Aircastle Limited Q4 2008 Earnings Call Transcript

Aircastle Limited (AYR)

Q4 2008 Earnings Call Transcript

February 27, 2009 12:00 pm ET

Executives

Julia Hallisey – IR

Ron Wainshal – CEO

Mike Inglese – CFO

Analysts

Louise North [ph] – Citi

Scott Valentin – FBR Capital Markets

Jamie Baker – JPMorgan

Rich Shane – Jefferies & Co.

Presentation

Operator

Good afternoon. My name is Ashley, and I will be your conference operator today. At this time, I would like to welcome everyone to the Aircastle fourth quarter and year-end earnings call. All lines have been place on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator instructions) Thank you. Ms. Julia Hallisey, you may begin your conference.

Julia Hallisey

Thank you Ashley and good afternoon everyone. I’d like to welcome all of you to the fourth quarter and full year 2008 earnings call for Aircastle Limited. Joining us today are Ron Wainshal, our Chief Executive Officer; and Mike Inglese, our Chief Financial Officer.

Before I turn the call over to Ron, I would like to mention that this call is being recorded and the replay number is 800-642-1687 from within the US or 706-645-9291 from outside of the US with a replay pass code of 83496844. This call will also be available via webcast on our Web site www.aircastle.com, in addition to the earnings release and an accompanying PowerPoint presentation.

I would also like to point out that statements today which are not historical facts may be deemed forward-looking statements. Actual results may differ materially from the estimates or expectations expressed in those statements and certain factors that could cause actual results to differ materially from Aircastle Limited’s expectations are detailed in our SEC reports. I direct you to Aircastle Limited’s earnings release for the full forward-looking statement legend.

Now I’d like to turn the call over to Ron.

Ron Wainshal

Thanks Julia, and thanks to everyone on the call for joining us. Let me start by giving you my top line assessment of Aircastle. First, our owned fleet is now long-term financed until at least 2013, a very significant advantage in today's market. Second, our cash position is good. We ended the year with $81 million in unrestricted cash and operating cash flow remains strong with cash flow from operations during 2008 coming in at nearly $322 million. Third, our diversified portfolio of modern aircrafts is performing well. In fact, utilization during the fourth quarter was 98%, and including signed letters of intent we currently have only two aircraft left to place this year. We accomplished this with a top caliber team of professionals, experienced and adept at managing through downturns.

During the call, I will go into greater detail and cover Aircastle’s performance during the fourth quarter of 2008 and our full year results. I will cover what we are doing now, and where we are going. Mike Inglese will then speak to our financial highlights before we address your questions.

Despite the challenging backdrop, we had another strong quarter during Q4 with adjusted net income for the quarter coming in at $46.6 million. Adjusted net income plus depreciation, which we think of is an important cash flow measure for our company, was $96.5 million or $1.24 per share. For the full year, our adjusted net income was $150.9 million, which is up nearly 30% versus last year. This figure grows to nearly $353 million or $4.53 per share after adding back depreciation. Putting it in perspective, our stock market capitalization based on yesterday’s closing share price is about 64% of 2008 adjusted net income plus depreciation.

As I alluded to upfront, I believe our biggest accomplishment during 2008 was completing nearly $1 billion in long-term financings in the face of a very tough credit market. So today our owned fleet is fully financed on a long-term basis and we have no remaining short-term debt. Our decision to stop making new investments commitments in late 2007 was the right one. During 2008, we made no new net investments as sales asset acquisitions that had been commented in the prior year. As a result of these activities, our fleet count went from 133 aircraft at the end of 2007 to 130 at the end of last year, and that's where it currently stands.

We focused early on to address our 2008 placement needs and also took care of most of our 2009 requirements on attractive terms, while successfully working through several restructurings. These actions kept our utilization rate high. Turning to our situation, I'm pleased to say at this point we only have two aircraft left to place this year, after taking into consideration signed letters of intent. As of December 31, the average remaining lease term for our entire portfolio stood at 5.1 years. We've signed leases and letters of intent for six out of the seven aircraft we took back following the Sterling bankruptcy in late October, three of these aircraft are back in operation as we speak and we expect the other three to be back in service over the next several weeks as well. We are in active discussions with customers on the remaining two aircraft left to lease in 2009, that is the remaining Sterling 737-700 and an Airbus 8319 whose lease expires at the end of the year. Both are new generation narrow-body aircraft, and we intend to have these placed by the end of this quarter.

