Willis Lease Finance - Q2 2024

Transcript

Operator (participant)

Good day, and welcome to the Willis Lease Finance Corporation Q2 2024 earnings call. Today's conference is being recorded. We would like to remind you that during this conference call, management will be making forward-looking statements, including statements regarding our expectations related to financial guidance, outlook for the company, and our expected investment and growth initiatives. Please note, these forward-looking statements are based on current expectations and assumptions, which are subject to risks and uncertainties. These statements reflect WLFC's views only as of today. They should not be relied upon as representative of views as of any subsequent date, and WLFC undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations.

For further discussion of the material risks and other important factors that would affect WLFC's financial results, please refer to its filings with the SEC, including, without limitation, WLFC's most recent quarterly report on Form 10-Q, annual report on Form 10-K, and other periodic reports, which are available on the Investor Relations section of WLFC's website at www.wlfc.global/investorrelations. At this time, I would like to turn the conference over to Austin Willis. Please go ahead.

Austin Willis (CEO)

Thank you, Ruth. Here with me today is Brian Hole, our President, and Scott Flaherty, our CFO. Firstly, I'd like to thank our employees for another great quarter. They're all working incredibly hard to deliver our results. Next, I'd like to recognize this as our first quarterly earnings call in recent history. We are engaging with the investor community to tell our story, and as you'll see from our earnings, it's a good story. Our services enhanced leasing strategy, coupled with favorable market dynamics, is resulting in exceptional performance. We began this year strong, with our first quarter pre-tax earnings, or EBT, of $29.9 million, representing the best quarter we've had to that point. Our second quarter EBT was $57.9 million, nearly double that of Q1.

Approximately $14 million of the Q2 earnings were the result of gain on sale, allowing us to recycle capital into new assets, such as the purchase of 10 engines consisting of GTF, LEAP, and GEnx. While we remain bullish on the long-term prospects of the current technology engines, such as the CFM56-5B, CFM56-7B, and V2500, we are taking the opportunity to modernize the portfolio as we have done in the past. I mentioned the gain on sale because I think we need to be thoughtful about annualizing total EBT amounts for the first half, when perhaps more focus should be placed on the core run rate. Our exceptional performance is the result of many factors, some macro and some resulting from decisions we have made in the past regarding our portfolio composition and augmenting our leasing business with services.

The supply chain issues in aviation, and more specifically among engines, have resulted in unprecedented demand. Both CFMI and Pratt & Whitney have been and continue to have teething issues with their newest technology engines, primarily the LEAPs and the Geared Turbofans that power the A320neo and MAX families of aircraft. The teething issues have resulted in engines requiring off-wing maintenance more frequently, which is met with capacity limitations at the maintenance or MRO facilities. At the same time, the OEMs are struggling to produce and repair enough parts to service the new engines they are producing, as well as the current technology engines such as the 7B, 5B, and V2500. This, in turn, is causing further delays in MROs trying to overhaul engines. To compound this, both Airbus and Boeing are pushing the engine OEMs to meet their delivery commitments.

Ultimately, this has caused an incredible strain on the supply chain and has resulted in a need to lease in spare engines to keep airplanes flying that would otherwise likely be grounded. As an owner of assets, the supply and demand imbalance has worked to our favor. Lease rates have risen considerably, allowing us to keep up with incremental costs due to inflation and interest rates. This paradigm has also allowed us to be more selective regarding the credit quality of our counterparties. The investments we have made in our services businesses over the past decade have proven fruitful. All of these service businesses allow us to have greater control over the life cycle of the assets we own and manage, through parts, maintenance, and planning. And this has provided us with a competitive advantage through the supply chain-constrained marketplace.

We have a business that provides used serviceable engine parts, making us less reliant on the OEMs. We have two engine repair shops, one in the U.K. and one in the U.S., making us less reliant upon external MROs. We have a consulting business that accurately forecasts engine maintenance events, allowing us to effectively plan ahead. And we have an airframe-based maintenance facility in the U.K. that allows us to tear down aircraft when they come back off lease, as well as perform C checks to bridge from one lessee to the next. We have created a platform that can provide airlines liquidity, assets, and reduced maintenance expense. This offering, when combined with the current market dynamic, has proven to be very attractive to customers.

