Notes to Condensed Consolidated Financial Statements
June 30, 2022
(Unaudited)
Unless the context requires otherwise, references to the “Company,” “WLFC,” “we,” “us” or “our” in this Quarterly Report on Form 10-Q refer to Willis Lease Finance Corporation and its subsidiaries.
1. Summary of Significant Accounting Policies
The significant accounting policies of the Company were described in Note 1 to the audited consolidated financial statements included in the Company’s Form 10-K for the fiscal year ended December 31, 2021 (the “2021 Form 10-K”). There have been no significant changes in the Company’s significant accounting policies for the six months ended June 30, 2022.
(a) Basis of Presentation
The accompanying Unaudited Condensed Consolidated Financial Statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”), consistent in all material respects with those applied in the 2021 Form 10-K, for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission. Therefore, they do not include all information and footnotes normally included in annual consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto included in the 2021 Form 10-K. In the opinion of management, the Unaudited Condensed Consolidated Financial Statements contain all adjustments (consisting principally of normal recurring accruals) necessary for a fair presentation of the condensed consolidated balance sheets, statements of income, statements of comprehensive income, statements of redeemable preferred stock and shareholders’ equity and statements of cash flows for such interim periods presented. Additionally, operating results for interim periods are not necessarily indicative of the results that can be expected for a full year.
In accordance with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. These estimates and judgments are based on historical experience and other assumptions that management believes are reasonable and the inputs into management's estimates and judgment consider the economic implications of the COVID-19 pandemic on the Company’s critical and significant accounting estimates. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ materially from these estimates. The significant estimates made in the accompanying Unaudited Condensed Consolidated Financial Statements include certain assumptions related to intangible assets, long-lived assets, equipment held for sale, allowance for doubtful accounts, inventory and estimated income taxes. Actual results may differ materially from these estimates under different assumptions or conditions. Given the uncertainty in the rapidly changing market and economic conditions related to the COVID-19 pandemic, the Company will continue to evaluate the nature and extent of the impact to its business, results of operations and financial condition.
(b) Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, including variable interest entities (“VIEs”), where the Company is the primary beneficiary in accordance with consolidation guidance. The Company first evaluates all entities in which it has an economic interest to determine whether for accounting purposes the entity is either a VIE or a voting interest entity. If the entity is a VIE, the Company consolidates the financial statements of that entity if it is the primary beneficiary of such entity's activities. If the entity is a voting interest entity, the Company consolidates the entity when it has a majority of voting interests in such entity. Intercompany transactions and balances have been eliminated in consolidation.
(c) Risks and Uncertainties
As a result of the COVID-19 pandemic, the Company had temporarily closed its headquarters and other offices, required its employees and contractors to predominately work remotely, and implemented travel restrictions, all of which represented a significant disruption in how the Company operates its business. In January 2022, the Company lifted travel restrictions and has also subsequently opened its corporate headquarters and other offices for employees and contractors to work from offices at their discretion. The Company has also taken various proactive actions in an attempt to mitigate the financial impact of the COVID-19 pandemic. The operations of the Company's partners and customers have likewise been disrupted. The worldwide spread of the COVID-19 virus has resulted in a global slowdown of economic activity. While the duration and extent of the COVID-19 pandemic depends on future developments that cannot be accurately predicted at this time, such as the extent and effectiveness of containment actions, it has had an adverse effect on the global economy, and the ultimate societal and economic impact of the COVID-19 pandemic remains unknown. In particular, the ongoing COVID-19 pandemic has caused significant disruptions to the airline industry and has resulted in a dramatic reduction in demand for air travel domestically and abroad, which is likely to continue for the foreseeable future. Lower demand for air travel in turn presents significant risks to the Company, resulting in impacts which have adversely affected the Company's business, results of operations, and financial condition. Lower demand for spare parts and engine and airframe leasing has negatively impacted collections of accounts receivable, caused the Company's lessee customers to not enter into new leases, resulted in reduced spending by new and existing customers for leases or spare parts or equipment, resulted in lower usage fees, caused some of the Company's customers to go out of business, and limited the ability of the Company's personnel to travel to customers and potential customers. The Company is not able to evaluate or foresee the full extent of these impacts at the current time.
Other than what has been reflected in the Unaudited Condensed Consolidated Financial Statements, the Company is not aware of any specific event or circumstance related to the COVID-19 pandemic that would require it to update its estimates or judgments or adjust the carrying value of its assets or liabilities. Actual results could differ from those estimates, and any such differences may be material to the Unaudited Condensed Consolidated Financial Statements.
In February 2022, Russia commenced military action with Ukraine. As a result of this action, various nations, including the United States, have instituted economic sanctions against Russia. Further, the full impact of this action and related sanctions on the world economy is not determinable as of the date of these financial statements, and the specific impact on the Company's financial condition, results of operations and cash flows is also not determinable as of the date of these financial statements.
(d) Recent Accounting Pronouncements
Recent Accounting Pronouncements Adopted by the Company
In July 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2021-05, “Lease (Topic 842): Lessors – Certain Leases with Variable Lease Payments” related to accounting for sales-type leases or direct financing leases with variable lease payments. This ASU is effective for interim and annual years beginning after December 15, 2021, with early adoption permitted. The Company adopted this guidance effective January 1, 2022, and the adoption had no impact to the Company’s consolidated financial statements and related disclosures.
