Fly Leasing Limited
Q3 2019 Earnings Call Transcript

Published: 9 Nov 2019

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the FLY Leasing Third Quarter Earnings Conference Call. At this time, all participant lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]I'd now like to hand the conference over to your speaker today Mr. Matt Dallas. You may begin, sir.

[Matt Dallas:]

Thank you and good morning. I'm Matt Dallas, the Investor Relations at FLY Leasing, and I'd like to welcome everyone to our Third Quarter 2019 Earnings Conference Call.FLY Leasing issued its third quarter earnings results press release earlier today, which is posted on the Company's website at flyleasing.com. We have a slide presentation that accompanies today's call which is available to participants on the webcast. If you are not accessing the webcast, you can find a copy of today's presentation in the Investor Relations section of our website on the Events and Presentations page.Representing the Company today on this call will be Colm Barrington, our Chief Executive Officer; Julie Ruehl, our Chief Financial Officer; and Steve Zissis, the President and CEO of BBAM, the Company that manages and services FLY's fleet.This conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, statements regarding the outlook for the Company's future business and financial performance. Forward-looking statements are based on the current expectation and assumptions of FLY's management, which are subject to uncertainties, risks, and changes in circumstances that are difficult to predict.Actual outcomes and results may differ materially due to factors that are summarized in the earnings press release and are described more fully in the Company's filings with the SEC. Please refer to these sources for additional information. An archived webcast of this call will be available for one year on the Company's website.And with that, I'd like to now hand the call over to Colm Barrington, the CEO of FLY Leasing. Colm.

[Colm Barrington:]

