Aircastle Limited Q2 2009 Earnings Call Transcript

Aircastle Limited (AYR)

Q2 2009 Earnings Call

August 7, 2009 12:00 pm ET

Executives

Julia Hallisey – IR

Ron Wainshal – CEO

Mike Inglese – CFO

Analysts

Rick Shane - Jefferies & Co.

[Larry Reeder - Reeder Brothers]

Andrew Light - Citigroup

Presentation

Operator

Good afternoon. My name is [Carrie] and I will be your conference operator today.

At this time I would like to welcome everyone to the Aircastle second quarter 2009 earnings conference call. (Operator Instructions)

I would now like to turn the conference over to Julia Hallisey, Investor Relations. Thank you, Ms. Hallisey, you may begin your conference.

Julia Hallisey

Thank you, [Carrie], and good afternoon, everyone.

I'd like to welcome all of you to the second quarter 2009 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 U.S. or 706-645-9291 from outside of the U.S., with a replay passcode of 18470034. This call will also be available via webcast on our website, 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 fact 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 report. 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. Welcome to the call.

Aircastle had another good quarter for the period ended June 30th. Earnings and [inaudible] performance were solid, with adjusted net income plus depreciation coming in at $81.4 million or $1.03 per diluted common share.

Our portfolio performance was good, with utilization coming in at 98%, as we discussed during our last quarterly call.

All of our aircraft are on lease at the end of Q2 and we enhanced the portfolio through both the acquisition of a new A330 aircraft and the completion of our first ECA-backed financing. And for the first time in quite awhile we see interesting growth opportunities starting to materialize.

During the call I'll go into greater detail and address Aircastle's performance during the second quarter of 2009, discuss what we're currently doing on a day-to-day basis to manage the business, and then cover the opportunities we see ahead. Mike Inglese will speak to our financial highlights and then we'll get into the Q&A.

Looking at our results, strong execution resulted in another good quarter, even against very tough market conditions. During the second quarter total revenues rose to $136.9 million from $132.1 million during Q1 2009 and we recorded net income of $27.6 million or $0.35 per diluted common share.

The Q2 results reflect the positive impact of having all the x Sterling aircraft back in service. Thanks to strong continuing cash flows generated by our business, the company's liquidity position remains good. Unrestricted cash on June 30th was nearly $96 million and this is after making $32 million of pre-delivery and freighter conversion payments and also acquiring a new aircraft during the second quarter.

Our portfolio of 131 modern aircraft is performing well. As I mentioned, utilization during Q2 rebounded to 98% and we expect it to remain at or above this level during Q3. As of June 30th the average remaining lease term was five years and we had 60 customers based in 35 countries. As shown by these diversification measures, we believe our portfolio has a good spread of risk.

During the second quarter we delivered seven aircraft and freighter conversion of four 737-400 aircraft is nearly complete, with the first aircraft expected to deliver to an affiliate of the Chinese post office later this month.

Accounts receivable are currently in good shape, with amounts outstanding more than 30 days currently totaling approximately $400,000.

We continue to manage our portfolio proactively and we've reduced our exposure in areas where market conditions are especially difficult. To this end, since the end of the first quarter we completed a transition of an A320 and signed a lease to transition a 767-300 ER to a new operator. We expect this aircraft to re-enter service imminently. These transactions better position the portfolio as we look ahead to seasonally slow fall and winter months.

And here's some bigger picture results of our efforts: Our exposure in India was 11 aircraft at the beginning of this year and it's now down to three. We transitioned our only aircraft in Mexico out last month, working with a customer seeking to address capacity issues in the wake of a huge drop in traffic following the swine flu outbreak. We also managed our exposure in Eastern Europe down a bit, which is not only suffering from poor economic conditions but also considerable currency devaluations. In each of these cases we succeeded in working things out with our customers constructively before things got worse. We believe our ability to directly and adeptly manage our assets is one of the key attributes that sets Aircastle apart.

I'll now turn to general market conditions and their affect on our business. As you know, airlines and air freight carriers have been experiencing significant revenue declines driven by lower traffic levels and decreasing yields. Passenger travel this month has generally been weak, particularly for the premium and long-distance markets. These conditions are very challenging for airlines and we expect that they'll remain so through the winter. On the other hand, air cargo continues to make a modest seasonally adjusted recovery, though overall traffic levels and yields remain low.