In November 2021, the FASB issued ASU 2021-10, “Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance” related to disclosures about transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy. This ASU is effective for annual periods beginning after December 15, 2021, with early application permitted. The Company adopted this guidance effective January 1, 2022, and the adoption had no impact to the Company's consolidated financial statements and related disclosures.
Recent Accounting Pronouncements To Be Adopted by the Company
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). ASU 2016-13 revises the measurement of credit losses for financial assets measured at amortized cost from an incurred loss methodology to an expected loss methodology. ASU 2016-13 affects trade receivables, debt securities, net investment in leases, and most other financial assets that represent a right to receive cash. Additional disclosures about significant estimates and credit quality are also required. In November 2018, the FASB issued ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses.” This ASU clarifies receivables from operating leases are accounted for using the lease guidance and not as financial instruments. In April 2019, the FASB issued ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments.” This ASU clarifies various scoping and other issues arising from ASU 2016-13. In March 2020, the FASB issued ASU 2020-03, “Codification Improvements to Financial Instruments.” This ASU improves the Codification and amends the interaction of Topic 842 and Topic 326. In March 2022, the FASB issued ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326)” which eliminated the accounting guidance for Troubled Debt Restructurings by creditors and enhances disclosure requirements for certain loan refinancing and restructurings. The amendment also requires an entity disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases. The amendments in this ASU are effective for the Company on January 1, 2023, with early adoption permitted. The Company expects to adopt this accounting standard update effective January 1, 2023. The Company is evaluating the potential effects on the consolidated financial statements.
2. Revenue from Contracts with Customers
The following tables disaggregate revenue by major source for the three and six months ended June 30, 2022 and 2021 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended June 30, 2022 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Lease rent revenue | | $ | 36,704 | | | $ | — | | | $ | — | | | $ | 36,704 | |
| Maintenance reserve revenue | | 24,245 | | | — | | | — | | | 24,245 | |
| Spare parts and equipment sales | | 49 | | | 6,743 | | | — | | | 6,792 | |
| Gain on sale of leased equipment | | 498 | | | — | | | — | | | 498 | |
| Gain on sale of financial assets | | 3,116 | | | — | | | — | | | 3,116 | |
| Managed services | | 4,787 | | | — | | | — | | | 4,787 | |
| | | | | | | | |
| Other revenue | | 1,904 | | | 58 | | | (29) | | | 1,933 | |
| Total revenue | | $ | 71,303 | | | $ | 6,801 | | | $ | (29) | | | $ | 78,075 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, 2021 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Lease rent revenue | | $ | 32,431 | | | $ | — | | | $ | — | | | $ | 32,431 | |
| Maintenance reserve revenue | | 17,278 | | | — | | | — | | | 17,278 | |
| Spare parts and equipment sales | | 84 | | | 3,375 | | | 110 | | | 3,569 | |
| | | | | | | | |
| Managed services | | 3,247 | | | — | | | — | | | 3,247 | |
| Asset transition fee (1) | | 6,256 | | | — | | | — | | | 6,256 | |
| Other revenue | | 3,669 | | | 41 | | | (19) | | | 3,691 | |
| Total revenue | | $ | 62,965 | | | $ | 3,416 | | | $ | 91 | | | $ | 66,472 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six months ended June 30, 2022 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Lease rent revenue | | $ | 74,829 | | | $ | — | | | $ | — | | | $ | 74,829 | |
| Maintenance reserve revenue | | 39,079 | | | — | | | — | | | 39,079 | |
| Spare parts and equipment sales | | 251 | | | 13,171 | | | — | | | 13,422 | |
| Gain on sale of leased equipment | | 2,796 | | | — | | | — | | | 2,796 | |
| Gain on sale of financial assets | | 3,116 | | | — | | | — | | | 3,116 | |
| Managed services | | 9,431 | | | — | | | — | | | 9,431 | |
| Other revenue | | 4,072 | | | 234 | | | (87) | | | 4,219 | |
| Total revenue | | $ | 133,574 | | | $ | 13,405 | | | $ | (87) | | | $ | 146,892 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six months ended June 30, 2021 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Lease rent revenue | | $ | 63,951 | | | $ | — | | | $ | — | | | $ | 63,951 | |
| Maintenance reserve revenue | | 37,090 | | | — | | | — | | | 37,090 | |
| Spare parts and equipment sales | | 169 | | | 7,966 | | | — | | | 8,135 | |
| Managed services | | 5,515 | | | — | | | — | | | 5,515 | |
| Asset transition fee (1) | | 6,256 | | | — | | | — | | | 6,256 | |
| Other revenue | | 6,607 | | | 97 | | | (54) | | | 6,650 | |
| Total revenue | | $ | 119,588 | | | $ | 8,063 | | | $ | (54) | | | $ | 127,597 | |
_____________________________
(1)Asset transition fee reflects the settlement received from the close out of an engine transition program.
3. Equipment Held for Operating Lease and Notes Receivable
As of June 30, 2022, the Company had $1,957.6 million equipment held in our operating lease portfolio, $83.3 million notes receivable, and $7.0 million investment in sales-type leases, which represented 293 engines, twelve aircraft, one marine vessel and other leased parts and equipment. As of December 31, 2021, the Company had $1,991.4 million equipment held in our operating lease portfolio and $115.5 million notes receivable which represented 304 engines, twelve aircraft, one marine vessel and other leased parts and equipment.