Thank you, Matt, and welcome, everyone. I'm happy to say that FLY is again reporting excellent results for the third consecutive quarter this year. We can ascribe this success to the development of the strategy that we put in place over the last few years and which has been executed expertly by BBAM and supported by continuing strong industry conditions.The fundamentals of our industry remain positive, supported primarily by continuing strong growth in global air passenger traffic. The International Air Transport Association continues to report positive growth numbers each month, including 3.8% growth in September and is predicting air traffic growth of 5% for 2019.Meanwhile, passenger load factors in IATA airlines, which is a very important metric for the aircraft leasing industry, which shows the supply-demand relationship for aircraft, continues at record highs, including an all-time high of 85.7% in August. IATA continues to protect worldwide airline profits of $28 billion for 2019 despite some pressure on yields and on the profitability in some carriers. Buoyant air traffic and prosperous airlines each support a strong aircraft leasing industry.The recent bankruptcy of the Thomas Cook group received a great deal of media publicity due mainly to the number of holidaymakers that had to be repatriated. However, Thomas Cook's demise and the recent demise of some other very minor airlines had a very -- has had very little impact on the aircraft leasing sector as the number of aircrafts involved is negligible in relation to the total leased portfolio.Strong demand for aircraft has ensured that the aircraft previously leased to Thomas Cook have been picked up rapidly. Thomas Cook's demise is primarily due to structural changes in the European travel industry that are seeing more and more passengers moving away from traditional tour operations towards the expanding low-fare airlines such as EasyJet, Ryanair and Wizz. It is interesting that it was Ryanair that was reported to be actively pursuing the aircraft returned from Thomas Cook, so that Ryanair could use them in its Lauda subsidiary.FLY had a single aircraft leased to the Thomas Cook group. This aircraft is still on lease to a German airline subsidiary of the group that continues to operate, which has been supported by a large working capital loan from the German government agency. FLY has also re-leased all three aircraft that were returned following Jet Airways bankruptcy earlier this year.Overall and for the reasons I just stated, we continue to see strong demand for leased aircraft from airlines in most of the world's regions. We are also seeing continued strong demand for sales of aircraft from our fleet. FLY has been availing of these strong market conditions. And in the nine months through September 30, FLY has sold a total of 25 aircraft at an aggregate 13% premium to our book value. In addition, FLY has 16 more aircraft contracted for sale, of which nine are expected to close in quarter four and the remaining seven are expected to close in the first quarter of 2020.These continuing sales, which now total more than 100 aircraft for the last four years and all have been a significant premium to book value, show the FLY's ability to trade aircraft at significant gains continues and is not limited to any one time period. It also demonstrates, one, the value in FLY's balance sheet; and two, that BBAM, our manager, continues to add significant value to FLY.The scale, experience and context that our manager, BBAM, provides are major assets to the company. The BBAM platform provides FLY the distinct scale advantage in buying, leasing and selling aircraft. This was particularly evident last year when BBAM's relationships allowed us to partner with other BBAM clients and completing our large portfolio acquisition, an acquisitions that was probably too big for any of our single competitor and continues today as we partner with other BBAM clients acquiring aircraft and then selling them into ABS transactions.BBAM's global network of long-term positive relationships with airlines, investors and lenders, a significant asset to assist FLY in leasing, acquiring and financing our fleet. And BBAM's development of the Horizon ABS structures, now totaling 3, has provided another avenue for the sale of FLY's aircraft.And FLY and BBAM continue to have a strong alignment of interests due to the more than 17% ownership of FLY's stock by BBAM's shareholders.Before moving on to FLY's third quarter results, I'd like to comment on two situations regarding Boeing 737 models. Regarding the 737 MAX, there's still uncertainty about its recertification. You'll note that several airlines have announced that they are not putting the MAX back into their schedules until the first quarter of 2020.However, this uncertainty has had little impact on FLY as we have only two MAX aircraft in our fleet, both of which we acquired under purchase and leaseback transactions, and both of which are long-term leases that remain current. We do not have any MAX's on order.Meanwhile, uncertainty regarding the MAX continues to give support demand and lease rates for other Boeing 737 models and A320 family aircraft, which comprise the core and majority of FLY's fleet.There have also been issues reported regarding cracks in the structures that bind the wings with the fuselage of older 737 next-generation aircraft. These issues have required immediate inspection of aircraft that have accumulated 30,000 or more flight cycles. And inspection within the 1,000 flight cycles for aircraft that have accumulated 22,600 or more cycles.Of the 39 Boeing 737 next-generation aircraft in FLY's fleet, only two aircraft have accumulated over 30,000 cycles, requiring this immediate inspection. Both aircraft have been inspected and neither have any signs of cracks. Other aircraft in our portfolio will be inspected as they approach the mandated flight cycle level.FLY continue to maintain a consistent strategy based on four main principles

[Julie Ruehl:]