While lease placement has definitely gone more difficult the market continues to function. One of the factors keeping the market going is the sharp drop in fuel costs which has helped sustain activity in the industry during what is traditionally a slow winter season. We are staying close to our customers in taking an active position in matching our portfolios. In cases where we believe there is a fundamental problem, we have acted decisively to reposition our aircraft. For example, we saw weakness in the Indian market, and moved to work with a customer to early terminate leases on two aircraft for which we have already secured new leases with comparable rentals. This move together with scheduled aircraft lease expirations will drop our exposure in India from 11 aircraft to three units in a few months.

Our accounts receivable are at modest levels. Receivables in excess of 30 days outstanding stand at approximately $1 million, primarily relating to three aircraft we are taking back early. Looking ahead, the outlook for the industry is still challenging for the next fall and winter after the traditionally busy spring and summer seasons, but for the moment I think we are in good shape.

Regarding our Airbus A330 program, we are continuing to work on placements. Our three 2010 positions, which are scheduled to deliver during the second half of the year are subject to executed leases with non-refundable security deposits. Our next available position is April 2011. Several factors give us confidence that placements are achievable over the next several months. Boeing 787 delays are leaving a lot of customers frustrated and presenting A330 placement opportunities. Also the fuel price drop makes the A330 performance look more competitive. And more generally, the availability of leased aircraft is an increasingly attractive alternative for airlines today versus buying and having to commit capital.

We have approximately $100 million in pre-delivery payments due during the course of 2009. Our relationships with the banks that remain active in the market are very good and we are in discussions with them regarding pre-delivery payment financing. We’re also starting to work on long-term delivery financing for earlier A330s, focusing on European Export Credit Agency market, where these governmental institutions have stepped up their commitment significantly for both airlines and for aircraft leasing companies.

As things stand right now, we remain confident in our ability to fund these pre-delivery payment amounts from internally generated resources, irrespective of the financing. Moreover, while the dividend decision is one our Board makes every quarter, we believe we have the ability to continue paying a dividend at the current level.

Turning to the market, it's clear that the extreme current conditions are continuing to have a very negative effect on share prices. While this appears to be affecting stock market quite broadly, in my view the current trading levels of our shares reflect a steep discount by almost any standard. The stock price is disappointing to say the least. It does not reflect what we believe are our consistently strong results, the value of assets and platform, and the prospects for our business. As we look around, our industry is going through a fundamental realignment and we believe we are among the best positioned players. We are keeping an eye out for strategic opportunities. Many of our competitors are for sale, undertaking realignments, or are struggling with financing issues. We expect to be one of the winners when the dust settles.

Before I turn it over to Mike, I’d just like to recap where we stand. Our owned fleet is long-term financed and we continue to generate strong cash flow. Our diversified portfolio of modern aircraft is performing well. We had a good year, and I believe we are very well positioned to thrive not to survive. Mike?

Mike Inglese

Thanks, Ron. I would like to spend a few minutes updating you on our financing activities as well as cover our business results for the quarter and year end. As Ron mentioned, we ended 2008 with $81 million of unrestricted operating cash, $183 million of restricted cash and our aircraft portfolio continues to generate strong cash flows.

During the fourth quarter, we completed the sale of three aircraft for approximately $132 million in gross proceeds, generating net proceeds after debt repayment of $40 million. We continued explore opportunistic asset sales as a fundamental aspect of our business strategy; however, we only do so when it makes economic sense. We repaid all outstanding amounts on our warehouse and terminated that facility, as well as our corporate revolver during December. We now have four long-term portfolio financings in place that are non-recourse to the parent company and are not crossed collateralized.

