Fly Leasing Limited (NYSE:FLY)
Q3 2016 Earnings Conference Call
November 16, 2016 9:00 AM ET
Matt Dallas - Manager, Investor Relations
Steven Zissis - President and Chief Executive Officer, BBAM
Colm Barrington - Chief Executive Officer
Gary Dales - Chief Financial Officer
Jason Arnold - RBC Capital Markets
Helane Becker - Cowen & Co., LLC
Gary Liebowitz - Wells Fargo Securities, LLC
Richa Talwar - Deutsche Bank Securities Inc.
Good day, ladies and gentlemen. Welcome to the FLY Leasing Third Quarter 2016 Earnings Conference Call. At this time, all participant lines are in a listen-only mode to reduce background noise. But later we’ll be holding a question-and-answer session, after the prepared remarks and instruction will follow at that time. [Operator instructions]
I would now like to introduce your first speaker for today, Matt Dallas, you have the floor sir.
Thank you. Good morning, I’m Matt Dallas, the Investor Relations Manager at FLY Leasing. And I would like to welcome everyone to our third quarter 2016 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 flyleasing.com. We have a slide presentation that accompanies today’s call; it 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 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 audio. Representing the Company today on this call will be Colm Barrington, our Chief Executive Officer; Gary Dales, 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 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. FLY expressly disclaims any obligation to update or revise any of these forward-looking statements whether because of future events, new information, a change in its views or expectations, or otherwise. An archived webcast of this call will be available for 90 days on the Company’s website.
And I would now like to hand the call over to Steve Zissis, the President and CEO of BBAM. Steve?
Thank you, Matt, and welcome to FLY’s third quarter earnings call. I’d like to update you on the industry conditions and the outlook for FLY. Like our peers we are seeing very strong industries fundamentals including record airline profits, a strong secondary trading environment for middle aged aircraft and robust bank and debt capital markets conditions.
Our airline customers are performing exceptionally well as evidenced by our 100% fleet utilization and negligible receivables balance. We are still seeing strong demand for our aircraft without any signs of weakness. In fact, we only have a handful of aircraft still available in 2017 and none until the fourth quarter of that year. Airlines appear to be maintaining or growing their fleet and we are noticing that they are making fleet decisions earlier suggesting confidence in future passenger demand.
While it's difficult to generalize about lease rates, we have seen stable lease rates for the aircraft we have remarketed this year. And in some cases even slight improvements over their prior leases. We're happy to report that FLY has essentially completed the disposition part of its fleet renewal plan embarked on approximately 18 months ago. Over the past year and a half FLY had significantly transformed its fleet. We have sold 60 aircraft almost all are older planes at prices above book value.
Reduced the sale proceeds to buy approximately 1 billion of basically brand new aircraft. As a result FLY now has second youngest fleet among the public lessors at 6.2 years of age and one of the longest average remaining lease terms at 6.7 years. We are very proud of the turnaround that we have achieved. We continue to see robust market and strong prices for selling aircraft.
While the origination market remains competitive we have sourced attractive opportunities and through the first nine months of the year we have acquired over 500 million of new aircraft. We will add this figure to the fourth quarter although we now expect to fall a little shy of our $750 million target.
We've always said that our strategy is to buy right and to avoid the temptation to grow for growth sakes. The metrics for our 2016 acquisitions bear this out. Our new aircraft will make significant improvements to our net income and return on equity. You're beginning to see these results show up in the quarter's results as well as in our guidance.
BBAM’s global platform provides FLY access to wide array of acquisition opportunities. And I'm confident despite the competitive end market that we will find attractive acquisitions. I previously mentioned that FLY contracted to acquire five A320 NEO’s in 2017. Given the delays with the new engines this transaction is likely to be delayed. That said we are evaluating additional NEO and MAX sale lease opportunities.
The market has not fully appreciated FLY’s transformation, nor has the market recognized the value in FLY’s fleet or the value created by the relationship BBAM has built over the many years with our airline customers, our financing partners and other market participants. Our shares continue to trade at significant discount to book value. As a result FLY has continued to repurchase shares and the BBAM shareholders have increased their ownership of FLY to 13% which is by far the largest insider ownership in the sector.
I’d now like to hand the call over to Colm.
Thank you, Steve, and good morning, everyone. Thank you very much for joining us. FLY had a very positive third quarter which is reflected in our net income and earnings per share. While these figures include recognition of a one-time tax benefit as Gary will explain further later on. The underlying earnings were also satisfactory with adjusted net income and adjusted earnings per share of $17.3 million and $0.53 per share respectively.
These results highlight the success of our continuing shareholder enhancement initiatives. We are specifically selling older less profitable aircraft at gains to book value while generating liquidity. Secondly, we are acquiring newer more profitable models. And thirdly, we are executing significant share repurchases. In the quarter FLY invested $467 million in predominantly young aircraft on long-term leases.
We also spent approximately $10 million repurchasing nearly 900,000 shares at an average cost of $11.34 per share. We also continued to sell aircraft at gains, completing the sales of three older aircraft for a gain of $4.1 million, which was a 19% premium to our book value. Meanwhile and reflecting the strong state of the global airline industry, we had 100% fleet utilization and end of the quarter with negligible lessee receivables.
All these factors contributed to the strong earnings described above that put FLY in a very solid financial position at quarter end with a non-restricted cash balance of $325 million and $539 million of unencumbered aircraft. This financial capacity gives FLY significant firepower to continue to invest and enhance shareholder value further.