The following table disaggregates equipment held for operating lease by asset class (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2022 | | December 31, 2021 |
| Gross Value | | Accumulated Depreciation | | Net Book Value | | Gross Value | | Accumulated Depreciation | | Net Book Value |
| Engines and related equipment | $ | 2,323,147 | | | $ | (506,318) | | | $ | 1,816,829 | | | $ | 2,368,496 | | | $ | (515,442) | | | $ | 1,853,054 | |
| Aircraft and airframes | 139,270 | | | (9,830) | | | 129,440 | | | 134,370 | | | (7,790) | | | 126,580 | |
| Marine vessel | 13,470 | | | (2,101) | | | 11,369 | | | 13,470 | | | (1,736) | | | 11,734 | |
| $ | 2,475,887 | | | $ | (518,249) | | | $ | 1,957,638 | | | $ | 2,516,336 | | | $ | (524,968) | | | $ | 1,991,368 | |
Notes Receivable
During the three months ended June 30, 2022 and 2021, the Company recorded interest income related to the notes receivable of $1.9 million and $3.6 million, respectively, and $4.0 million and $6.5 million during the six months ended June 30, 2022 and 2021, respectively, and is presented within Other revenue. The effective interest rates on our notes receivable ranged from 7.1% to 12.2% as of June 30, 2022 and 6.3% to 12.2% as of June 30, 2021.
4. Investments
In 2011, the Company entered into an agreement with Mitsui & Co., Ltd. to participate in a joint venture formed as a Dublin-based Irish limited company, Willis Mitsui & Company Engine Support Limited (“WMES”) for the purpose of acquiring and leasing jet engines. Each partner holds a fifty percent interest in the joint venture, and the Company uses the equity method in recording investment activity. As of June 30, 2022, WMES owned a lease portfolio, inclusive of 36 engines and five aircraft with a net book value of $258.9 million.
In 2014, the Company entered into an agreement with China Aviation Supplies Import & Export Corporation (“CASC”) to participate in a joint venture named CASC Willis Engine Lease Company Limited (“CASC Willis”), a joint venture based in Shanghai, China. Each partner holds a fifty percent interest in the joint venture, and the Company uses the equity method in recording investment activity. CASC Willis acquires and leases jet engines to Chinese airlines and concentrates on the demand for leased commercial aircraft engines and aviation assets in the People’s Republic of China. As of June 30, 2022, CASC Willis owned a lease portfolio of four engines with a net book value of $45.5 million.
| | | | | | | | | | | | | | | | | | | | |
| As of June 30, 2022 | | WMES | | CASC Willis | | Total |
| | (in thousands) |
| Investment in joint ventures as of December 31, 2021 | | $ | 39,069 | | | $ | 16,858 | | | $ | 55,927 | |
| Loss from joint ventures | | (931) | | | (216) | | | (1,147) | |
| | | | | | |
| Foreign currency translation adjustment | | — | | | (848) | | | (848) | |
| Other comprehensive gain from joint ventures | | 1,409 | | | — | | | 1,409 | |
| Investment in joint ventures as of June 30, 2022 | | $ | 39,547 | | | $ | 15,794 | | | $ | 55,341 | |
“Other revenue” on the Condensed Consolidated Statements of Income includes $0.5 million and $0.4 million of management fees earned during the three months ended June 30, 2022 and 2021, respectively, and $1.0 million and $0.7 million during the six months ended June 30, 2022 and 2021, respectively, related to the servicing of engines for the WMES lease portfolio.
There were no aircraft or engine sales to WMES or CASC Willis during the six months ended June 30, 2022 and 2021.
Unaudited summarized financial information for 100% of WMES is presented in the following tables:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (in thousands) | | (in thousands) |
| Revenue | $ | 21,185 | | | $ | 4,885 | | | $ | 30,726 | | | $ | 9,646 | |
| Expenses | 17,687 | | | 6,606 | | | 32,690 | | | 12,775 | |
| WMES net income (loss) | $ | 3,498 | | | $ | (1,721) | | | $ | (1,964) | | | $ | (3,129) | |
| | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
| (in thousands) |
| Total assets | $ | 285,114 | | | $ | 310,260 | |
| Total liabilities | 202,735 | | | 225,917 | |
| Total WMES net equity | $ | 82,379 | | | $ | 84,343 | |
The difference between the Company’s investment in WMES and 50% of total WMES net equity is primarily attributable to the recognition of deferred gains, prior to the adoption of ASU 2017-05, related to engines sold by the Company to WMES.
