Fly Leasing Limited
Q3 2018 Earnings Call Transcript

Published: 8 Nov 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the FLY Leasing’s Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Mr. Matt Dallas. Sir, you may begin.

[Matt Dallas:]

Thank you, and good afternoon from Ireland and good morning to everyone in the United States. This is Matt Dallas, the Investor Relations Manager of FLY Leasing, and I’d like to welcome everyone to our third quarter 2018 earnings conference call. FLY Leasing, which we will refer to as FLY or the Company, issued its third quarter earnings results press release, which is posted on the company’s website at www.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 & Presentations page. If you are listening to both the live call and the webcast, you may want to mute your computer as there will be a slight delay in the webcast’s audio. 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 turn the call over to Steve Zissis, the President and CEO of BBAM. Steve.

[Steve Zissis:]

Thanks Matt and welcome everyone. By now I assume you’ve all read FLY’s Q3 earnings release and have seen that FLY has had one of the best quarters ever and is delivering on its promise of improving earnings, and increasing value for its shareholders. I think it’s fair to say that the choices we made over the past few years to sell older aircraft, aggressively buy back our stock, drive down costs and invest in newer aircraft, including our most recently announced AirAsia transaction are not only paying off in terms of producing higher earnings per share and stronger returns on equity, but also de-risking the company by having a younger fleet with longer weighted average lease term and a sound balance sheet with long dated debt maturities and scheduled amortization. But before getting into more details about FLY’s result, and future activities, I’d like to update you on the industry conditions. As I have mentioned throughout this year’s calls, underlying industry fundamentals have been and continue to remain extremely positive. While we continue to keep an eye on rising fuel prices, crude oil prices have fallen for the past four weeks in a row and remain in check. We see aircraft demand being driven by passenger traffic, which continues to grow. Air traffic numbers continue to be strong worldwide and in many highly populated emerging markets they are growing at double digit rates. For the year IATA is forecasting worldwide growth of around 7% which is significantly above prior 10 year average, and of course the Asian and Indian markets continue to grow at rates significantly above that, with India currently growing at more than 20% per year and China expected to overtake the U. S. as the largest air travel market in the world within 5 years. Similarly, India will become the third largest market after surpassing the U. K. in 2025 with Indonesia following close behind 5 years later. Thus by 2030 China, U.S., India and Indonesia will be the fourth largest air traffic markets in the world and one of the reasons why despite some recent turbulence in India and Indonesia, we will continue to invest in those regions. It is also why the AirAsia transaction which gave us improved foothold is so many faster emerging markets and access to new technology aircraft at attractive prices is so valuable to FLY. I’m pleased to report that we completed the initial phase of the AirAsia transaction last month, bringing our total Phase 1 purchases to 33 aircraft and 7 engines. I’d like to personally thank our dedicated staff who worked tirelessly over the past 12 months to complete a tremendously complicated transaction that involved multi-faceted financing solutions, multiple jurisdictions, and a complex structuring and accounting issues. I’d also like to thank our banking partners and our shareholders who have not only supported this deal, but continue to show their confidence in BBAM and FLY management team. As Colm will describe in more detail later on in this call, we still have 21 new neos aircraft under agreed sale leaseback terms to complete, as well as options for up to 20 more new A320neo family aircraft. As I said many times recently, the AirAsia deal will not only be transformational to FLY, but is further evidence how FLYs management arrangement with BBAM is highly valuable and powerful. There is simply no way this deal could have been done without FLYs access to BBAM’s platform. Moving to the FLY remarketing front, between now and the end of 2019 we have 18 aircrafts scheduled to come off lease. Of those we expect to sell seven, part out two and four more have either been extended or expected to be released, leaving only five aircraft that still need to be remarketed in 2019. Overall, we are still seeing very good demand from airlines and the recent manufacturing in engine issues associated with new delivers only serves to bolster than demand. As you know, as part of the AirAsia transaction we have been targeting a minimum of 300 million of AirAsia aircrafts to sell by the end of next year, to manage concentration risk and lower our leverage ratio. On our last call, I noted that it was still a bit early to provide definitive feedback on these sales programs, but we were generally seeing strong interest from a wide array of buyers in the secondary market. Now that we’ve completed a more thorough review of these bids, I can say that we’re seeing prices that are generally meet or exceed our expected return requirements, and as a result have entered into negotiations with several buyers with the expectation of closing our first round of sales in the first quarter of 2019. Before handing the call over to Colm, I want to remind everybody that in connection with the AirAsia transaction, BBAM’s management team, one of BBAMs instructional owners and AirAsia have completed the purchase and issuance of 4.66 million of FLYs shares at $15 per share. After this latest transaction the BBAM shareholders now own approximately 70% of FLYs stock. We continue to believe FLY is on the right track, but remain frustrated that FLY is trading at a significant discount to book value. We remain committed to doing everything in our power to grow earnings and book value per share, and continue to deliver strong results for our shareholders. Thank you all again for your support and I’d like now to turn the call over to Colm Barrington, FLYs CEO.