In the aircraft market we're seeing capacity adapting to falling demand in two ways: Planes are getting taken out of service or flown less and production of new aircraft is being cut, and capacity reductions, particularly important in the cargo market, where we estimate 15% to 20% of the world's Western-built freighter fleet was removed from service during the past 12 months.

On the new aircraft front manufacturers are announcing production cuts for both passenger and cargo planes. For example, Boeing announced that it would reduce output of the 777 wide body by 30% beginning late next year and Airbus is planning to reduce A320 capacity by two units a month next year and is ditching plans to increase A330 production. Also, the delay in the 787 is in effect a meaningful production cut. We continue to believe that more cuts are very possible given both the drop in traffic and the rough capital market conditions.

As I mentioned during our last call, there's been more traction on our lease placement efforts during the past few months as fear about the worst begins to dissipate. Nevertheless, demand for aircraft remains soft and, as in the past, we believe the lease market will likely lag the overall economy in its recovery as airlines take a cautious approach to their fleet plans.

We're optimistic that we'll see a modest recovery in 2010, however, but we're managing our portfolio conservatively. And what I mean by that is getting placements done well in advance of lease end, keeping new lease terms short, continuing to emphasize better credits and jurisdictions by choosing lease counterparties, and maintaining a keen eye on our portfolio.

There are some brighter spots, with domestic Chinese traffic continuing to recover strongly and South American, Middle Eastern and African markets holding up reasonably well. The affect of the cargo markets' recovery, particularly long haul, will be evident during the balance of the year, as traffic is seasonally stronger during the second half.

Turning to placements, we've got only one unplaced aircraft with a scheduled lease expiry this year. It's an A319 coming off lease during the fourth quarter and we've been remarketing it actively. For 2010, nine of the 19 scheduled expirations have been addressed to date. Two are 757s subject to signed forward sales agreements, seven are aircraft that have been extended or placed on new leases, and we're working hard on the rest. Rental levels have softened this year and we expect overall rentals on the schedule of 2010 lease rolloffs to be below the levels of existing leases.

Looking a little bit ahead to 2011, of the 11 aircraft with scheduled lease expirations that year, three have been recently extended and one aircraft is subject to a forward sales agreement, leaving seven to go. All in all we have a total of 18 scheduled aircraft placements left to complete through the end of 2011 relative to a portfolio of 131 aircraft. This is a very manageable task for us.

Turning to our Airbus A330 program, we're continuing to make good progress here. In May we acquired a new A330-200 on a long-term lease to Colombia slag carrier, Avianca. In addition to purchasing a good aircraft leased to a fine airline with attractive deal economics, we've now done our first ECA-backed debt financing and we believe this should facilitate future similar transactions. As Mike will describe further, this financing was well priced, benefiting from a guarantee by Coface, the French government's export credit agency.

We're continuing to work on new A330 placements. Our first available position is in April 2011 and we're focused on securing customers for this and the other four unplaced aircraft scheduled to deliver that year. In this regard, greater emphasis on capital preservation by airlines is leading more to consider leasing than buying. Further, 787s are also a plus for A330s, creating new placement opportunities. In addition, we're also pursuing other order stream advancement opportunities similar to the Avianca transaction.

Let me conclude by spending a few moments looking ahead.

The current environment presents a great opportunity for Aircastle for two reasons: Firstly, capital remains scarce for the aviation industry; and secondly, many lessors and airlines have significant long-dated financial commitments that will be very difficult for them to honor.

We're keeping an eye out for how to capitalize on these situations, particularly for new aircraft, and we believe we're in a great position to take advantage of these potential growth opportunities because, first, we've managed our portfolio well and built a great team with the capacity to manage significant additional assets. Second, we've put in place a solid capital structure; our entire portfolio is long-term financed, with no near-term debt maturities. And, third, we have proven access to additional capital, particularly government-backed debt markets like ECA and Exim and the equity markets.

I'll now turn it over to Mike.

Mike Inglese

Thanks, Ron.

I'd like to spend a few minutes reviewing business results for the quarter and provide an update on our capital structure and financing activities.