Thank you, Colm. FLY is reporting net income of $51.7 million for the third quarter of 2019, a $31 million increase from Q3 2018.FLY achieved ROE of 26.6%, the sixth consecutive quarter of double-digit ROE and more than 100% increase from the year ago quarter.Earnings per share increased nearly 150% from $0.68 a year ago to $1.67 in the current quarter. These strong financial results were fueled by significant gains from aircraft sales as we continue to take advantage of a widely secondary market to self-select aircraft.In Q3, FLY completed a sale of eight aircraft, including seven aircraft in the 12 aircraft portfolio sale announced in early July. As a result of FLY's superb financial results over the past several quarters and the rapid deleveraging enabled by selling aircraft at significant gains to book value, our net debt-to-equity ratio has declined from 4x at the beginning of the year to 2.6x at September 30, as Colm mentioned.FLY's operating lease rental revenue in Q3 2019 decreased 2.8% to $96.1 million, driven by the aircraft sales we have discussed on the call. Although operating lease rental revenue declined, we believe that our aircraft sales strategy has improved the quality of earnings as demonstrated by FLY's increased net spreads.Total revenue increased 33% to $139 million in Q3 2019 from $104.6 million in Q3 2018. In Q3 2019, FLY recognized no end of lease income as compared to $3.1 million in the prior year period. FLY recognized $38.9 million of gains on sale of aircraft in Q3 '19 from the sale of eight aircraft, which represents a 17% premium to net book value, as Colm mentioned.Turning to expenses. Depreciation and interest expense are down as compared to the prior year quarter due to aircraft sales. Although on a combined basis, these expenses declined by 8.9%, a larger decline than operating lease rental revenue at less than 3%.SG&A expense was up slightly in Q3 as compared to a year ago, primarily due to lease-related costs, a portion of which had previously been deferred and amortized and are now expensed under the new lease accounting standard.Loss on derivatives in Q3 2019 relates primarily to interest rate swaps that no longer qualify for hedge accounting due to debt prepayments associated with aircraft sales.Also, in Q3 2019, FLY incurred a $1.6 million loss on debt extinguishment, consisting almost entirely of noncash write-offs of debt costs. The debt extinguishment costs incurred were also related to debt repayments due to aircraft sales.Overall, total expenses as a percentage of total revenues declined 25% year-over-year from 77% to 58%.Now I'd like to cover our guidance for Q4 2019. Our gain on sale of aircraft guidance assumes that nine aircraft sales will close in Q4, as Colm mentioned. Several of these sales are expected to be part of, including our two A340s, which we expect to be disposed off at an economic gain. As Colm also noted, seven additional contracted aircraft sales are expected to close in Q1 2020.For the fourth quarter of 2019, we are expecting operating lease rental revenue of $88 million to $90 million. We expect amortization of lease incentives of $1 million to $2 million. Gain on sale of aircraft is expected to be $14 million to $15 million. We expect end of lease income of more than $30 million.Depreciation expense will be approximately $32 million to $33 million. We expect interest expense of $30 million to $31 million.Debt extinguishment costs are expected to be approximately $2 million. Maintenance and other costs are expected to be $1 million to $2 million. We expect SG&A expense of approximately $9 million without consideration of any foreign exchange gains or losses that may occur.Overall, Q4 pretax income is expected to be more than $60 million. A further leverage reduction is expected by the end of the year, at which time they're expecting net debt-to-equity of approximately 2.5x. And in our near-term outlook, we expect net debt-to-equity to remain below 3x. Our improved leverage profile coupled with a recent credit rating upgrade has positioned FLY well as we think about refinancing opportunities for a long-dated debt facility as well as financing new acquisitions.I'll turn it back to Colm now for his closing remarks.

[Colm Barrington:]

Thank you, Julie. Okay. Well, let's recap the highlights of quarter three 2019. We achieved 33% growth in total revenue to $139 million. We sold eight aircraft for a gain of $38.9 million, 17% above our book value. We produced $59.8 million of adjusted net income, $1.93 of adjusted earnings per share and 31% adjusted ROE.We continued our track record of growing book value, which was $25.85 per share at quarter end. That is 24% higher than a year ago. Then looking ahead, we have a contracted pipeline of aircraft valued at $1.3 billion, including 21 of the latest-generation Airbusneo aircraft. We expect to add to this pipeline through four further acquisitions.And finally, we've given pretax income guidance of over $60 million for the December quarter. These outcomes are all highly positive and demonstrate that FLY continues to represent a real value proposition.And with that, we are now ready to take your questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Helane Becker from Cowen.

[Helane Becker:]

So Colm, I have two questions. One question is with respect to the aircraft -- the two A340s that you're -- I guess, you're what parting out. Are you going to just sell the aircraft to a part out group or are you going to part it out and then sell the parts to yourself?

[Colm Barrington:]

We are selling them to a third party, Helane, and it's -- they -- I'm not actually quite sure what they are doing with the aircraft. I understand their part any much. We're not part out experts ourselves.

[Helane Becker:]

Right. Got you. Okay. That totally makes sense. And then the other question I have is, I was in Hong Kong earlier this week at one of the conferences. And one of the things that people talked about, including myself, was the whole idea of ESG and how there's flight shaming and then government got involved yesterday. And I feel like if there's no -- if the industry doesn't take this on, obviously, the governments are going to do it for us, and we probably won't like it, which is my opinion.But my question, sorry, is as you think about your fleet and the sale leasebacks that you do and the way you're growing, is it a focus on just new technology? Will you just try to sell all the old technology aircraft? How are you thinking about that, one? And two, are your customers also coming to you with the idea that they've got to spruce up their fleet and get out of the old technology aircraft on a more timely basis? So sorry for that long winded.