[Colm Barrington:]

Thank you Steve and thank you everyone for joining us this morning. As you can see from this slide, FLY has had another excellent quarter and indeed an excellent year-to-date. For the quarter we produced $0.75 adjusted earnings per share and a 14.4% adjusted return on equity, both very positive numbers that were based on our 13% growth not raising lease rental revenues, combined with the lower growth and expenses. Of particular importance for our future and as summarized by Steve earlier, FLY acquired 28 aircrafts in the quarter, bringing our feet total to 112 aircraft and representing a year-on-year fleet growth of 33%. These 28 aircrafts were part of the initial phase of our purchase and leaseback transaction with five airlines from within the AirAsia group. Following the end of the quarter we took delivery of four more AirAsia Group aircraft and thus completed the initial phase of that transaction. For the nine months through September 30, FLY adjusted earnings per share of $2.10 and adjusted return on equity of 13.6%. These positive earnings also added significantly to FLY’s net book value per share, which at the end of the quarter stood at $20.89. This net book value represents an approximate 60% premium to our current share price, and I’ll refer to this again later on the call. Of the 28 aircraft acquired by FLY in the quarter, more than half were acquired in the latter half of the quarter and so with little impact on our Q3 revenues or income. We will see these aircrafts having a more positive impact on our Q4 revenues and results. Incidentally during the quarter FLY has a fleet utilization of 100% and we have no aircraft downtime since the end of the quarter. Our Q3 financial results were a significant increase in the same period last year with operation lease rental revenue growing by 13% to $98.9 million, adjusted net income growing by $33 million to $22.8 million our adjusted earnings per share growing by $1.09 to $0.75. FLYs disciplined business strategy is showing positive results. As Steve had also mentioned, we have now completed the initial part of the large portfolio acquisition with AirAsia that we announced last February. This has involved the acquisition and lease of 33 Airbus A320 aircraft and seven CFM56 engines for an investment of more than $1 billion. As part of this transaction, in August FLY issued approximately 3.3 million shares to AirAsia valued at $15 per share, a good premium on our current share price. Now that these aircrafts and spare engines are bedded into our portfolio, we expect to see a positive outcome on future revenues and earnings. We are now looking forward to completing the second and third phases of this transaction, starting in 2019. The second phase will involve the purchase and lease back to AirAsia Group Airlines of 21 A320neo family aircraft. Four of these aircrafts have slated delivery in 2019 and the balance in 2020 and 2021. The third and final phase of transaction provides FLY with the option to purchase 20 more A320neo family aircraft, again starting early in 2019 and stretching out to 2025. Together these 41 A32neo family aircrafts provide FLY with an investment pipeline of more than $2 billion. FLYs fleet has now grown to 112 aircraft and is one of the most attractive of any lessor, comprised entirely of Airbus and Boeing manufactured aircrafts. All of our feet by value is in production types from these manufacturers. We expect to dispose of our two remaining B757s in the first quarter of 2019 and there are two A340s by the end of 2019. Together these four aircrafts represent less than 2% of our fleet value. However, we expect to show economic gains from the sale of the four aircrafts. At the end of September, our average fleet age was 7.1 years and our average lease term was 5.9 years. FLYs aircraft are currently leased to 48 airlines in 27 countries, a pretty diverse portfolio of lessees in location. Some of our lessees are shown on the slide. While our AirAsia Group Airlines together currently represent 21% of our portfolio, there is only one AirAsia Group Airlines which represents more than 10% of our exposure, that being the parent airline AirAsia Berhad at 12%. In the next slide I will address our strategy and expectations in selling down this exposure, while also choosing our leverage. In the nine months through September 30, FLY sold three aircrafts for a total economic gain of $21 million. This economic gain was a combination of the aggregate sales price above our net book value, plus recognition of end of lease income where this was not required to be passed on. Incidentally since the beginning of 2015 FLY sold a total of 75 aircrafts for an aggregate gain of approximately $130 million or a 6.6% premium above our net book value. FLY has continually demonstrated and indeed proven that our aircraft and lease portfolio has a value that is well above our net book value. We have stated that it is part of our strategy to sell at least 300 million worth of AirAsia aircraft by the end of 2019, to reduce our lessee exposure and to reduce our leverage. We have also stated that we expect there to be a strong market demand for these aircraft, and indeed for the AirAsia credits. I can now report that we have found a voracious market appetite for these aircraft and expect that we’ll have no problems in meeting on target. We expect to execute on or sales strategy in late 2018 and in early 2019. These sales will reduce our exposure to all AirAsia airlines to less than 20% and our exposure to any single airlines via AirAsia Group that fall below the 12% that it is today. The sales will also have the effect of reducing our leverage towards our target of 3.5 to one 1 and will generate cash providing FLY with further ammunition for future growth. FLY provides investors with a real value proposition. With grown up fleet substantially with attractive aircrafts and our producing strong financial results, as evidence by the figures we are presenting today and by our increased guidance for 2018. Our valuable portfolio of modern, in-demand aircraft and long term leases to a diverse group of airlines globally provides FLY and its shareholders with a secure stream of income with existing and prospective leases. Meanwhile our $2 billion pipeline of state of the art A320neo family aircraft provides FLY with positive growth prospects. It should be noted that the 21 aircraft that we are committed to purchase already have leases in place and the remaining 20 aircrafts are auctions, which can exercise or not depending on leasing and financing conditions at the time. However, we currently expect to exercise these options. FLY has demonstration that it can grow its portfolio without having to place indeed pay delivery payments on speculative order. We have also demonstrated that we can achieve an attractive sales program allowing us to recognize substantial gains and reduced lessee exposure. We are continuing to do this and very actively in the case of the AirAsia transaction. We also have a disciplined financing strategy, which is substantially based on long term and amortizing secured debt. Our current average financing terms of 5.5 years matches our average lease terms. In particular this financing structure isolates FLY from the vagaries of the capital markets and the need to refinance large trenches of debt at times for the capital markets that maybe dry. Based on rewards and risks, we believe that FLY is currently a very good value proposition; the value that our insiders have recognized over the last few months. Our shares are currently trading as a significant discount to net book value and a very low multiple of 2018 and prospective 2019 earnings. With that, I’ll hand you over to our CFO, Julie Ruehl, who will take you through our Q3 financial overview. Julie.

