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Aircastle Limited (NYSE:AYR)

Q3 2009 Earnings Call

November 6, 2009 11:00 am ET

Executives

Julia Hallisey – Director of Investor Relations

Ron Wainshal – Chief Executive Officer

Michael J. Inglese – Chief Financial Officer

Analysts

Jamie Baker – JPMorgan Chase & Co.

Richard Shane – Jefferies & Company, Inc.

Operator

At this time I would like to welcome everyone to the Aircastle third quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) I would now like to turn the conference over to Julia Hallisey, Director of Investor Relations.

Julia Hallisey

I’d like to welcome all of you to the third 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 US or 706-645-9291 from outside the US with the replay pass code of 36526839. This call will also be available via webcast on our website www.Aircastle.com in addition to the earnings release and the 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 expectation are detailed in our SEC reports. I direct you to Aircastle Limited’s earning release for the full forward-looking statement legend. Now, I’d like to turn the call over to Ron.

Ron Wainshal

Aircastle’s results during the quarter ended September 30th were once again strong. Earnings and cash flow performance were solid with adjusted net income plus depreciation, a good measure of cash flow coming in at $92.8 million or $1.17 per diluted common share. Our portfolio performance was excellent with fleet utilization coming in at nearly 100%. This has allowed unrestricted cash to grow to $132 million at the end of September. Building on my comments during last call, we see exciting growth opportunities in the market and we started pursuing them actively.

With so many of the leading aircraft lessors on the sidelines or worse, we believe we’re entering an incredibly attractive investment climate and we believe it’s a climate where we can obtain better returns for less risk. During the call I’ll go in to greater detail and address Aircastle’s performance during the third quarter. I’ll 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 have a Q&A session.

Looking at our results, we delivered another strong quarter in Q3 and all-in-all I’m very pleased with how we’re managing our way through the current market’s challenges. I’ll briefly cover the highlights. During the third quarter net income increased to $33.5 million or $0.42 a share versus $27.6 million or $0.35 per share during the second quarter. Adjusted net income during Q3 was also good coming in at $35.7 million or $0.45 per share.

An important driver of our operating performance was our high portfolio utilization rate. For Q3 it was nearly 100% which indicates almost full deployment of our aircraft throughout the quarter. By keeping our fleet in revenue service, our cash flow continues to be strong and as a result our unrestricted cash balance at 9/30 grew by $36 million since June 30th. As of September 30th our fleet stood at 120 aircraft. The average remaining lease term was just under five years and we had 60 customers based in 34 countries. This is a good spread of risk.

We continue to manage our portfolio proactively keeping a close eye on market conditions across the global and on the condition of our customers. We’re also staying on top of receivables. As of this morning, our accounts receivables more than 30 days outstanding totaled about $420,000. To put it in context, this compares to a monthly rental roll of around $43 million or so.

We’re also making sure assets are deployed in their highest and best use. To that end, we delivered to an affiliate of the Chinese post office the first two of four 737 400 aircraft which have been converted to freighters and put on 10 year leases. We expect to deliver the other two aircraft in the next month or so. These are among the first 737 400 Class 6 that have been made in to freighters and I believe our investment will significantly increase the productive lives of these aircrafts. During the quarter we also sold three 737 300 aircraft that were about 20 years old, roughly on a breakeven basis.

On the new investment side, during the quarter we entered in to a commitment with Avianca to purchase and lease back a second A330-200 which is delivering from Airbus in December. As an aside, December is the month in which Avianca will be celebrating their 90th anniversary. We expect to fund this acquisition using ECA backed debt just as we did last time.

Turning to current market conditions we see positive signals both in the industry data and from our customers. Over the past few months, the year-over-year drops in traffic have become smaller. In fact, the overall International Air Transport Association figures for September show a slight increase in revenue passenger kilometers versus year ago results.