I feel that our model will continue to maintain our position as the world's premier engine lessor for the foreseeable future, even as the supply chain normalizes over time. Finally, I'd like to mention that we paid a one-time dividend of $1 per share on our common stock on June seventh, and the Board has approved a recurring dividend policy. We are pleased with the performance of the company, and we wanted to take the opportunity to return capital to our shareholders while supporting growth and leverage targets. With that, I'd like to hand it over to Scott Flaherty, our CFO.

Scott Flaherty (CFO)

Thank you, Austin, and good afternoon all. As you can see from our P&L, the company produced record earnings before tax, or EBT, in the second quarter of $57.9 million. This performance was up $38.9 million, or 205%, from the comparable quarter in 2023, and up $28 million, or 94% sequentially from Q1 2024, which also happened to be a record quarter for the company. First half 2024 EBT of $87.8 million is close to our full-year record profitability achieved in 2019. Walking through the P&L, revenues for the quarter were $151.1 million.

Significant total revenue drivers were core lease rent revenues of $55.9 million, primarily reflecting the increased total portfolio size of $2.47 billion at quarter end, as the company purchased equipment, including capitalized costs totaling $258.8 million in the quarter, only slightly offset by $65.3 million of equipment sales. Maintenance revenues for the quarter were $62.9 million, up $27.5 million or 78% from the comparable quarter in 2023.

As you parse through these revenues, you can see that $17 million were long-term maintenance reserves associated with engines coming off lease and the associated release of any maintenance reserve liabilities, and $45.9 million of these reserves were short-term maintenance reserves, which are highly correlated to the amount of time our portfolio is flying, as we generally get paid an hourly and cyclic rate on our lease assets. These short-term maintenance revenues were up $17.3 million, or 60%, when compared to the same period in 2023. Spare parts and equipment sales, $6.2 million in the quarter, produced 12% gross margins, while also providing a valuable outlet to recognize residual values on our engine portfolio and provide feedstock for our and our customers' fleet in a tight parts market.

Gain on sale of lease equipment, a net revenue metric, was $14.4 million in the quarter. As mentioned above, this was associated with $65.3 million of gross equipment sales and compared to $4.5 million of gain in the comparable period of 2023. During the quarter, the company sold numerous engines and airframes to various trading partners. Maintenance services, which represents fleet management, engine and aircraft storage, and repair service and revenues related to management of fixed base operator services, was $6.8 million in the quarter, up 16% from the comparable period in 2023. The company produced 16% gross margins on these sales, while also generating significant business opportunities for our core leasing business, enabling us to become more relevant to our customers by being able to offer a broader bundled product solution.

On the expense side of the equation, depreciation remained relatively flat at $22 million. The company had no impairments in the quarter, as we have seen continued strength and appreciation in asset values. G&A was up $3 million from the prior comparable period, mainly driven by increased personnel costs as we grow our services footprint, as well as increases in incentive compensation, which is correlated to the profitability of the overall business. Despite this increase, G&A declined over 6 points as a percentage of total revenue relative to the prior period as we leveraged the platform and gained benefits from scale. Technical expense, which generally consists of non-capitalized engine repair costs, engine thrust rental fees, and other related costs, was $4.5 million in the quarter, down $2.2 million from the comparable period.

These expenses tend to vary with the timing of shop visits associated with off-lease engines. Net finance costs were $24.6 million for the quarter, compared to $19.1 million in Q2 2023. The increase in costs were related to an increase in indebtedness as total debt obligations increased from $1.8 billion in Q2 2023 to $1.9 billion in Q2 2024, as well as an increase in the weighted average cost of debt, which, inclusive of our interest rate hedge positions, was 4.93% at 06/30/2024, compared to 4.08% at 06/30/2023.

The company also picked up $3.8 million in ratable earnings from our 50% ownership interest in our Willis Mitsui and CASC Willis joint ventures. As I mentioned earlier, EBT was $57.9 million for the quarter, and the company produced $41.7 million of net income attributable to common shareholders, factoring GAAP taxes and the cost of our preferred equity. Diluted weighted average income per share was $6.21 for the quarter, up 207% from the comparable period in 2023.