5. Debt Obligations
Debt obligations consisted of the following:
| | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
| (in thousands) |
Credit facility at a floating rate of interest of one-month LIBOR plus 1.375% at June 30, 2022, secured by engines. The facility has a committed amount of $1.0 billion at June 30, 2022, which revolves until the maturity date of June 2024 | $ | 569,000 | | | $ | 590,000 | |
WEST VI Series A 2021 term notes payable at a fixed rate of interest of 3.10%, maturing in May 2046, secured by engines and one airframe | 266,982 | | | 273,723 | |
WEST VI Series B 2021 term notes payable at a fixed rate of interest of 5.44%, maturing in May 2046, secured by engines and one airframe | 37,086 | | | 38,022 | |
WEST VI Series C 2021 term notes payable at a fixed rate of interest of 7.39%, maturing in May 2046, secured by engines and one airframe | 16,762 | | | 18,158 | |
WEST V Series A 2020 term notes payable at a fixed rate of interest of 3.23%, maturing in March 2045, secured by engines | 263,489 | | | 272,909 | |
WEST V Series B 2020 term notes payable at a fixed rate of interest of 4.21%, maturing in March 2045, secured by engines | 36,609 | | | 38,004 | |
WEST V Series C 2020 term notes payable at a fixed rate of interest of 6.66%, maturing in March 2045, secured by engines | 14,646 | | | 16,342 | |
WEST IV Series A 2018 term notes payable at a fixed rate of interest of 4.75%, maturing in September 2043, secured by engines | 251,949 | | | 262,260 | |
WEST IV Series B 2018 term notes payable at a fixed rate of interest of 5.44%, maturing in September 2043, secured by engines | 38,885 | | | 38,885 | |
WEST III Series A 2017 term notes payable at a fixed rate of interest of 4.69%, maturing in August 2042, secured by engines | 217,020 | | | 223,815 | |
WEST III Series B 2017 term notes payable at a fixed rate of interest of 6.36%, maturing in August 2042, secured by engines | 32,195 | | | 32,195 | |
Note payable at a fixed rate of interest of 3.18%, maturing in July 2024, secured by an aircraft | 4,313 | | | 5,307 | |
| 1,748,936 | | | 1,809,620 | |
| Less: unamortized debt issuance costs | (17,129) | | | (19,356) | |
| Total debt obligations | $ | 1,731,807 | | | $ | 1,790,264 | |
One-month LIBOR was 1.79% and 0.10% as of June 30, 2022 and December 31, 2021, respectively.
Principal outstanding at June 30, 2022, is expected to be repayable as follows:
| | | | | | | | |
| Year | | (in thousands) |
| 2022 | | $ | 50,832 | |
| 2023 | | 62,369 | |
| 2024 | | 630,536 | |
| 2025 | | 60,300 | |
| 2026 | | 282,048 | |
| Thereafter | | 662,851 | |
| Total | | $ | 1,748,936 | |
Virtually all of the above debt requires ongoing compliance with certain financial covenants, including debt/equity ratios, minimum tangible net worth and minimum interest coverage ratios, and other eligibility criteria including customer and geographic concentration restrictions. The Company also has certain negative financial covenants such as liens, advances, change in business, sales of assets, dividends and stock repurchases. These covenants are tested either monthly, quarterly or annually, and the Company was in full compliance with all financial covenant requirements at June 30, 2022.
6. Derivative Instruments
The Company periodically holds interest rate derivative instruments to mitigate exposure to changes in interest rates, predominantly one-month LIBOR, with $569.0 million and $590.0 million of variable rate borrowings at June 30, 2022 and December 31, 2021, respectively. As a matter of policy, management does not use derivatives for speculative purposes. As of June 30, 2022, the Company had five interest rate swap agreements. During the first quarter of 2021, the Company entered into four fixed-rate interest swap agreements, each having notional amounts of $100.0 million, two with remaining terms of 19 months and two with remaining terms of 43 months as of June 30, 2022. One interest rate swap agreement was entered into during 2019 which has a notional outstanding amount of $100.0 million with a remaining term of 24 months as of June 30, 2022. One interest rate swap agreement which the Company entered into in 2016 expired in April 2021. The derivative instruments were each designated as cash flow hedges at inception and recorded at fair value.
The Company evaluated the effectiveness of the swap agreements to hedge the interest rate risk associated with its variable rate debt and concluded at the swap inception dates that each swap was highly effective in hedging that risk. The Company evaluates the effectiveness of the hedging relationships on an ongoing basis and concluded there was no ineffectiveness in the hedges for the period ended June 30, 2022.
The Company estimates the fair value of derivative instruments using a discounted cash flow technique and has used creditworthiness inputs that corroborate observable market data when evaluating the Company’s and counterparty’s risk of non-performance. Valuation of the derivative instruments requires certain assumptions for underlying variables and the use of different assumptions would result in a different valuation. Management believes it has applied assumptions consistently during the period. The Company applies hedge accounting and accounts for the change in fair value of its cash flow hedges through other comprehensive income for all derivative instruments.
The net fair value of the interest rate swaps as of June 30, 2022 was $28.4 million, representing an asset and is reflected within other assets on the condensed consolidated balance sheet. The net fair value of the interest rate swaps as of December 31, 2021 was $7.3 million, representing an asset of $8.0 million and a liability of $0.7 million, reflected within other assets and accounts payable and accrued expenses on the condensed consolidated balance sheet, respectively. The Company recorded an adjustment to interest expense of $(0.9) million and $0.5 million during the three months ended June 30, 2022 and 2021, respectively, and $(0.6) million and $1.4 million during the six months ended June 30, 2022 and 2021, respectively, from derivative instruments.
Effect of Derivative Instruments on Earnings in the Condensed Consolidated Statements of Income and Comprehensive Income
The following tables provide additional information about the financial statement effects related to the cash flow hedges for the three and six months ended June 30, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivatives in Cash Flow Hedging Relationships | | Amount of Gain (Loss) Recognized in OCI on Derivatives
(Effective Portion) |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands) | | (in thousands) |
| Interest rate contracts | | $ | 3,945 | | | $ | (769) | | | $ | 21,096 | | | $ | 5,727 | |
| Total | | $ | 3,945 | | | $ | (769) | | | $ | 21,096 | | | $ | 5,727 | |
The effective portion of the change in fair value on a derivative instrument designated as a cash flow hedge is reported as a component of other comprehensive income and is reclassified into earnings in the period during which the transaction being hedged affects earnings or it is probable that the forecasted transaction will not occur. The ineffective portion of the hedges, if any, is recorded in earnings in the current period.