South America and the Middle East continue to be relative bright spots and there’s also been a noticeable recovery in many aviation markets. Europe and North America however remain weak. This overall pattern of market strength is consistent with the demand we see in the lease market. I’m encouraged by the brighter and more optimistic outlook several of our Asian and South American customers have been sharing with us recently and to this end for modern narrow body aircraft particularly 737 800s and 320s we believe lease rentals may have bottomed out and started increasing. For older generation aircraft, demand continues to be soft. In short, I think we’re through the worst of it.

Our lease market observations are consistent with the trends we see regarding the fleet of parked aircraft. The proportion of parked aircraft seems to be peaking at a level similar to that of the last downturn which was at its maximum the middle of 2002. More importantly, while the overall number of parked aircraft has grown, much of the increase is in older out of production aircraft, regional jets and 747 passenger aircraft.

These are aircraft that don’t play a role in our fleet and I believe many will never be reintroduced in to service. Significantly, the numbers of parked new generation aircraft have decreased over the past several months as airlines adjust their fleets trading up to more efficient models. With respect to Aircastle’s lease placements we’re making very good progress on getting these aircraft leased. At present we have eight aircrafts coming off lease by the end of next year which we don’t yet have commitments or letters of intent. To put it in context, these aircraft represent about 4% of net book value of our whole fleet.

Rental rates for these aircraft are going to reflect current market conditions and will be lower than current leases and so our approach here is two-fold. Firstly, keep the lease term short so we stand a better chance of benefitting from market improvements and in this regard I expect the average lease term for next year’s roll off will be around four years versus the six plus years we contracted during the past two years’ roll off. Secondly, we’re focusing on better quality leasees rather than on maximizing rents.

So, while our outlook is not more upbeat, we still believe the industry’s recovery is still quite fragile. The winter is always a tough time for airlines. Against this backdrop, our portfolio is performing quite well and we don’t anticipate any major issues this winter. That said, we’re tempering our optimism a bit and we’re remaining cautious and vigilant.

Regarding our Airbus A330 program, the second Avianca deal I mentioned earlier is an advancement of one of our 2012 delivery positions. It’s a deal with attractive economics with a solid carrier on the rise. We’re also continuing to work on sourcing leases and are in active discussions regarding the placement of several aircraft. Let me wind up my remarks by putting our look ahead in the context of where we’ve been as a company.

Aircastle was formed up five years ago as a brand new enterprise. It was a terrific time to build a company and a portfolio and during our first three years we made approximately $4 billion of investments through 56 transactions with 47 different counterparties and we did this while assembling a world class team. We stopped making new investment commitments in late 2007 when we saw the investment climate deteriorate sharply.

During the past nearly two years we’ve focused on solidifying our capital structure and on servicing our portfolio and we’ve done an exceptionally good job during the industries’ worst ever crisis. Overall utilization was more than 98% since the beginning of 2008. At the same time, our portfolio yield has remained essentially flat with the same period last year. While we look at the investment environment now we think this is good, if not a better time to invest than when we first launched the business in 2004.

We believe the buying opportunities over the new two years or so will be the most attractive it has been in quite a number of years. A large number of the major aircraft leasing players are now on the sidelines as they undergo restructurings, struggle with the financial and operational demands of large new aircraft deliveries and grapple with debt maturities. Access to capital will be a critical differentiating factor particularly with respect to debt.

Financial institutions are being extremely selective about their choices of counterparties. Aircastle has demonstrated success in accessing the bank market and the export credit agency market and we believe we can do so now for the right new sale and lease back opportunities or secondary market purchases for aircraft owners in need of liquidity. It’s an excellent backdrop for us. We’re eager to turn our investment – our management team and grow the company’s for new investments. I believe Aircastle’s financial strength top notch servicing capabilities and track record places us in very good position to both source really attractive new investments and to access capital.

I’ll now turn it over to Mike.

Michael J. Inglese

I’d like to spend a few minutes reviewing the business results in the quarter and provide an update on the capital structure and liquidity business. Third quarter total revenues were $165.7 million up $21.3 million from the third quarter of 2008. Q3 2009 revenue included $31.4 million of end of lease maintenance revenue and lease termination payments of $9.4 million both due primarily from unscheduled transitions in the quarter.