Of our first three financings, Securitizations 1 and 2 and Term Financing No. 1 completed in May of ’08, account for $2.33 billion of our $2.48 billion of debt outstanding at year-end. They have no financial tests that could trigger an event of default, any potential financial test issues in these financings would merely apply excess cash to additional debt amortization for the facilities.

Term Financing No. 2, which we completed in September which had a $149 million outstanding at year-end has interest coverage and loan-to-value tests that could potentially trigger a default, but we believe we have ample cushion against these thresholds, and more importantly, flexible cure rights.

Aircastle continues to have a strong balance sheet built with a stable conservative capital structure that takes into account the cyclical nature of this industry. With respect to the Airbus 330 program, as Ron just mentioned, we continue discussions with several banks to arrange pre-delivery and permanent financing. Given current capital markets conditions we don't expect to have a PDP facility in place until later in 2009. PDP payments required for the program total approximately $100 million through the end of 2009 with over a half that amount due during the fourth quarter of this year.

Given our current unrestricted cash balance plus our expected operating cash flows from our existing aircraft portfolio we believe we have more than enough liquidity to meet our PDP funding requirements and maintain our dividend level for the 2009 year even without any PDP financing.

Turning to financial results. We earned adjusted net income of $46.6 million, up 32% or $0.60 per diluted share, up 30% on revenue of $157.8 million for the fourth quarter of 2008 compared to 2007 results of $35 million or $0.46 per diluted share on revenues of $120.7 million. As reported in this morning's release, fourth quarter revenue included $24.9 million of maintenance revenue related to end of lease compensation and lease terminations, which was partially offset by $5.1 million amortization of lease discounts and lease incentives. The Q4 ‘08 adjusted net income figure excludes about $600,000 gain on the sale of aircraft and $22.2 million of charges related to our interest rate hedges.

Adjusted net income plus depreciation for the fourth quarter was $96.5 million or $1.24 per diluted share, up 25% and 23% respectively over Q4 ‘07. Full year adjusted net income was $150.9 million or $1.94 per diluted share, up 30% and 13% respectively over the full year 2007 figures. Full year 2008 revenue included $34.5 million of maintenance revenue related to lease end compensation and lease terminations and $1.8 million of net lease discounts and lease incentives. Full year 2008 adjusted net income excludes approximately $42 million of charges related primarily to interest rate hedges as well as $6.5 million related on gains and sale of flight equipment.

At year-end 2008, we owned 130 aircraft, for our owned aircraft we had a contractual aircraft lease rentals on a monthly run rate basis of approximately $43 million or about $514 million on an annualized basis reflecting the aircraft sales activity in the fourth quarter as well as eight aircraft which we are transitioning to new leases at year-end producing a gross yield on the portfolio of 13.4% or 1.12% monthly. Our fleet revenue utilization during the quarter and year-to-date continue to exceed 98%.

For fourth quarter 2008, total SG&A was $12.3 million, up from $11.7 million in Q4 ’07, including non-cash share-based compensation expenses of $1.7 million in Q4 ‘08 and $1.4 million in Q4 ’07. Full year cash SG&A results were consistent with our expectations and came in at about $40 million. We remained focused on operating this business efficiently and for 2009 we are exploring several initiatives to drive that amount down.

Reported interest expense net for Q4 was $57.1 million, including hedge related charges of approximately $12 million and is net of $1.1 million of interest earned on cash balances and $700,000 of capitalized interest. For full year 2008, reported interest expense was $203.5 million, including approximately $29.6 million of certain hedge related charges and this figure is also net of $7.3 million of interest income and $5.7 million of capitalized interest for the year.

Gross interest expense, excluding the hedge items previously noted, on debt facilities for the quarter, was $46.4 million on weighted average debt outstanding of approximately $2.6 billion during the quarter with a weighted cost of funds of approximately 6.9%. At the end of the year, we had $2.4 billion of net debt outstanding, which is 62% of the net book value of our flight equipment.

Depreciation expense for the quarter was approximately $50 million compared to $42 million for Q4 ’07, reflecting the growth in the aircraft portfolio year-over-year. At year-end, our run rate depreciation on a monthly basis is about $17 million. Our 2008 tax provision was $7.5 million for an effective tax rate of approximately 6.1%.