Counterparty Credit Risk
The Company evaluates the creditworthiness of the counterparties under its hedging agreements. The counterparties for the interest rate swaps are large financial institutions that possessed investment grade credit ratings. Based on these ratings, the Company believes that the counterparties were credit-worthy and that their continuing performance under the hedging agreements was probable and did not require the counterparties to provide collateral or other security to the Company.
7. Income Taxes
Income tax expense (benefit) for the three and six months ended June 30, 2022 was $5.0 million and $(1.5) million, respectively. The effective tax rate for the three and six months ended June 30, 2022 was 46.1% and 8.8%, respectively. Income tax benefit for the three and six months ended June 30, 2021 was $1.9 million and $2.3 million, respectively. The effective tax rate for the three and six months ended June 30, 2021 was 103.1% and 64.1%, respectively. The Company’s effective tax rates differed from the U.S. federal statutory rate of 21.0% primarily due to executive compensation exceeding $1.0 million as defined in Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"), and a discrete item recorded in the prior quarter associated with a write-down of engines due to the Russia and Ukraine conflict. Refer to Note 8 "Fair Value Measurements" for further detail on the write-downs related to Russia.
The Company records tax expense or benefit for unusual or infrequent items discretely in the period in which they occur. The Company’s tax rate is subject to change based on changes in the mix of assets leased to domestic and foreign lessees, the proportions of revenue generated within and outside of California, the amount of executive compensation exceeding $1.0 million as defined in Section 162(m) of the Code and numerous other factors, including changes in tax law.
The Company qualified for the Employment Retention Credit (“ERC”) and recognized a credit of $0.7 million and $1.4 million for the three and six months ended June 30 2021, respectively, as a reduction to payroll tax.
8. Fair Value Measurements
The fair value of a financial instrument represents the amount at which the instrument could be exchanged in a current transaction between willing parties in contrast to a forced sale or liquidation. Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of judgment, and therefore cannot be determined with precision.
Accounting standards define fair value as the price that would be received from selling an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Accounting standards establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value and also establishes the following three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
•Cash and cash equivalents, restricted cash, receivables, and accounts payable: The amounts reported in the accompanying Condensed Consolidated Balance Sheets approximate fair value due to their short-term nature.
•Notes receivable: The carrying amount of the Company’s outstanding balance on its Notes receivable as of June 30, 2022 and December 31, 2021 was estimated to have a fair value of approximately $85.3 million and $117.7 million, respectively, based on the fair value of estimated future payments calculated using interest rates that approximate prevailing market rates at each period end (Level 2 inputs).
•Investment in sales-type leases: The carrying amount of the Company's outstanding balance on its Investment in sales-type leases as of June 30, 2022 was estimated to have a fair value of approximately $7.0 million based on the fair value of estimated future payments calculated using interest rates that approximate prevailing market rates at each period end (Level 2 inputs). The Company did not have investment in sales-type leases at December 31, 2021.
•Debt obligations: The carrying amount of the Company’s outstanding balance on its Debt obligations as of June 30, 2022 and December 31, 2021 was estimated to have a fair value of approximately $1,549.0 million and $1,827.4 million, respectively, based on the fair value of estimated future payments calculated using interest rates that approximate prevailing market rates at each period end (Level 2 inputs).
Assets Measured and Recorded at Fair Value on a Recurring Basis
As of June 30, 2022 and December 31, 2021, the Company measured the fair value of its interest rate swap agreements based on Level 2 inputs, due to the usage of inputs that can be corroborated by observable market data. The Company estimates the fair value of derivative instruments using a discounted cash flow technique and has used creditworthiness inputs that corroborate observable market data evaluating the Company’s and counterparties’ risk of non-performance. The net fair value of the interest rate swaps as of June 30, 2022 was $28.4 million, representing an asset. The net fair value of the interest rate swaps as of December 31, 2021 was $7.3 million, representing an asset of $8.0 million and a liability of $0.7 million. The Company recorded an adjustment to interest expense of $(0.9) million and $0.5 million during the three months ended June 30, 2022 and 2021, respectively, and $(0.6) million and $1.4 million during the six months ended June 30, 2022 and 2021, respectively, from derivative instruments.
Assets Measured and Recorded at Fair Value on a Nonrecurring Basis
The Company determines fair value of long-lived assets held and used, such as Equipment held for operating lease and Equipment held for sale, by reference to independent appraisals, quoted market prices (e.g. an offer to purchase) and other factors. An impairment charge is recorded when the carrying value of the asset exceeds its fair value. The Company uses Level 2 inputs to measure write-downs of equipment held for lease and equipment held for sale.
| | | | | | | | | | | | | | | | | | | | | | | |
| Total Losses |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (in thousands) | | (in thousands) |
| Equipment held for lease | $ | — | | | $ | 2,246 | | | $ | 21,117 | | | $ | 4,113 | |
| Equipment held for sale | 78 | | | — | | | 78 | | | — | |
| Total | $ | 78 | | | $ | 2,246 | | | $ | 21,195 | | | $ | 4,113 | |
Write-downs of equipment to their estimated fair values totaled $0.1 million for the three months ended June 30, 2022. Write-downs of equipment to their estimated fair values totaled $21.2 million for the six months ended June 30, 2022, primarily reflecting an adjustment of the carrying value of three impaired engines. Of this write-down, $20.4 million reflects the impairment of two engines located in Russia which were determined due to the Russia and Ukraine conflict to be unrecoverable. The remaining write-downs were in the ordinary course of business. As of June 30, 2022, included within equipment held for lease and equipment held for sale was $32.8 million in remaining book values of 19 assets which were previously written down.