[Colm Barrington:]

It's obviously a big issue, and it's certainly affecting airlines. And people are concerned about higher taxes on fuel, et cetera, et cetera. So airlines are very focused on this. And if they're focused, then we need to be focused also. And we are. But as you can see, we are moving on a lot of our midlife to older aircraft. And you mentioned the A340s, in particular. Those two aircraft are gas guzzlers, and that's why they have the -- they are being retired generally around the world. So we are moving with airlines from older technology to newer technology aircraft, and we will continue to do that. And -- because that's where the world is going.

[Operator:]

Your next question comes from the line of Catherine O'Brien from Goldman Sachs.

[Catherine O'Brien:]

So you know that you'll be acquiring six aircraft in the fourth quarter. Can you tell us where you're sourcing those from? And then any updates on where you're finding the most attractive acquisition opportunities for incremental aircraft on top of the areas you want?

[Steve Zissis:]

Well, Catherine, it's Steve. Well, we can't tell you exactly where we're sourcing them from. But generally, it's in the general marketplace. It is harder and harder to find deals, so we pretty much have to run, what you call, the seams of the market to find deals that work for us. We have originated a few deals with start-up airlines in Asia, which we thought were attractive deals. So in general, things are not as easy as we were expecting it, but we're still able to originate stuff as we go along.

[Catherine O'Brien:]

That's great. And I didn't mean by name, just maybe sale leaseback from other lessors, just like what general pool is yielding the best deals right now?

[Steve Zissis:]

Yes. It's a combination of both sale leasebacks and purchasing what we'd call secondary aircraft from passive lessors.

[Catherine O'Brien:]

Okay. Understood. And then just maybe -- I think in the guidance you have been expecting about $50 million plus in gains on sales in the quarter and ended up coming in a little bit shy of that. Is that just a matter of timing of transaction closes? Or some of those deals are not materializing? Any help there would be great.

[Julie Ruehl:]

This is Julie. And it is solely due to timing. We had expected a few more sales to close in the quarter, and those couple that didn't close in the quarter have since closed in October. So it's strictly timing.

[Operator:]

Your next question comes from the line of Scott Valentin from Compass Point.

[Scott Valentin:]

Just with regard to leverage, I mean, it's down to 2.6x now. I guess, you guys point to to 2.5x leverage ratio by year-end. Is that a function of just -- Steve, you mentioned the opportunities are challenging out there. Is that a function of just the lack of opportunities or is that related to S&P upgrade? Are you looking for additional upgrades, and that's what's kind of limiting the leverage?

[Colm Barrington:]

Scott, we've been running the business rather than focusing on getting upgrades specifically. But hopefully, we've been running the business the way that has also implied upgrades. Basically, we -- as you know, when we acquired the big portfolio from the AirAsia transaction, we said at the time that we needed to deleverage from the 4x that we are at, at the beginning of the year. And we were going to do that through various ways, but including selling some aircraft during the course of this year.We've now sold, I think, 25 aircraft in the course of the year-to-date. And that has obviously contributed significantly to our equity. As you've seen, our equity has gone up very significantly in the year by 24%. There's -- obviously, we paid down some debt as part of those transactions as well. So a combination of paying down debt, increasing equity. And we've now gotten ourselves into a very low leverage situation. So we feel very comfortable with where we are today.

[Scott Valentin:]

Agreed. I'm just wondering in terms of like -- as we think about return on equity going forward, one of the cutoffs for investment grade, I think, is 2.5x leverage. The rest of it would be secured versus unsecured debt. And I know in the past you guys have run with more secured debt with the thought, I guess, that it was too expensive to get to that investment-grade rating. Is that still the case? Or you guys -- have you changed your thoughts there? Or maybe I misinterpreted, but are you looking for investment-grade rating at some point? Or is it still going to be mostly asset-based borrowings?

