 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

 

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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.

 

Despite these guidelines, 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 demand for air travel, 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 financial results and 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, 2001, all but 6 (2 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, 2001, the Company had a total portfolio of 114 aircraft engines and related equipment (including 4 engines classified as discontinued operations), four spare parts packages and six aircraft with an aggregate original cost of $529.9 million in its lease portfolio.  As of December 31, 2000, the Company had a total portfolio (including 10 engines classified as discontinued operations) of 110 aircraft engines and related equipment, four spare parts packages and six aircraft with an aggregate original cost of $451.9 million in its lease portfolio.

 

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As of December 31, 2001, 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, 2001, for continuing operations, the Company had 54 lessees of commercial aircraft engines and other aircraft-related equipment in 27 countries.

 

The following table displays the regional profile of the Company’s lease customer base for continuing operations for the years ended December 31, 2001, 2000 and 1999.  No single country other than the United States accounted for more than 10%, 8% and 10% of the Company’s lease revenue for the years ended December 31, 2001, 2000 and 1999, respectively.

 

		Year Ended December 31, 2001					Year Ended December 31, 2000					Year Ended December 31, 1999
		Lease					Lease					Lease
		Revenue			Percentage		Revenue			Percentage		Revenue			Percentage
			(dollars in thousands)
United States		$	12,669		21	%	$	12,554		26	%	$	10,191		23	%
Europe		27,919			46		16,775			34		13,557			31
Mexico		2,004			3		3,560			7		4,546			10
Canada		3,409			6		4,141			8		3,327			8
Australia/New Zealand		–			–		280			1		551			1
Asia		5,446			9		4,173			9		4,147			10
South America		5,787			10		5,840			12		6,751			15
Middle East		3,281			5		1,689			3		1,009			2
Total		$	60,515		100	%	$	49,012		100	%	$	44,079		100	%

 

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.

 

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DISCONTINUED OPERATIONS

 

Equipment Held for Lease

 

As part of the transaction with SRT and its affiliates, the Company sold its parts subsidiary, WASI, and its interest in its engine repair joint venture, PGTC LLC, and agreed to retain a lease portfolio of aircraft engines previously 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.

 

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, 2001, for discontinued operations, the Company had three lessees of commercial aircraft engines in three countries, the USA, Mexico and Venezuela.  The portfolio consists of 4 engines with a book value of $1.2 million, 3 of which having a book value of $1.0 million are subject to put option agreements with SRT Group America.

 

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 and private placements.  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

 

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