Second quarter total revenues were $136.9 million, down $8.5 million from the second quarter of 2008. Lease rental revenue was $8.2 million lower compared to Q2 '08, resulting from the combined effects of revenue downtime from transitioning aircraft and aircraft and freighter conversions of approximately $5 million, the impact of net dispositions across the year of $2.7 million, and changes in floating rate leases of approximately $700,000.

Second quarter revenue included $9.6 million of end of lease maintenance revenue, a $5.5 million increase compared to Q2 '08, primarily resulting from unscheduled transitions, which was partially offset by $5.3 million of higher amortization of net lease discounts and lease incentives compared to second quarter 2008.

EBITDA for the second quarter of 2009 was $125.6 million, down $11.8 million from Q2 '08 due primarily to lower lease rental revenues of $8.2 million and higher transition costs of $3.9 million compared to the prior period results.

Adjusted net income, which excludes gains and losses from asset sales and certain charges related to our interest rate hedge agreements, was $26.9 million or $0.34 per diluted share on revenue of $136.9 million for the second quarter of 2009 compared to $34.3 million or $0.44 per diluted share on revenues of $145.5 million in the second quarter of 2008. The $7.4 million decrease in adjusted net income reflects the lower total revenues of $8.5 million, higher transition costs of $3.9 million, which was partially offset by lower interest expense net of $5.4 million compared to the prior period.

Adjusted net income plus depreciation and amortization for Q2 '09 was $81.4 million or $1.03 per diluted share. The $81.4 million was down only $2 million from Q2 '08 driven by lower lease rental revenues, higher transition costs, offset by higher lease maintenance revenue and lower interest expense.

As we've discussed on our last call, the primary factor driving the reduced lease rental revenue and increased transition costs on a year-over-year basis were related to the repossessions in Q4 '08 and Q1 '09. Our fleet revenue utilization during the second quarter of '09 was 98%, up from 96% during the first quarter of 2009, reflecting the transitioning aircraft coming back into service. At June 30, 2009 we had all our aircraft on lease.

For Q2 '09, total SG&A was $11.1 million, down from $11.4 million in the second quarter of 2008, and includes non-cash share-based compensation expenses of $1.7 million for the second quarter of 2009 and $1.6 million for the second quarter of 2008. The year-over-year reduction in quarterly SG&A was driven by reduced personnel costs and professional fees.

Reported interest expense net, which includes hedge-related charges, was $41.5 million in the second quarter of 2009 and is net of $400,000 of interest income earned on cash balances and approximately $300,000 of capitalized interest during the quarter. Gross interest expense on our financings for the quarter excluding the hedge items was $42.2 million on weighted average debt outstanding of approximately $2.5 billion, for a weighted average cost of funds of approximately 6.83%.

At the end of the quarter we had $2.4 billion of net debt outstanding, which is approximately 62% of the net book value of our flight equipment.

Depreciation expense for the quarter was $51.7 million, essentially flat compared to the second quarter of 2008. And at quarter end, our run rate depreciation on a monthly basis was approximately $17.3 million.

For the second quarter, the tax provision was $2 million, $1.7 million of which was deferred, for an effective tax rate of approximately 6.9%, reflecting the revenue and income sourcing mix from the portfolio during the quarter. For the full year, consistent with prior years' guidance, we believe the effective tax rate will be in the 5% to 10% range this year.

At second quarter end all of our aircraft were on lease or in freighter conversion. As Ron mentioned earlier, after the end of the second quarter we completed an early return of one 767-300 that was on lease to an airline in Mexico. We have a signed lease for this aircraft and expect to have it back on lease in August. Also after the end of the quarter we completed one early return of a 737-300 Classic aircraft and we have LOI to sell this aircraft during the third quarter. The impact of this downtime should be minimal and we anticipate our third quarter utilization to be at or above the 98% level reported in Q2 2009.

On the capital structure and financing front, we ended the second quarter with $96 million of unrestricted operating cash and approximately $199 million of restricted cash, and the portfolio continues to generate strong cash flows.

As Ron mentioned earlier, in May we took delivery of our first A330-200, which was financed with a $71 million term loan supported by a guarantee from Coface, the French government-sponsored export credit agency. The loan is a 12-year fully amortizing loan and bears interest at a fixed rate of 4.475%.