These increases were offset by $5.8 million of higher lease amortization compared to Q3 ’08 and $8.3 million of lower lease rental revenue compared to the third quarter of 2008. The year-over-year lease rental revenue decline of $8.3 million resulted from an increase in revenues of $4.5 million related to aircraft acquisitions which was offset by a decrease of $5.8 million related to aircraft sold, $2.2 million related to aircraft and freighter conversion and $4.1 million related to lease rate changes and extensions.

For the third quarter of 2009 the annualized portfolio yield annualized revenue compared to weighted average aircraft assets held for lease was 13.5% essentially flat for the third quarter of 2008. As Ron mentioned earlier during the third quarter we executed on opportunistic sales of three 737-300s one of which was an early return and also negotiated the early return of five other aircraft. All but one aircraft has either been placed, sold or is subject to a sale agreement.

As a result of these negotiated early terminations and sale transactions Aircastle reported incremental pre-tax income of approximately $3 million comprised of end of lease maintenance revenue of $11.6, lease termination revenue of $9.4, gains on the sale of aircraft of $200,000 offset by aircraft impairment charges of $18.2 million in the quarter.

EBITDA for the third quarter of 2009 was $135 million up $5.8 million from the third quarter of 2008 due primarily to higher maintenance and lease termination revenue totaling $35.3 million offset by lower lease rental revenue of $8.3, higher transition costs of $3.8 and $18.2 million of impairment charges. Adjusted net income was $35.7 million or $0.45 per diluted share on revenue of $165.7 for the third quarter of 2009 as compared to $35 million or $0.44 per diluted share on revenue of $144.5 million in the third quarter of 2008.

The increase in adjusted net income reflects higher total revenues of $21.3 million, lower adjusted interest net of $2.2 million, offset by impairment charges of $18.2 million and higher maintenance and other costs of $3.8 million due to lease transitions in the quarter. Adjusted net income plus depreciation and amortization increased over the third quarter of 2008 by $7.5 million to $92.8 million or $1.17 per diluted share. This increase in adjusted net income plus D&A was driven primarily by higher maintenance and lease termination revenue totaling $35.3 million, $2.2 million net interest, impairment charges of $18.2 million, lower lease rental revenues of $8.2 and higher maintenance and other costs of $3.8.

Reported interest net which includes hedge related charges was $43 million for the third quarter 2009. Cash interest expense which excludes all non-cash interest charges and hedge items was $36.8 million for the third quarter of 2009 down $4.4 million from the third quarter of 2008. Third quarter 2009 total SG&A was $11.1 million down from $11.6 million in the third quarter of 2008 and includes non-cash share based compensation expenses of $1.7 million in each of the quarters.

The year-over-year reduction in quarterly cash SG&A of approximately $500,000 was primarily driven by reduced personnel costs and professional fees. Depreciation expense in the third quarter was $53.1 million. At quarter end 2009 our run rate depreciation on a monthly basis is approximately $17.8 million. For the third quarter our tax provision was $1.4 million representing an effective tax rate of 4.1% for the quarter and our full year expectation is in the 6% to 8% range overall.

With respect to capital structure and financing activities, the aircraft portfolio continues to generate strong cash flows and we ended the third quarter with $132 million of unrestricted operating cash and $218 million of restricted cash. At the end of September 2009 we had $2.4 billion of securitization in term debt outstanding comprised of five separate long term facilities with the earliest maturity being September 2013.

With net debt outstanding of $2.3 billion which is approximately 61% of the net book value of our flight equipment. Our net debt to equity ratio excluding the mark-to-market of our interest rate through derivatives was 1.6 times at the end of the quarter. We are in compliance of all relative financial tests in each of our financings and our next required aircraft appraisals for our term financing is March of next year.

Our current [PDP] requirements for full year 2010 are approximately $120 million. Based on our unrestricted cash balance plus our expected operating cash flows from our existing portfolio, we believe we have more than enough liquidity to meet our PDP funding requirements and maintain our current dividend levels through 2010 even without any PDP financing.