[Julie Ruehl:]

Thank you, Colm. FLY is reporting net income of $20.7 million for the third quarter of 2018 a $33 million increase from a net loss of $12.5 million in a year ago quarter. Earnings per share increased from a loss per share of $0.43 a year ago to EPS of $0.68 in the current quarter. Overall we are very pleased with our improved financial results. FLY achieved double digit ROE for the second quarter in a row and at 13.1% ROE was 22% greater than a year ago. FLY’s operating lease rental revenue in Q3, 2018 increased 13% to $98.9 million due to the growth of the fleet and higher lease rate factors. This marks the third consecutive quarter of double digit growth. As positive trends will continue in Q4, given the addition of 28 aircraft during the quarter, plus another four aircraft since quarter and. Our portfolio stands at a 116 aircraft today an increase of over 35% since the beginning of the year. Total revenue increased 21% to $104.6 million in Q3, 2018 from $86.2 million in Q3, 2017. In Q3 2018 FLY recognized $3.1 million of end of lease income and a $2.6 million gain on sale related to the sale of one aircraft, which taken together represent the 46% premium to the net book value of this aircraft. For the second time this year, FLYs economic gain was maximized. They are making a smart decision to accept cash compensation and retained maintenance reserves at the end of the lease rather than requiring a lessee to perform maintenance work which would not have resulted in a dollar for dollar increase in the sales proceeds for our parted-out aircraft. In comparing expenses to the prior year quarter, depreciation, interest expense and SG&A are all up due to the growth of FLY’s aircraft portfolio. Although on a combined basis these expenses grew by 10.8%, a lower growth rate than the operating lease rental revenue growth rate of 13%. There were no impairment charges recorded in the quarter. Also in Q3, 2018 we recognized a $2.1 million gain related to interest rate lock contracts entered into the partially hedged, the expected debt on the AirAsia portfolio acquisition. Of this $2.1 million gain, $1.7 million was a realized gain related to terminated contracts. In Q3 FLY incurred $560,000 of debt extinguishment costs consisting almost entirely of non-cash write-off of debt costs related to financing activities undertaken to lower the interest rate margin and extend the weighted average maturity of the company’s debt. Now I’d like to cover our guidance for Q4. Given the uncertainty of the exact timing of aircraft sales, our guidance for Q4 does not include any gains on sales of aircraft. For the fourth quarter of 2018 we are expecting operating lease rental revenue of $112 million to $113 million. We expect amortization of lease incentives of $2 million to $3 million. We expect end of lease income of $1 million to $3 million. Depreciation expense will be approximately $40 million to $41 million. We expect interest expense of $40 million to $41 million. Maintenance and other costs are expected to be less than $1 million. We expect SG&A expense of $8 million to $9 million without consideration of any foreign exchange gains or losses that may occur. Given the strength of our earnings to-date and Q4 outlook, we are increasing our full year pre-tax income range by $5 million to $80 million to $85 million. I’ll turn it back to Colm now for his closing remarks.