At the end of the quarter we had approximately $2.5 billion of total securitization and term debt outstanding, comprised of five separate long-term facilities, with the earliest maturity being in September 2013.

We are in compliance with all relevant financial tests in each of our financings and our next required appraisal is for our term financing number two, which had approximately $134 million outstanding at quarter end 2009. We currently do not expect any LTV issues with respect to that test, which comes in September of this year.

As we've discussed on previous calls, given current capital market conditions we're not expecting to have a PDP facility in place until some time maybe next year, and during July we deferred one aircraft delivery position from December of 2010 to July of 2011. That leaves our current PDP requirements for the remainder of 2009 totaling approximately $43 million.

Based on our 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 current dividend level through the remainder of 2009 and into 2010, even without securing any PDP financing.

And with that I'll turn it back over to Ron for some closing comments.

Ron Wainshal

Thanks, Mike.

To conclude, we're very pleased with our second quarter results, which I believe reflect excellent execution by a world class team. We remain bullish about the long term as we see global air travel and air cargo continuing to grow over time. We also believe leasing companies like Aircastle will own an increasing share of the world's fleet.

In the meantime, the current market dislocations are starting to present some exciting opportunities for well positioned companies like us to grow. I think the critical success factors for growth today are having a strong existing platform, capital structure stability, and access to additional capital, particularly government-backed debt like ECA or Exim, and Aircastle has all three.

Operator, we're ready to proceed with the Q&A portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Rick Shane - Jefferies & Co.

Rick Shane - Jefferies & Co.

Given what's happening with aircraft prices, what is your appetite at this point to add new planes through any acquisitions? Again, we realize that you want to be really judicious in terms of use of capital, but are you seeing things out there that sort of want to move you off the sidelines?

Ron Wainshal

So far we haven't seen too many distressed opportunities in the more modern aircraft side. There's a lot of more obsolete aircraft trading at quite low levels compared to last year.

We are seeing a few opportunities, though, on new aircraft as airlines look to preserve capital on their purchases. And I think hanging around the rim with the manufacturers might present opportunities as well.

Our appetite is a function of the deal economics.

Rick Shane - Jefferies & Co.

So realistically, the bigger opportunity may be sale and leaseback transactions as opposed to portfolios trading in distressed scenarios?

Ron Wainshal

We'll look at everything. I think portfolios trading in distressed scenarios can be one aircraft or it could be many, many aircraft and it's really hard to gauge that.

I think there's a predictable flow of newer aircraft which you can get a pretty good sense on the economics, particularly given the debt side of it. If you have access to ECA or Exim financing, as we do, it's much easier to get a sense for what the overall deal looks like to our investors.

Operator

(Operator Instructions) Your next question comes from [Larry Reeder - Reeder Brothers].

Larry Reeder - Reeder Brothers

I've got a question that kind of builds on the question I asked you about a year ago. I made reference then and requested color on the value of net assets, the value of the planes, and in my remarks I mentioned that AirCab used to always mention how their aircraft had asset values over $1 billion higher than the way they showed it on the balance sheet. And at that time I asked you guys to take a shot at or give me some insights as to your own, say, marked-to-market, and in a long way you basically said that you, too, had a lot of hidden value. I think at the time it was $500 or $600 million. And, of course, then we went through the malaise and a decline in the value of these assets, and now I assume we're going through a recovery.

Where would you think we are now on the value of aircraft? Do we have a little hidden value where, if you had to actualize value on the aircraft, we would have a little more than what we show or would we be under water in a minor sort of way.

Ron Wainshal

It's really hard to put values on anything today and I'll just make this comment.

There are appraisals out there and they serve a purpose. The most significant impact they have on companies like us is in the form of calculations for loan-to-value tests. But there are very, very, very few deals getting actually executed, so when you talk about what are real transactable values, it's really tough to peg. And I don't think this is unique for aircraft; it's pretty much across a lot of asset classes. The difficulty is that there's no debt. You might find an aircraft here or there that trades close to a current market value estimate from an appraiser, but valuing a whole portfolio is a very challenging thing.