[Colm Barrington:]

I mean, I think we will likely to continue primarily with the secured financing for the time being. We're not big enough yet to get investment-grade. And therefore, there's no point in trying to do all the things to get investment where you're not going to get there. So until we can grow the portfolio more significantly above its present level and we're not going to do that stupidly. We're going to do it very conservatively. So until we can do that, we won't be pursuing investment-grade per se.

[Scott Valentin:]

Okay. And then just on the end of lease income, it spikes to $30 million on the guidance in the fourth quarter. What's driving that increase? Is it lease terminations?

[Colm Barrington:]

Yes. Well, it's not actually. It's mainly that A340 transaction that Julie mentioned has had -- has very significant end of lease income, so we won't make any significant gain on the sale of the aircraft, but because of the improved maintenance accruals, we'll have very significant end of lease income out of those two aircraft in this quarter.

[Scott Valentin:]

Okay. So the gain on sale then for the fourth quarter, again, margin should be lower than it was in the third quarter?

[Colm Barrington:]

Well, as you see in the guidance, it's relatively low considering the number of aircraft we're selling. It's lower than it has been, but that's mainly because of the A340s. But that's offset by the economic gain from the end of lease income that we have in the quarter.

[Scott Valentin:]

Okay. And then just one final question, I'll get back in the queue. Steve, you mentioned the -- I guess, it's challenging to find opportunities that meet the return thresholds that you guys set or require. Others have said that it's maybe getting a little less competitive, seeing some of the Chinese lessors pull back a little bit, maybe some shrinking or selling. I'm just wondering if you're seeing that? And then secondarily would be, as the MAX comes back into service, do you expect a glut of aircraft maybe by the second half of the year as supply of narrow bodies picks up?

[Steve Zissis:]

Yes. To the first part of your question, definitely, the Chinese have pulled back from the marketplace. And that's been positive for some of the returns that you see on, what we call, the Tier 1 type of deals. But keep in mind, Scott, that really for FLY, we don't compete in that segment of the market, right? That's still a too thin of a return for us. So we have to go down market, slightly older or more difficult credits where the Chinese really don't compete to meet our returns. Our internal targets are in the mid-teens. And so that's the type of deals that we're looking for.As respect with the MAX, and whether there will be a flood of deals, look, it's a good question. A lot of the capital has now migrated over to the Neo. And so it's pushed kind of values on NEOs and the price is higher because, obviously, they can't do MAXs at this point. But as the MAXs come back in, we expect that to balance out a bit. There might be a few opportunities for FLY in that segment of the market, but we really have to wait and see.

[Operator:]

Your next question comes from the line of Jamie Baker from JPMorgan.

[Abdul Tambal:]

This is Abdul Tambal on behalf of Jamie Baker. Most of my questions have been answered, but just to clarify from the last answer that you just gave. So have you already started seeing general impact on lease rates in the marketplace so far because of the MAX finding? And do you expect that to kind of change again once it returns back to service and starts getting delivered again?

[Steve Zissis:]

Yes. Sorry, ask that again. What was your question?

[Abdul Tambal:]

So just to clarify from the last question. When looking at the MAX -- you already mentioned that it has limited -- FLY has limited exposure to the MAX. But can you just briefly talk about how it impacted general lease rates in the marketplace so far and how you expect that to change when deliveries start again?

[Steve Zissis:]

Sure. So it has had a direct impact, obviously, on the NGs. We've seen a pickup in lease rate and demand for the NGs as the airlines are finding themselves short of lift. So that's been positive for FLY. I think the question for all of us is how long that will last. Obviously, the MAX isn't going to be resolved overnight, even if they get it recertified. In the fourth quarter or first quarter next year, we expect this to play out over the next two years. So it's not going to be immediate kind of a flip back, right? So there'll be opportunities, I think, for the next couple of years on the NG side. And then on the MAX situation, it just depends where lease rates and values go and how fast that aircraft gets picked up in the general marketplace.