With respect to our hedging activities, during the fourth quarter we terminated hedges in connection with Term Financing No. 2 for a cost of $16 million, which will be amortized over the life of that facility. Also given the extremely volatile interest rate environment during the quarter, we chose to terminate our remaining hedges for the Airbus program that required collateral posting and paid approximately a $70 million termination fee. We now have no remaining hedge agreements that require collateral posting of any kind. And finally with respect to AOG, as Ron mentioned earlier, we’ve been able to place six of the seven Sterling aircraft with new lessees, and expect the remaining aircraft to be placed by the end of the first quarter.

In terms of the financial impact, during the fourth quarter we recognized approximately $24.9 million of maintenance revenue, primarily in connection with the Sterling repossessions. As a consequence of these repossessions, we expect to have total revenue downtime of about $7 million after applying security deposits, with $1 million recognized in Q4 '08, and expect to have about $6 million in 2009, most of that occurring in the first quarter as aircraft transition to new lessees. In addition, we expect to have about $14 million of total transition costs related to the 7 Sterling aircraft. We expect $9 million of the $14 million to be capitalized as improvements to the aircraft, for example seat checks, wing lifts, thrust upgrades, etc. and the remaining $5 million of that total to be expensed.

We paid approximately $1 million of the $14 million in Q4 ‘08 and expect the balance to be paid out during the first half of 2009, with the majority of the $5 million expense estimate expected to hit during the first quarter.

And with that, Operator, we are ready to proceed to the Q&A portion of the call.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Louise North [ph] with Citi.

Louise North – Citi

Hi, I am calling on behalf of Andrew Light, who is on a plane at the moment, and I got a couple of –

Ron Wainshal

Good to hear that.

Louise North – Citi

Sorry?

Ron Wainshal

Good to hear that he is on a plane.

Louise North – Citi

Good to hear he is on a plane, yes, he spends a lot of time on planes. First of all, you have got a $9.6 million other expense for the quarter. What does that relate to?

Mike Inglese

That is the net of two items primarily, $10.5 million of the $22.5 million of hedge charges that occurred in the fourth quarter relate to mark to market on the hedge primarily for our last term financing, which we have not designated as a cash flow hedge for accounting purposes. And then the offset of about $900,000 was other income related to settlement of a dispute with a prospective lessee.

Louise North – Citigroup

Okay. In terms of the six Sterling aircraft that you placed, what are the rental rates like on the new leases compared to what Sterling used to pay?

Mike Inglese

The Sterling leases were at about $300,000 a month and the new leases are going to be on average of around $230,000 a month.

Louise North – Citigroup

I mean is that representative of how far lease rates are coming down at the moment?

Mike Inglese

To some degree it is. The timing of the Sterling bankruptcy couldn't have been worse from the seasonal perspective because it happened just as the slow season happened.

Louise North – Citigroup

Yes.

Mike Inglese

And getting the airlines to step up and take the aircraft early in particular comes during the slow season for them, and so we had to probably give up a little in the way of economics that way in terms of rental, but we had less downtime.

Louise North – Citigroup

Yes. Okay, fair enough. In terms of all cargo aircraft we are just kind of curious on how the residual values of these are falling, given that freight volumes have come off very significantly.

Mike Inglese

Well, let me say a few things about our cargo portfolio. The average remaining lease term is on average something like 8.5 years. The customers we have in the cargo portfolio I think are quite strong financially. There is no doubt a lot of stress in the cargo market right now. I am glad we don't have to place anything in that market, but I think the guys we have as lessees are good for the money. And I think the good news is that these aircraft don't have come back on the market for years and years.

Louise North – Citigroup

No, but in terms of carrying value on the balance sheet, do you think they are fairly valued at the moment, or do you think that actual aircraft values are going to come off.

Mike Inglese

Well, the whole question of aircraft values is a tricky one in today's market. I think that it is probably a good point for any asset. On the subject of aircraft values I will say this. There's absolutely no trading going on right now. That’s maybe an overstatement. We sold three aircraft during the fourth quarter. I thought that was actually a pretty good accomplishment, but I have never seen this low of a level of trading activity in my entire career. I think it reflects the near shut down of the debt markets.