[Colm Barrington:]

Thank you, Julie. Before we move to your questions, let’s recap on the third quarter. In the quarter we achieved a 30% growth in operation lease rentals to nearly $100 million. We grew our fleet by 28 aircraft or 33%. We produced $0.75 of adjusted EPS and 14.4% adjusted ROE. At quarter end our net book value per share stood at $20.89. These outcomes are all highly positive and have allowed us to increase our 2018 pretax income guidance by $5 million to $80 million to $85 million as Julie has just commented. This should allow us to exceed at $2.50 EPS in 2018 as we indicated earlier in the year. We are also very excited about our $2 billion plus pipeline. With that, we will now take your questions.

[Operator:]

Thank you. [Operator Instructions]. First question is coming from Helane Becker of Cowen & Company. Your line is open.

[Helane Becker:]

Thanks very much operator. Hi everybody; thanks for the time. Just a couple of questions for me or from me I guess. End of lease revenue, can you talk about the airlines that you may be, if you don’t want to say the specific airlines, but what you’re like watch list look like and your concern about higher energy prices, interest rates and you know the dollar going into the fourth quarter and first quarter which is obviously one of the weaker or two of the weaker quarters for the year?

[Colm Barrington:]

Well Helane, I mean we all know that air traffic continues to grow very strongly. Its 7% approximately up for the year as Steve has commented, which is above the long term trend of 5%. So while there are issues out there, airlines are still benefiting from very strong traffic growth and that’s reflected in IATA’s continuing forecast of airline profits for the year of over $30 billion. So you know on balance despite higher fuel costs or despite some ups and downs in some jurisdictions, we feel still very comfortable about the industry as a whole. As you see from our presentation we have 48 lessees in 27 different countries, so we are very well diversified in terms of our lessees and our jurisdictions. So overall we are still very comfortable with the situation and there will be ups and downs we know, but the overall situation is still very positive.

[Helane Becker:]

Well, so I wouldn’t disagree with what you just said, but then why are you forecasting end of lease revenue for the fourth quarter or do you just... [Cross Talk].

[Colm Barrington:]

Sorry – End of lease revenue Helane, sorry end of lease revenue Helane is maintenance accruals which we have accrued and at the end of the lease so not have to return to the lessee, because we are selling the aircraft to third party or parting out the aircraft. So end of lease revenue has nothing to do with the credit of lessees. It’s purely to do the accounting for maintenance accruals at the end of a lease.

[Helane Becker:]

Okay, and then my other question is, as we think about that $2 billion that you are talking about in opportunity for the next, you know more than one year. How should we think about that in like 2019, 2020 CapEx?

[Colm Barrington:]

Well I think, we’ll show you in one of our sides, of the committed 21 A320neos, A321 family neos, I think four are coming in 2019. So that’s you know give or take $200 million and I think we have three of our options in 2019 that’s another give or take $150 million.

[Helane Becker:]

Okay, alright. Well, those are my questions. Thank you.

[Colm Barrington:]

Thanks Helane.

[Operator:]

The next question is coming from Nish Mani of J.P. Morgan. Your line is open.

[Nish Mani:]

Hey, thank you so much for taking my questions. Could you refresh our memory on how to think about the flexibility regarding the options for the additional 20 A320neo aircraft from AirAsia?

[Steve Zissis:]

Sure. Look it’s a one way option in FLYs favor. They can exercise it 12 months prior to delivery of the aircraft and it’s pretty straightforward. So as Colm said, we don’t put up any PDPs to secure that and obviously we would work with AirAsia to the extent they wanted to keep those aircrafts in the fleet. But in general, we could just exercise them 12 months ahead of time, and lease them to third party airlines.