Cash flows from operations for the first half of the year were up 32% to $129.7 million, driven primarily by the growth in pretax earnings, as the business enjoyed significant tax depreciation shield, slightly offset by growth in spare parts inventory, as the company opportunistically purchased an attractive portfolio of engine parts earlier in the year. On the financing side of the equation, in early May, the company closed a $500 million non-recourse warehouse facility with a small group of banks, where alongside our $500 million credit facility, we will aggregate asset portfolios to be subsequently refinanced in the term market. We continually look to diversify our sources of funding and minimize our overall cost of capital and have been successful accessing numerous markets over the years.

In the second quarter, our Board of Directors declared a one-time special dividend of $1 per share, which was paid to record holders in early June. With our Q2 earnings release, we announced a $0.25 per share regular quarterly dividend, which speaks to the health of the business, provides our shareholders with a moderate current cash yield on their investment, while not degrading the strong cash flow and equity growth characteristics of the business. With respect to leverage, the company has brought balance sheet leverage, defined as total debt obligations to equity, inclusive of our preferred stock, to 3.59x at Q2 2024, compared to 3.91x in the comparable period of 2023. When factoring net debt, leverage is at 3.3x.

At times, we maintain higher levels of restricted cash as we retain and reinvest ABS asset sale proceeds, which are held as restricted cash into new assets. This allows the company to benefit from attractive fixed rate debt pricing for a longer period of time, while maintaining a lower cost of capital for the business. We target leverage in the mid-3s, recognizing that leverage may, at times, slightly tick higher should we identify purchase opportunities that enhance the characteristics of the overall portfolio. With that, I will now open the call up to questions. And, operator, if you could please provide instructions on how participants can ask questions, that would be great. Thank you.

Operator (participant)

Yes, sir. Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. If you would like to ask a question on the web, type your question in the ask a question box and press send. Again, please press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll go first to Adam Seessel with Gravity Capital.

Adam Seessel (Founder and Managing Member)

Yes, hi. Thanks for taking the question, and thanks more generally, Austin, and for doing this call. I hope to learn a lot. I would hope, just by way of overview or introduction, you could contrast and compare your business with Fortress. They're quite public about what they do, of course, and have regular slide decks and so forth. We don't know much about you in contrast, so I was hoping you could just sort of as a business model, a business plan, compare and contrast the two publicly traded engine leasing companies for us.

Austin Willis (CEO)

Sure. Thank you for your question, Adam. So I'll, I'll refrain from really speaking to, to Fortress, but I will tell you a bit about ourselves. So we are, we're about 50% short term and 50% long term in the leasing market. And I mention that because the short-term nature of our business allows us to get to get very active in the programmatic side of the, the business. So that's when we, we do programs like ConstantThrust, where we'll do a sale leaseback on a portfolio of aircraft or engines, and when one of those engines becomes unserviceable, we'll exchange it for another one of our engines that we have in our portfolio.

It's really that short-term leasing capability that gives us the confidence that we'll have availability of assets at any given time to be able to fill that demand. So I mentioned that particular product because it really draws on different elements of our business. So our two 145 repair stations, they enable us to repair engines more quickly and get them out on lease to the customers, and they also draw from materials from our parts business, WASI. And that business buys engines or gets engines from our portfolio, disassembles them and sells the pieces. So between those two, we're able to get engines out the door much faster than we typically would from a third-party MRO, and more inexpensively, because we're reusing materials that are coming either from our engines or third-party engines.

And then we also draw from expertise from our consulting business, WAML, that does pretty accurate forecasting to tell you when engines will become unserviceable. So really, we're a combination of a handful of services businesses and a leasing company that enable us to provide really an enhanced leasing product to the customer, where we can save them money on maintenance as well as from a planning perspective.

Adam Seessel (Founder and Managing Member)

I see. That's helpful. If I could follow up, you know, they always talk about, Fortress does, about their MRO business and how they have a better mousetrap that saves customers time and money. And I've just, you know, I don't know much about the engine leasing business or the MRO business. Are you effectively saying the same, that you have the same mousetrap?

Austin Willis (CEO)

Again, I don't really want to comment to them specifically. I think there probably are similarities. You know, we focus on the maintenance element because that's the biggest driver of expense, and we have done for years. You know, we've been providing these products for about over 10 years now. So this is nothing new or novel for us.