I think the hidden value in our company is actually in the enterprise itself. I know a lot of people have kind of taken a view well, let's just go get appraisal numbers on the company and put a value on that and that's it. I think the value of Aircastle is not only in its hard assets but in its people.

And I think the portfolio performance we just showed in this quarter is outstanding, and I think our ability to source attractive investments is another thing that sets us apart from most of the other players in the industry.

So the short answer is I can't really give you a great sense for that because I don't know how much I'll trust any of the appraisal numbers.

Larry Reeder - Reeder Brothers

Well, am I correct in saying that during the malaise that we went from having a fairly significant amount of value in that sense to quite a discount at the bottom of all this difficult period? Am I correct in saying that, given credit markets are unfrozen and life has proved the sky didn't fall, that we have made a significant recovery from bottom in terms of whatever the values are - that there has been improvement? Would that conceptually be correct?

Ron Wainshal

I don't know that I would predict - I'd be saying that there's a recovery right now. I would say there's probably been a stoppage in declines; maybe that's a better way to put it. There has been a rally in the capital markets and that helps with valuations to the extent that you want to apply a theoretical basis.

But this is a cyclical industry. It always has been; it probably always will be. And the key to it is what do you think about the investments on a long-term basis. And if you're not a forced seller - and we're definitely not - the current market values are less of a relevant indicator.

Operator

(Operator Instructions) Your next question comes from Andrew Light - Citigroup.

Andrew Light - Citigroup

Is there a risk of impairment? Would you agree that older aircraft and freighter planes have probably dropped in value in the secondhand market more than the newer types and the passenger types, and that with - I can't remember now - 13 or so aircraft coming up for renewal next year, what would it take for there to be an impairment charge? Would it be not being able to place the aircraft for a few months or what?

Ron Wainshal

Well, impairment may mean two different things here. One, there's an accounting term which is a technical thing which I'll let Mike cover in a moment.

When I think of impairment economically I'm thinking of something that is affecting the long-term value of an aircraft, okay? As I mentioned just a moment ago, we're in the midst of a sharp cyclical downturn and if you don't have to be liquidating an asset the current market value is not, in my view, relevant for an impairment.

There are some aircraft that are definitely not going to bounce back, though, from this downturn. The MD-80s come to mind. There's no doubt that older technologies are getting hit badly. There's a drop in overall demand and there's also pressures on the environmental and fuel efficiency side, not to mention maintenance costs, which are always there. And the most marginal aircraft always come out. I think there's impairment on those.

I don't believe there's impairment in the economic sense on our portfolio.

Mike Inglese

And, Andrew, just to focus on accounting impairment, you take into account your view of the recoverable cash flows from the asset over its entire economic life. And typically every re-lease is going to be downtick in rental and that's what we generally assume when we do our impairment assessment.

So to date through the end of the second quarter we have not recorded any impairments and I can't sort of generalize or specify and say an extra X% of lease rental decline would translate into some impairment.

It's a very asset-by-asset specific assessment.

Andrew Light - Citigroup

But wouldn't it be fair to say that if you have a plane on lease with another at least five years to go that there's going to be no impairment on that plane unless there's a default or something like that?

Ron Wainshal

Unless that or there's some condition that makes you think that that aircraft - the residual value of an aircraft should be recessed.

Andrew Light - Citigroup

I'm just going to ask you another accounting question. Your maintenance rents, I think, jumped to about $9 million in the quarter from around $6 million, I think, or [inaudible] $6 million in the first quarter. And also the amortization of lease discounts went up from $1.1 million to $2.8 million. Have those risen to the state of renewed levels perhaps because of the new plane you got or are they very much one offs?

Mike Inglese

It's still going to be a one off kind of quarter by quarter issue dealing with whatever leases happen to terminate in that quarter and whatever lease incentives get embedded into any new leases greenfield. So it's very hard to sort of run rate it or annualize it for you.

Ron Wainshal

That's one of the reasons we broke it out.

Andrew Light - Citigroup

So it's nothing to do with the new A330?

Ron Wainshal

No.

Mike Inglese

No.

Operator

That concludes the Q&A portion. I would now like to turn the call over to Julia Hallisey for any closing remarks.

Julia Hallisey

Thank you. This concludes the Aircastle second quarter 2009 call. We look forward to speaking with you.

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