[Operator:]

Your next question comes from the line of Koosh Patel from DB.

[Koosh Patel:]

Just two questions here. One, are you seeing any delays from Airbus on the 320neos that you guys are expecting to be delivered in the next 6 to 12 months? And then second, given the -- it looks like it's going to take a little bit of time to reabsorb all of the MAXs that are grounded back into the global fleets. Has that created any incremental opportunities for you with respect to some of the options you have on some of the 320neos looking out into the future years?

[Steve Zissis:]

Yes. So look, in general, we're seeing some delays on the NEO deliveries, but the schedule that Colm laid out in his presentation where we're taking one in the fourth quarter of 2019 and then seven in 2020 and 11 in '21 is the rescheduled delivery proposal that's been revised by AirAsia. So we're pretty comfortable with that. It may slide by a couple of months, each of those deliveries. But right now, we're pretty comfortable that those will deliver in those quarters. And what was the second question? Was...

[Colm Barrington:]

Uncertainty about the MAX. I think, Koosh, that uncertainty about the MAX both in its timing and how it's going to be picked up by airlines has certainly helped the A320neo family aircraft and has certainly made us more enthusiastic about our options for those aircraft. As you know, we've exercised eight of the options, and we're looking at obviously more, but we don't have to exercise the balance of those options for quite a while yet. So there's no point in jumping in until we need to. But we're increasingly comfortable with the eight options that we have exercised.

[Operator:]

[Operator Instructions] Your next question comes from the line of Bill Mastoris from Baird.

[Bill Mastoris:]

I'd like to begin with the deleveraging question, which was actually touched on a little bit earlier. Several times throughout the course of the presentation, you talked about how much you've delevered. And you even referenced the fact that you expect to be below 3x on a net debt basis. Is this a reset of the former target leverage ratio of 3.5 to 4x? Are we -- can we expect to see you now roughly right around 3x going forward? Is that the new target leverage ratio? That's my first question.

[Colm Barrington:]

Yes. I don't think we've changed our target, Bill. I think we emphasized the fact that we've gotten to 2.6x from the 4x in nine months, which is faster than we told the market we were going to do. So we're pretty comfortable with what we've done and very happy with it. So I think we just need to put some emphasis on that. And we will actually be increasing -- decreasing the leverage slightly by the end of the year. But we and our Board have not set any new targets for future leverage, so we're going to be on around that 3% -- 3x going forward, to be record.

[Bill Mastoris:]

Okay. And that new target leverage and obviously, the upgrades by S&P and the positive outlook by Moody's, that kind of begs the question of you do have a 6.38 out there, which is currently callable and you could refinance that at considerably lower rates. Do you have any updated plans for that right now? Is that going to be replaced by secured financing or will this be a refinancing?

[Colm Barrington:]

Obviously, we've just finished the quarter. We've just got the upgrade. We've just got the positive outlook. And we are looking at all our financing facilities right now. As you say, the call has got away, so that long-term unsecured debt is one of the targets that we're certainly looking at.

[Bill Mastoris:]

Okay. My final question is, with the strong secondary market right now that you have for leasing, I'm just kind of wondering what lease placements do you have remaining for 2019? And how many do you have for 2020 at this point? And howmany of those have been placed?

[Steve Zissis:]

Yes. So for 2019, we have zero remaining aircraft. Everything has been placed and leased. And for 2020, we have five remaining aircraft, two in the first quarter and three in the last quarter of the year. But for the most part, those look like all of them will be placed shortly.

[Bill Mastoris:]

Okay. And sorry, if I could slip in one more. Your level of unencumbered aircraft at the end of the quarter. What was that amount?

[Colm Barrington:]

Julie?

[Julie Ruehl:]

It's about $320 million.

[Operator:]

I'm showing no further questions at this time. I would now like to turn the conference back to Mr. Matt Dallas.

[Matt Dallas:]

We'd like to thank everyone for joining us for our third quarter earnings conference call. We look forward to updating you again next quarter. You may now disconnect.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and have a wonderful day. You may all disconnect.