Finally, as Ron mentioned earlier we have agreed to acquire a second new A330 aircraft which is to be leased to Avianca in December of this year. Upon deliver the order will be treated as an advancement of one of our existing positioning from 2012 and this acquisition will be funded with ECA supported debt similar to our May 2009 transaction.

With that operator, I think we’re ready to move over to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jamie Baker – JPMorgan Chase & Co.

Jamie Baker – JPMorgan Chase & Co.

Ron, first question juts a basic one on aircraft production, I think most analysts are of the view that Boeing and Airbus are going to have to cut production rates sometime in the foreseeable future. I’m wondering how much of an impact on values, if any, you think that is actually going to have and whether this is even a phenomena that we should be thinking about as we model out your earnings for the next year?

Ron Wainshal

I agree with the contention that production cuts ought to happen. I don’t think that it’s very easy for Boeing or Airbus to reduce capacity once an aircraft is in the production pipeline. So, I was expecting that to happen sooner but other than the Airbus 320 line not increasing as originally planned it’s remained flat for the narrow body aircraft. It has shrunk for the wide bodies, Boeing is ramping on the 777. Any decrease though I think Jamie will be a positive thing, most immediately or rental rates and then down the road for values.

Jamie Baker – JPMorgan Chase & Co.

Second question, could you add some color on the $18 million impairment charge in the quarter particularly with an eye towards fourth quarter if we should be modeling for that sort of things?

Michael J. Inglese

Basically the $18 million of impairment was related to a number of aircraft which had early lease terminations in the quarter. Fundamentally the amount of revenue we recognized or collected from those customers with respect to maintenance revenue and lease termination payments basically offset the amount of the impairment charge. The impairment test simply says what are my future cash flow compared to the carrying value of my asset.

So when you have an early termination particularly on older aircraft you might have a circumstance where you collect those future lease rentals today and then you have to restate your expectations going forward for what you can get out of that asset. That is what drove the impairment in the quarter. We did our full fleet impairment testing during the third quarter and these were the only aircraft that had any impairment charge resulting from that.

Jamie Baker – JPMorgan Chase & Co.

One final one for Ron, any comment as to how the tire kicking of Genesis played out for you guys? We all know the outcome obviously but I’m interested in how serious of a look you took and whether we should assume that M&A is either high or low on your priority list?

Ron Wainshal

Jamie I can’t comment on specific opportunities or situations like that but I think the simplest way to put it is rest assured we look at everything.

Operator

Your next question comes from Richard Shane – Jefferies & Company, Inc.

Richard Shane – Jefferies & Company, Inc.

I have two questions, you made the comment that as you have renewals due in the next year one of the things you are really focused on is improving counterparty risk. What are the characteristics there that you’re looking for? Are there certain geographies or certain types of airlines, how do you define that? Then the second question is given all the disruptions in the industry currently related to bankruptcies and portfolio sales and everything else that is going on, are you seeing any competitive behavior that you think is irrational that’s being driven by sort of exigent circumstances?

Ron Wainshal

First question, a few dimensions, the first thing is the financial capability, the financial health of the airline itself and clearly a big factor there is the environment in which it’s operating. The second one is the jurisdiction in which this airline is operating. So, some places are more straight forward than others. It’s very, very circumstance specific but generally the first thing is, is the airline in good financial shape and that’s usually a pretty apparent thing.

The second question was are we seeing irrational behavior given the turmoil in the world. I don’t think any more than usual but there’s always behavior by certain folks that have financial pressures or other pressures in terms of the way they report results, etc., in terms of getting aircraft leased. I don’t think any more than usual. If it’s happening it’s always generally at the lower end of the aircraft spectrum.

Operator

There are no further questions in queue at this time. I’ll now turn the call over to Mrs. Julia Hallisey.

Julie Hallisey

This concludes the Aircastle third quarter 2009 call. We look forward to speaking with you next quarter.

Operator

This concludes today’s conference call. You may now disconnect.

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