[Nish Mani:]

Okay, great, and since the transaction was announced, you know at the beginning this year, how is your thinking kind of on growth regarding this specific A320neo aircraft type you know regarding new aircraft changed in that time. I mean, are you incrementally more bullish on potentially growing the portfolio in that direction or have macro-economic developments kind of the change in the fuel price environment and such you know maybe caused you to think about slowing growth potentially longer term with that aircraft type.

[Steve Zissis:]

No, nothing’s changed since we underwrote the transaction and our view on the new technology aircraft, both the max and the neos is very positive and to the extent that we could get more in the fleet, we would do it.

[Colm Barrington:]

And I suppose to add to that, the higher fuel prices make neos more attractive than they were even nine months ago.

[Nish Mani:]

Okay, great. Thank you so much for the time guys.

[Operator:]

[Operator Instructions] Your next question comes from Jason Arnold of RBC Capital Markets. Your line is open.

[Jason Arnold:]

Hi guys, nice results. I mean thanks for the commentary on the AirAsia sales marketing. It seems very strong. I guess just on that topic, the aircraft is obviously very attractive, but perhaps you can also comment on the added appeal of these aircrafts being leased to AirAsia given that I don’t believe that there’s a whole lot of exposures. Is there any exposure to the leasing community on AirAsia. So maybe you could kind of separate those two factors in terms of demand?

[Steve Zissis:]

Yeah look, that was one of our kind of underwriting assumptions when we did the deal. We looked around to seek exposure our peers had in the AirAsia basket and as you know, it was very small. So AirAsia has not in general used the leasing community to finance our aircraft. It was primarily done with ECA and bank financing and so that was one of the attractive things about the deals that we thought there will be lots of demand in the various capital markets and also from other lessors for the AirAsia. Now as Colm said, we’d like to keep the AirAsia exposure below 20% on our books. So we want to keep as much as we can, but we will be forced to utilize third party market to sell down some of our exposure as we start building out the book with AirAsia.

[Jason Arnold:]

Okay, great, and then out of the additional, I guess $170 million targeted sales, how much of those would be AirAsia versus Legacy I guess in your opinion here at this point?

[Steve Zissis:]

Look, our focus on the $300 million that Colm has mentioned in the initial comments here is all AirAsia, right. So our target is to sell down $300 million between now and the end of next year AirAsia exposure, and it will be across the AirAsia family, so it would include you know AirAsia, Indonesia, India, Tai and Malaysia.

[Colm Barrington:]

And then I think just to add to that, the $170 million additional is other aircrafts which we were targeting for sale during the course of the next 12 months.

[Jason Arnold:]

Okay, great, thanks very much for the color.

[Operator:]

Next question is coming from Gary Liebowitz of Wells Fargo Securities. Your line is open.

[Gary Ludwig:]

Thank you, operator. Maybe for Julie, the other asset balance went from $50 million to over $200 million. Are those held for sale assets and can you quantify that number if that’s the case.

[Julie Ruehl:]

Hi Gary. We don’t have anything classified as held for sale at the end of the quarter. The bulk of what’s in that other asset number is an escrow deposit that we had to put up for the AirAsia transaction, that’s about $100 million of that and we also have a value on our books for the sale lease back portfolio and intangible assets; that’s about $87 million.

[Gary Ludwig:]

Okay, thanks for that color. And Steve, it doesn’t sound like there has been any changes to the pace of AirAsia aircraft disposal. I think you talked last quarter about agreeing to sell some planes but the end of this year, but not actually closing until late next year. Was that the case? Has there been any change there?

[Steve Zissis:]

Look, we are in the process of executing LOI’s in about 22 aircraft for sale between now and first quarter and we typically do not announce them until we sign up the purchase agreements, because as you know Gary some of these sales can be a little uncertain, especially the innovation timing. So between now and the first quarter or maybe perhaps the second quarter, we should have a handful of sales completed.

[Gary Ludwig:]

Okay, thank you very much.

[Operator:]

Ladies and gentlemen, that concludes today’s Q&A session. I would like to turn the call back over for further remarks.

[Steve Zissis:]

Thank you very much for joining us for FLY Leasing’s third quarter earnings call. We look forward to updating you again next quarter. You may now disconnect.

[Operator:]

Ladies and gentleman, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone, have a great day!