Louise North – Citigroup

Okay.

Mike Inglese

So to value anything right now is a very, very tricky proposition. I think of these assets as long term investments, and we bought them well. We think the residual values are still priced appropriately, looking at the horizons for the leases, and I don't know what else I could say to comment further, but asset valuation is a very tricky thing today.

Louise North – Citigroup

Yes, fair enough. And finally, what progress you have made on placing the 12 A330s that you got on order?

Ron Wainshal

Well, as I said during the prepared remarks, the first three aircraft are signed up. We have a cargo airline taking the first three aircraft. Those are all of our 2010 delivery positions. We are in discussions with I would say half a dozen prospective lessees, in serious discussions, on the next batch. It’s always a bit tricky to get airlines to make commitments this far out in advance. And we are talking about deliveries that are basically more than two years from now and in some cases more than three years from now. In today's market it's a lot more difficult for people to make commitments, but as I said again during the prepared remarks, there is good interest from airlines that are, say Boeing 787 customers. A lot, what I would call, very strong customers that really don't want to buy aircraft for themselves, and instead would prefer to lease, airlines like everybody else are feeling the capital crunch, and leasing is a very efficient thing to do these days.

Louise North – Citigroup

Yes, absolutely. That is great. Thank you very much for your help.

Ron Wainshal

Thank you.

Mike Inglese

Thank you.

Operator

(Operator instructions) And we do have a question from the line of Scott Valentin with FBR Capital Markets.

Scott Valentin – FBR Capital Markets

Good afternoon. Thanks for taking my question. Just in terms of the number of countries you disclosed I think 31 countries as being I guess the lessors, but do you have a break down by region maybe in terms of Asia, Europe, North America?

Mike Inglese

Yes, that's going to be noted in the 10-Q, which is coming out very shortly. I don't think there is going to be any substantial changes versus the last one which we published in Q3. But to give you a sneak review, the breakdown geographically, and this is by net book value, is in Europe, 44%; in Asia 23%; North America, 12%, most of that is in the US; 11% for the Middle East and Africa; 5% for Latin America; and the remaining 5% are basically Sterling aircraft, which are going to three different operators all over the world.

Scott Valentin – FBR Capital Markets

Okay, thank you for that. And in terms of number of lessees, you probably have this in the Q as well, in terms of, it looks well diversified just on average, but can you maybe go through the top two concentrations, three concentrations?

Mike Inglese

Yes, top concentrations are the same as they were before. Biggest customer is Martinair. Martinair is primarily a cargo carrier based in the Netherlands. They were 50% owned by Air France and a shipping company 50%. And over the last several weeks, they are now 100% owned by Air France KLM, so that's our biggest customer. They represent a little bit less than 8% of our portfolio by value. Emirates is our second customer, and US Airways is the third largest customer.

Scott Valentin – FBR Capital Markets

Thanks for that. And then in terms of – you mentioned the new lease rates on the Sterling leases being down a little bit from where they were coming off of. What about lease term? Are you seeing that compress as well? You mentioned the airlines basically reluctant to enter long term contracts right now.

Ron Wainshal

No, I think there are several different leases here. Let me give you a little color on how we approach this. We had one customer that was willing to take the aircraft as-is, and no redeployment costs, but the rate was low. We kept the lease term short, that was three years. Another customer, we had to make a few modifications, like new galleys, and in that case the rental was higher and the lease term was higher. So we had to make some trade-offs there. I'd say the average is around between four and five years, and it is case-by-case still.

Scott Valentin – FBR Capital Markets

Okay.

Ron Wainshal

Generally what lessors try to do in a market like this is if you have a low lease rate, you try to keep the lease term short, and we do credit adjust. So, if we have a customer that’s very strong, we try to keep those guys in generally longer, and if it is a weaker customer then we try to extract a higher return, and more collateral.

Scott Valentin – FBR Capital Markets

Okay. Thanks very much.

Ron Wainshal

Sure.