Write-downs of equipment to their estimated fair values totaled $2.2 million for the three months ended June 30, 2021, reflecting an adjustment of the carrying value of four impaired engines. Write-downs of equipment to their estimated fair values totaled $4.1 million for the six months ended June 30, 2021, reflecting an adjustment of the carrying value of four impaired engines and one airframe.
9. Earnings Per Share
Basic earnings per common share is computed by dividing net income, less preferred stock dividends and accretion of preferred stock issuance costs, by the weighted average number of common shares outstanding for the period. Treasury stock is excluded from the weighted average number of shares of common stock outstanding. Diluted earnings per share attributable to common stockholders is computed based on the weighted average number of shares of common stock and dilutive securities outstanding during the period. Dilutive securities are common stock equivalents that are freely exercisable into common stock at less than market prices or otherwise dilute earnings if converted. The net effect of common stock equivalents is based on the incremental common stock that would be issued upon the vesting of restricted stock using the treasury stock method. Common stock equivalents are not included in diluted earnings per share when their inclusion is antidilutive. Additionally, redeemable preferred stock is not convertible and does not affect dilutive shares.
There were no anti-dilutive shares for the three months ended June 30, 2022. There were 0.2 million anti-dilutive shares excluded from the computation of diluted weighted average earnings per common share for the six months ended June 30, 2022. There were 0.2 million and 0.3 million anti-dilutive shares for the three and six months ended June 30, 2021, respectively.
The following table presents the calculation of basic and diluted EPS (in thousands, except per share data):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Net income (loss) attributable to common shareholders | $ | 5,076 | | | $ | (774) | | | $ | (16,947) | | | $ | (2,928) | |
| | | | | | | |
| Basic weighted average common shares outstanding | 6,129 | | | 6,218 | | | 6,040 | | | 6,107 | |
| Potentially dilutive common shares | 117 | | | — | | | — | | | — | |
| Diluted weighted average common shares outstanding | 6,246 | | | 6,218 | | | 6,040 | | | 6,107 | |
| | | | | | | |
| Basic weighted average income (loss) per common share | $ | 0.83 | | | $ | (0.12) | | | $ | (2.81) | | | $ | (0.48) | |
| Diluted weighted average income (loss) per common share | $ | 0.81 | | | $ | (0.12) | | | $ | (2.81) | | | $ | (0.48) | |
10. Equity
Common Stock Repurchase
Effective December 31, 2018, the Board of Directors approved the renewal of the existing common stock repurchase plan, extending the plan through December 31, 2020 and amending the plan to allow for repurchases of up to $60.0 million of the Company's common stock until such date. Effective December 31, 2020, the Board of Directors approved the renewal of the existing common stock repurchase plan, extending the plan through December 31, 2022. Repurchased shares are immediately retired. During the six months ended June 30, 2022, the Company repurchased a total of 154,215 shares of common stock for approximately $5.2 million at a weighted average price of $33.98 per share. During the six months ended June 30, 2021, no shares were repurchased. At June 30, 2022, approximately $39.6 million is available to purchase shares under the plan.
Redeemable Preferred Stock
Dividends: The Company’s Series A-1 Preferred Stock and Series A-2 Preferred Stock accrue quarterly dividends at the rate per annum of 6.5% per share. During the six months ended June 30, 2022 and 2021, the Company paid total dividends of $1.6 million, respectively, on the Series A-1 and Series A-2 Preferred Stock.
11. Stock-Based Compensation Plans
The components of stock-based compensation expense were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (in thousands) | | (in thousands) |
| 2007 Stock Incentive Plan | $ | — | | | $ | 957 | | | $ | — | | | $ | 1,642 | |
| 2021 Stock Incentive Plan | 3,027 | | | 3,507 | | | 7,634 | | | 5,506 | |
| Employee Stock Purchase Plan | 14 | | | 72 | | | 36 | | | 150 | |
| Total Stock Compensation Expense | $ | 3,041 | | | $ | 4,536 | | | $ | 7,670 | | | $ | 7,298 | |
The significant stock compensation plans are described below.
The 2007 Stock Incentive Plan (the “2007 Plan”) was adopted in May 2007. Under the 2007 Plan, a total of 2,800,000 shares were authorized for stock-based compensation available in the form of either restricted stock awards (“RSAs”) or stock options. The RSAs are subject to service-based vesting, typically between one and four years, where a specific period of continued employment must pass before an award vests. The expense associated with these awards is recognized on a straight-line basis over the respective vesting period, with forfeitures accounted for as they occur. For any vesting tranche of an award, the cumulative amount of compensation cost recognized is equal to the portion of the grant‑date fair value of the award tranche that is actually vested at that date. As of June 30, 2022, there were no stock options outstanding under the 2007 Plan.