Adam Seessel (Founder and Managing Member)

Thanks so much.

Austin Willis (CEO)

Certainly.

Operator (participant)

As a reminder, if you would like to ask a question, that is star one, or ask a question in the ask the question box over the web. We'll go to our next caller, Will Waller with M3F.

Will Waller (Portfolio Manager)

Hey, Air Lease, in their presentation and press release yesterday, said they have a lot of value in their order book, given all the backlogs with the manufacturing of engines and aircraft and so on. You guys have quite a large order book, and it seems like you've put in orders at pretty ideal times over the last four years or so. I was just wondering if you could kind of comment on the status of your order book and if you feel the same way.

Austin Willis (CEO)

Yeah. I think there's, there's similarities to comparing our order books to the, the aircraft lessors, but there's, there's certainly differences as well. You know, we work a bit more closely with the OEMs to to provide aftermarket service to their customers. We do have a strong order book, and we've taken delivery of a number of engines this year, and we're on course to to take delivery of an additional amount, and the same thing over the next few years. So that, that constitutes a decent proportion of our pipeline going forward, but we also solicit a lot of transactions from the marketplace as well.

Will Waller (Portfolio Manager)

Okay, great. And then if I could just ask one other question, and it might have been partially answered in that first question, but there's been a lot of, it seems like a trend towards the use of modules to save time and money with engine overhauls. Could you kind of talk about your views on the use of modules, in an engine overhauls, and then kind of talk to if that's a product that you're offering?

Austin Willis (CEO)

Sure. So we will do module swaps from time to time. We've done, I think, 20 in this past year, but that really isn't a core focus for us. You know, we look at a variety of different avenues to manage maintenance costs most effectively. You know, the reality is, it's very hard to get high pressure turbine HPT modules, and, you know, that's gonna continue for the foreseeable future. So each engine's different. In some cases, it makes sense to do module swaps, in some cases, it doesn't.

Will Waller (Portfolio Manager)

Great. Thanks a lot.

Austin Willis (CEO)

You bet.

Operator (participant)

We will take a follow-up question from Adam Seessel with Gravity Capital.

Adam Seessel (Founder and Managing Member)

Yeah, thanks. I understand you don't want to compare and contrast with Fortress, but one thing that struck me when I spoke with both companies is, they have not bought any of the next-gen engines. They have not bought any LEAP and not bought any GTF, where you guys have quite a bit of both. What's your rationale for buying the new engines, especially when the GTF is essentially, the service on the 1100 on the narrow body?

Austin Willis (CEO)

Thanks, Adam. So for us, it's a natural progression for just modernizing our portfolio. If you look back historically, you know, 10, 20 years ago, you'd see that the majority of our portfolio was CFM56-3 and JT8 engines. So this is normal course for us. You know, we feel that the GTF and the LEAP-1A and LEAP-1B will be the engines that drive the future of aviation for the 737 MAX and the A320neo. So, you know, that's the long-term view. In the short term, a lot of the maintenance issues or teething issues that have plagued those engines, really are causing demand events for us. So every time an engine is removed, it creates an opportunity to put another engine on lease. So we see it as both a, a good short-term and a good long-term investment.

Operator (participant)

We'll go next to Andrew Del Medico with Phase 2 Partners.

Andrew Del Medico (Partner and Portfolio Manager)

Hey, guys. Thanks for taking the time. Just on, on the gain on sales, you mentioned the positive operating backdrop that you're experiencing. Can you just talk to kind of the sustainability that you see on the gain and sale of the engines, how you guys are thinking about the, you know, the value of the portfolio as, as some of these come off lease, and, kind of what you're looking at in the operating environment that's leading to, leading to this, this positive backdrop? Thanks.

Austin Willis (CEO)

Sure. Thanks, Andrew. We did an investor information call recently, and I think there was some publications that covered this as well. You know, our portfolio is fairly undervalued from a book value relative to market value basis, and I think we're seeing that reflected in the gain on sale. You know, gain on sale for assets right now is probably a bit higher than it has been historically. But we generally have a run rate in the sort of mid-low teens for gain on sale. And once things normalize, at some point, I expect it to be back in that neighborhood.