Operator

Our next question comes from the line of Jamie Baker with JPMorgan.

Jamie Baker – JPMorgan

Hi, Ron. Apologies for getting on the call kind of late. You may have already addressed this, but one or two conference calls ago there was chatter discussion about 330 freighters, possibly working something out with Airbus that those would convert into passenger. Has there been a decision, or any progress made on that?

Ron Wainshal

Well there is nothing new there. Actually during the last Q, we disclosed the basic parameters of what we have agreed. We do have flexibility in our contract, and the way it works right now is the first three aircrafts are already set. Those are freighters. Then we have 5 aircraft that are fixed as passenger, and then we have some flexibility about the remainder.

Jamie Baker – JPMorgan

Okay. That helps jog my memory. And secondly, one of your competitors identified earlier this week that they consider about 5% of their portfolio to be at risk. They didn’t add much color as to how they define that. I am curious if you are also willing to assess the overall risk of your customer base right now?

Ron Wainshal

I don't really know what that means to be honest. I mean I am concerned about everybody, and like I said during the call we are in discussions with our customers all time. We stay in touch with them. In cases where we think there is a fundamental problem we will move. In addition to the two aircraft I mentioned that were in India, there is a third aircraft that is going to expire at the end of the year that we are moving out early so we were able to redeploy during the spring season, during a more favorable time. And that way we removed drama from the revenue stream. But it is a pretty weird market right now, and everybody is under pressure in one sort or another, so I don't know that my characterization here actually has a whole lot of value. We do have folks that we worry about a little bit more based on where they are located, and their particulars, but I don't think it's really appropriate for me to mention any names. I don't think any kind of number here actually really adds all that much. That is not how we think about it.

Jamie Baker – JPMorgan

Well the color is still helpful. So, thank you very much for that, I appreciate it.

Ron Wainshal

The most immediate measure is the accounts receivable which is standing at $1 million, and almost all of that is coming from those three aircraft that are being repositioned. We are still very hopeful we will get paid a majority if not all of that back. But that’s where it stands today.

Jamie Baker – JPMorgan

Got it. Thanks, Ron.

Ron Wainshal

Sure.

Operator

Our next question comes from the line of Rich Shane with Jefferies & Co.

Rich Shane – Jefferies & Co.

Thanks for taking my questions. Most of them have been asked at this point, but are you seeing any airlines with long term leases in place, try to come back at this point and actually negotiate rates down? I mean, the release rates that you just described down from $300,000 a month to $230,000 a month. That’s a pretty significant shift. Are you – is anybody trying to come back and change terms?

Ron Wainshal

The short answer is not really. I mean there are a bunch of guys, and actually this happened a lot more during the summer when fuel prices were spiking. People said look, I am hurting, help me out here. And for the most part, most of those concerns just went away, as fuel prices plummeted. I actually see a lot of this than I expected. There isn't that much in general. And I don’t think it’s tied more to the lease term versus other factors. I think that actually the lease terms we have that are long are what I would say generally with stronger customers, and most of those guys haven't made a peep about that. There are folks that are in trouble and we talk with them and we try to make sure that in cases where it is just a temporary seasonal thing. And again, during the winter, we always have a little bit more drama as it relates to payments. And we are through most of that. We will take to people and see whether it makes any sense to have a short-term deferral, and their repayment [ph] during the summer. We did that with one customer. But I think the amount of restructuring issues at least so far have been a lot less than I expected.

Rich Shane – Jefferies & Co.

Okay. And do the short-term deferrals show up in accounts receivable or is that non-recognized revenue, so it wouldn’t show up that way. So can we see that within the numbers?

Ron Wainshal

Well number one, the amounts that we are talking about here are really very, very insignificant. So, they wouldn’t show up in any way.

Rich Shane – Jefferies & Co.

Okay. Thank you.

Ron Wainshal

Sure.

Operator

And we have no further questions at this time. I would now turn the call back over to Julia Hallisey for closing remarks.

Julia Hallisey

Thank you. This concludes the Aircastle fourth quarter 2008 call. We look forward to speaking with you next quarter.

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