The 2018 Stock Incentive Plan (the “2018 Plan”) was adopted in May 2018. Under the 2018 Plan, a total of 800,000 shares are authorized for stock-based compensation, plus the number of shares remaining under the 2007 Plan and any future forfeited awards under the 2007 Plan, in the form of RSAs. In November 2021, the 2018 Plan was amended and restated as the 2021 Stock Incentive Plan (the “2021 Plan”) to increase the number of shares reserved for issuance under the 2021 Plan by 1,000,000 shares. The RSAs are subject to service and performance-based vesting, typically between one and four years, where a specific period of continued employment or service must pass before an award vests. The expense associated with these awards is recognized on a straight-line basis over the respective vesting period, with forfeitures accounted for as they occur. For any vesting tranche of an award, the cumulative amount of compensation cost recognized is equal to the portion of the grant‑date fair value of the award tranche that is actually vested at that date.
As of June 30, 2022, the Company had granted 1,256,700 RSAs under the 2021 Plan and had 637,896 shares available for future issuance. The fair value of the restricted stock awards equaled the stock price at the grant date.
The following table summarizes the restricted stock activity during the six months ended June 30, 2022:
| | | | | |
| Shares |
| Balance of unvested shares as of December 31, 2021 | 560,608 | |
| Shares granted | 330,400 | |
| Shares forfeited | — | |
| Shares vested | (368,810) | |
| Balance of unvested shares as of June 30, 2022 | 522,198 | |
Under the Employee Stock Purchase Plan (“ESPP”), as amended and restated effective November 10, 2021, 425,000 shares of common stock have been reserved for issuance. Eligible employees may designate no more than 10% of their base cash compensation to be deducted each pay period for the purchase of common stock under the ESPP. Participants may purchase no more than 1,000 shares or $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 from 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. During the six months ended June 30, 2022 and 2021, 9,919 and 8,307 shares of common stock, respectively, were issued under the ESPP. The Company issues new shares through its transfer agent upon an employee stock purchase.
12. Reportable Segments
The Company has two reportable segments: (i) Leasing and Related Operations which involves acquiring and leasing, primarily pursuant to operating leases, commercial aircraft, aircraft engines and other aircraft equipment and the selective purchase and resale of commercial aircraft engines and other aircraft equipment and other related businesses and (ii) Spare Parts Sales which involves the purchase and resale of after-market engine parts, whole engines, engine modules and portable aircraft components.
The Company evaluates the performance of each of the segments based on profit or loss after general and administrative expenses. While the Company believes there are synergies between the two business segments, the segments are managed separately because each requires different business strategies.
The following tables present a summary of the reportable segments (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, 2022 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Revenue: | | | | | | | | |
| Lease rent revenue | | $ | 36,704 | | | $ | — | | | $ | — | | | $ | 36,704 | |
| Maintenance reserve revenue | | 24,245 | | | — | | | — | | | 24,245 | |
| Spare parts and equipment sales | | 49 | | | 6,743 | | | — | | | 6,792 | |
| Gain on sale of leased equipment | | 498 | | | — | | | — | | | 498 | |
| | | | | | | | |
| Gain on sale of financial assets | | 3,116 | | | — | | | — | | | 3,116 | |
| Other revenue | | 6,691 | | | 58 | | | (29) | | | 6,720 | |
| Total revenue | | 71,303 | | | 6,801 | | | (29) | | | 78,075 | |
| | | | | | | | |
| Expenses: | | | | | | | | |
| Depreciation and amortization expense | | 21,585 | | | 27 | | | — | | | 21,612 | |
| Cost of spare parts and equipment sales | | 4 | | | 7,010 | | | — | | | 7,014 | |
| | | | | | | | |
| Write-down of equipment | | 78 | | | — | | | — | | | 78 | |
| General and administrative | | 19,581 | | | 846 | | | — | | | 20,427 | |
| Technical expense | | 3,436 | | | — | | | — | | | 3,436 | |
| Net finance costs: | | | | | | | | |
| Interest expense | | 16,023 | | | — | | | — | | | 16,023 | |
| | | | | | | | |
| Total finance costs | | 16,023 | | | — | | | — | | | 16,023 | |
| Total expenses | | 60,707 | | | 7,883 | | | — | | | 68,590 | |
| Earnings (loss) from operations | | $ | 10,596 | | | $ | (1,082) | | | $ | (29) | | | $ | 9,485 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, 2021 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Revenue: | | | | | | | | |
| Lease rent revenue | | $ | 32,431 | | | $ | — | | | $ | — | | | $ | 32,431 | |
| Maintenance reserve revenue | | 17,278 | | | — | | | — | | | 17,278 | |
| Spare parts and equipment sales | | 84 | | | 3,375 | | | 110 | | | 3,569 | |
| | | | | | | | |
| Asset transition fee (1) | | 6,256 | | | — | | | — | | | 6,256 | |