Andrew Del Medico (Partner and Portfolio Manager)

Great, thanks. I guess also on the, as a follow-up on some of the assets that have been tied up in Russia, and obviously there's a lot of litigation, et cetera, going on around that. Do you have any color that you could give us on kind of when you would expect some ruling or some type of recovery, whatever potential there might be on those?

Austin Willis (CEO)

I wish I could. No, we're pursuing our rights to the extent that we can. I really can't get into too much detail because we're very much in discussion with the insurance companies. What I can say is we were very proactive early on in the war between Russia and Ukraine, and we were able to get some assets out. And frankly, we've been very fortunate in the low value of assets that we had confiscated in Russia relative to a lot of competitors. We do still feel strongly that we will recover that value, but that's just a matter of when.

Andrew Del Medico (Partner and Portfolio Manager)

Great, thanks. Then just as a reminder, could you how much do you have tied up? And like I said, if you were to recover those, how big of a gain would that be for the portfolio?

Austin Willis (CEO)

I won't comment on that now, but if you look back at our previous disclosures, I think you can find that historically.

Andrew Del Medico (Partner and Portfolio Manager)

Okay, perfect. Thank you.

Austin Willis (CEO)

Thanks.

Operator (participant)

There are no other questions over the phone lines.

Scott Flaherty (CFO)

Yeah, operator, I think we'll switch to a couple questions that we have. We have one question here from MUFG, and the question is congratulating us, thank you, on the quarter. And the question: How do we see the rest of the year in the context of some of the signs of overcapacity in the U.S. domestic or the European market, and what are the potential risk factors you see for the second half of the year?

Austin Willis (CEO)

Thanks, Scott. I'll take this initially, if I can. So you know, obviously, we've read the same headlines that you guys have read with regard to the overcapacity issues. I really can't opine on what trends that may or may not mean. I think part of it is due to the U.S. and Europe emerging more quickly than Asia-Pac and other countries from the pandemic. But more importantly, I'd like to focus on, you know, what we have seen in the past when there are difficulties among the airlines and their, you know, their cash straps, they tend to avoid overhauling engines. So when they have an engine become unserviceable, they'll remove it from wing, park it, and lease in engines from us. And this is reflected in our earnings post 9/11, post-economic crisis.

There is an element of countercyclicality in our business, so I think it's worth noting that. And then was there a second part to that question, Scott?

Scott Flaherty (CFO)

No, I think that's the... I think that was the key question, Austin, there. Austin, the next question we have is within your maintenance reserve, and this question comes again from Phase 2 Partners. Within your maintenance reserve revenue, how sustainable is the long-term portion of it? I realize as it relates to when leases come off lease, but any additional color would be appreciated. So...

Austin Willis (CEO)

Sure. So the long-term element of maintenance reserves occur when we have an engine come off of long-term lease, and by their nature, they tend to be lumpy. When we have a lot of engines extending, as is the case now and what we expect in the near future, I would expect it to be a bit lower. Now, that being said, I do recognize we had significant long-term maintenance reserve recognition in the quarter, and that was due to a few circumstances that were somewhat outside of the normal. Scott, if you'd like to add any color to that, please, please do so.

Scott Flaherty (CFO)

Yeah. No, no, Austin, I think you, you've got that right. I agree with that. I think the last question that we have is coming from M3, Jason Stock over at M3. The company's historically done an excellent job repurchasing shares in the past via both open market, private transactions, and tender offers. With how inexpensive your shares still trade on both book value and now earnings, what are your views on repurchases going forward?

Austin Willis (CEO)

Well, I appreciate your view on us being inexpensive. Beyond that, I can't really speak to any specific strategy on repurchasing shares in the foreseeable future.

Scott Flaherty (CFO)

Yeah, I guess I would, I would add, fortunately, the shares are not as inexpensive, as they were some time ago. Operator, I think that was, I think that was the last question, that we had, that we had in the queue. So we want to, you know, thank everybody for, for joining the call and, and we look forward to speaking to everybody, in the next quarter. So thanks for your time.

Austin Willis (CEO)

Thank you, everybody. I appreciate you, joining us today.

Operator (participant)

This does conclude today's conference call. Thank you for your participation. You may now disconnect.