| Other revenue | | 6,916 | | | 41 | | | (19) | | | 6,938 | |
| Total revenue | | 62,965 | | | 3,416 | | | 91 | | | 66,472 | |
| | | | | | | | |
| Expenses: | | | | | | | | |
| Depreciation and amortization expense | | 23,311 | | | 29 | | | — | | | 23,340 | |
| Cost of spare parts and equipment sales | | 2 | | | 3,276 | | | — | | | 3,278 | |
| Write-down of equipment | | 2,246 | | | — | | | — | | | 2,246 | |
| General and administrative | | 19,143 | | | 466 | | | (110) | | | 19,499 | |
| Technical expense | | 2,296 | | | — | | | — | | | 2,296 | |
| Net finance costs: | | | | | | | | |
| Interest expense | | 16,987 | | | — | | | — | | | 16,987 | |
| | | | | | | | |
| Total finance costs | | 16,987 | | | — | | | — | | | 16,987 | |
| Total expenses | | 63,985 | | | 3,771 | | | (110) | | | 67,646 | |
| (Loss) earnings from operations | | $ | (1,020) | | | $ | (355) | | | $ | 201 | | | $ | (1,174) | |
_____________________________
(1)Asset transition fee reflects the settlement received from the close out of an engine transition program.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, 2022 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Revenue: | | | | | | | | |
| Lease rent revenue | | $ | 74,829 | | | $ | — | | | $ | — | | | $ | 74,829 | |
| Maintenance reserve revenue | | 39,079 | | | — | | | — | | | 39,079 | |
| Spare parts and equipment sales | | 251 | | | 13,171 | | | — | | | 13,422 | |
| Gain on sale of leased equipment | | 2,796 | | | — | | | — | | | 2,796 | |
| Gain on sale of financial assets | | 3,116 | | | — | | | — | | | 3,116 | |
| Other revenue | | 13,503 | | | 234 | | | (87) | | | 13,650 | |
| Total revenue | | 133,574 | | | 13,405 | | | (87) | | | 146,892 | |
| | | | | | | | |
| Expenses: | | | | | | | | |
| Depreciation and amortization expense | | 43,367 | | | 54 | | | — | | | 43,421 | |
| Cost of spare parts and equipment sales | | 10 | | | 11,866 | | | — | | | 11,876 | |
| Write-down of equipment | | 21,195 | | | — | | | — | | | 21,195 | |
| General and administrative | | 42,387 | | | 1,645 | | | — | | | 44,032 | |
| Technical expense | | 9,082 | | | — | | | — | | | 9,082 | |
| Net finance costs: | | | | | | | | |
| Interest expense | | 32,906 | | | — | | | — | | | 32,906 | |
| | | | | | | | |
| Total finance costs | | 32,906 | | | — | | | — | | | 32,906 | |
| Total expenses | | 148,947 | | | 13,565 | | | — | | | 162,512 | |
| Loss from operations | | $ | (15,373) | | | $ | (160) | | | $ | (87) | | | $ | (15,620) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, 2021 | | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Revenue: | | | | | | | | |
| Lease rent revenue | | $ | 63,951 | | | $ | — | | | $ | — | | | $ | 63,951 | |
| Maintenance reserve revenue | | 37,090 | | | — | | | — | | | 37,090 | |
| Spare parts and equipment sales | | 169 | | | 7,966 | | | — | | | 8,135 | |
| Asset transition fee (1) | | 6,256 | | | — | | | — | | | 6,256 | |
| Other revenue | | 12,122 | | | 97 | | | (54) | | | 12,165 | |
| Total revenue | | 119,588 | | | 8,063 | | | (54) | | | 127,597 | |
| | | | | | | | |
| Expenses: | | | | | | | | |
| Depreciation and amortization expense | | 47,423 | | | 58 | | | — | | | 47,481 | |
| Cost of spare parts and equipment sales | | 8 | | | 7,093 | | | (14) | | | 7,087 | |
| Write-down of equipment | | 4,113 | | | — | | | — | | | 4,113 | |
| General and administrative | | 34,700 | | | 950 | | | — | | | 35,650 | |
| Technical expense | | 3,606 | | | — | | | — | | | 3,606 | |
| Net finance costs: | | | | | | | | |
| Interest expense | | 32,006 | | | — | | | — | | | 32,006 | |
| Total finance costs | | 32,006 | | | — | | | — | | | 32,006 | |
| Total expenses | | 121,856 | | | 8,101 | | | (14) | | | 129,943 | |
| Loss from operations | | $ | (2,268) | | | $ | (38) | | | $ | (40) | | | $ | (2,346) | |
_____________________________
(1)Asset transition fee reflects the settlement received from the close out of an engine transition program.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Leasing and
Related Operations | | Spare Parts Sales | | Eliminations | | Total |
| Total assets as of June 30, 2022 | | $ | 2,345,586 | | | $ | 50,797 | | | $ | — | | | $ | 2,396,383 | |
| Total assets as of December 31, 2021 | | $ | 2,415,635 | | | $ | 47,292 | | | $ | — | | | $ | 2,462,927 | |
13. Related Party Transactions
Joint Ventures
“Other revenue” on the Condensed Consolidated Statements of Income includes management fees earned of $0.5 million and $0.4 million during the three months ended June 30, 2022 and 2021, respectively, and $1.0 million and $0.7 million during the six months ended June 30, 2022 and 2021, respectively, related to the servicing of engines for the WMES lease portfolio.
14. Subsequent Event
In July 2022, Scandinavian Airlines System ("SAS") announced that it had filed for relief under Chapter 11 of the U.S. Bankruptcy Code. The impact to the Company for the three and six months ended June 30, 2022 was de minimis. The full impact of the SAS bankruptcy on the Company's financial condition, results of operations and cash flows is not determinable as of the date of these financial statements.