We continued our fleet renewal program with the completion of all of our 20 previously announced aircraft sales. These aircraft at an average age of 15 years under our leases with an average remaining term of three years. And importantly, the sales of these older less profitable aircraft produced an aggregate gain of nearly $10 million over FLY’s net book value through the first three quarters of 2016.
So FLY continues to demonstrate that it can sell its older aircraft at premiums to book value. We are pleased to announce that we have identified seven additional aircraft sales of which two have already closed in quarter four and the other five are expected to close by year end. The average age of these seven aircraft is 12 years while the sales prices are expected to be in excess of net book values.
FLY continues to acquire aircraft selectively and opportunistically. So far this year we have acquired eight aircraft for a total of $510 million. These eight aircraft have an average age of two years under our leases that average 11 years. And yesterday our Board of Directors approved the acquisition of two more narrow-body aircraft, but closing is expected before year end. The eight aircraft acquired this year have reduced our fleet age yet again and have lengthened our average lease term. They are also expected to contribute $19 million in annual pretax income with the consequential positive impact on FLY’s return on equity.
We have the financial capacity to acquire more than $2 billion of additional aircraft. And using the global network and expertise of BBAM, we will continue to pursue selective acquisitions provided that we can acquire the aircraft at attractive prices and provided that the acquisitions are accretive to shareholder returns. FLY will continue to pursue growth aggressively, but prudently.
The combination of sales of older aircraft in the purchase of younger aircraft that have a significantly positive impact on FLY’s fleet metrics. At the end of Q3, our average fleet age would reduce to 6.2 years and 11% reduction from a year earlier. Meanwhile, our average lease term which increased from 5.9 years to 6.7 years, a 14% increase. As Steve mentioned, FLY now is the second youngest fleet of any of the public lessors and one of the longest average lease terms. This is a major transformation of our fleet.
FLY continues to actively purchase its own shares. In quarter three, we purchased nearly 900,000 shares and since September 2015, we have repurchased a total of 22% of FLY’s shares. The repurchase completed since September 2015 have been at a 34% discount to our quarter three net book value per share and had a positive impact on ROE and earnings per share. We expect to continue with our share repurchases and had $69 million remaining in our current repurchase program at the end of quarter three.
Selling older aircraft at well above book value and repurchasing shares as well below book value continues to be a great trade for FLY and for its shareholders. FLY’s fleet transformation and share repurchase have been hugely accretive to shareholder value. At the end of quarter three FLY’s net book value per share had increased to $19.99 up $2.50 from year earlier and showing a 11% compounded annual growth rate since quarter two 2015. This has resulted directly from the initiatives described above.
Meanwhile, we continue to focus on liability management. FLY’s has always adopted to relatively conservative financing strategy seeking to match debt maturities to lease terms and adopting similar conservative strategies to our interest rate hedging. These strategies will serve us well if interest rates continue to rise in the coming months.
In this context, we recently extended maturity date of our $410 million term loan from August 2019 to February 2022. Our average debt maturity is now seven years just beyond our average lease term of 6.7 years. We believe that this removed significant risk from FLY’s capital structure. Once again FLY demonstrated its ability to available market conditions and a strong credit profile and debt markets to lock in benefits for the Company and for its stakeholders.
With that, I’ll handover to Gary to take you through the quarter and year-to-date numbers.
Thank you, Colm. We are reporting net income of $22.9 million or $0.70 per share for the third quarter of 2016 and $34.7 million or $1.03 per share for the nine months ended September 30, 2016. Our rental revenues for the third quarter of 2016 were $82.7 million. This is a 12% increase over rental revenues last quarter. The decline when compared to the third quarter of 2015 is due to our aircraft sales.
During the third quarter of 2016, we recognized $4.1 million and gains from the sale of three aircraft versus a sale of 15 aircraft and gains of $13.6 million in the same quarter last year. As I'll discuss when I get to guidance, we intend to sell more aircraft in the fourth quarter generating additional gains.
Total expenses for the third quarter of 2016 were $71.2 million. This compares to restated expenses of $82.2 million for the same period in the previous year. The decrease is due principally to lower interest expense, lower debt extinguishment costs and lower maintenance expense, which were offset by an increase in depreciation. The decreases are driven by aircraft sales.
Our interest expense was decreased by $5.1 million reflecting more than $800 million of debt repaid from proceeds of aircraft sales and regular amortization. The $1.3 million increase in depreciation in 2016 is due to the fact that under GAAP aircraft classified is held for sale or not depreciated.
During the third quarter of 2016, only two of our aircraft were classified as held for sale. While during the same quarter last year we had 45. Depreciation been recorded on the aircraft were held for sale, our depreciation expense in the third quarter of 2015 would have been approximately $13 million higher.
Below the line, our third quarter 2016 results include an $8.8 million tax benefit. This is principally due to our use of deductions to offset income tax on earnings repatriated during the quarter. Cash taxes will not be due on repatriated earnings. This is a one-time benefit and it is excluded from our calculations of adjusted net income and adjusted earnings per share.
Now let me cover a few items of guidance. For the fourth quarter of 2016, we are expecting operating lease rental revenue to be between $81 million and $83 million. We expect amortization of lease incentives to be between $1 million and $2 million. We expect end-of-lease income of up to $2 million. We have identified eight aircraft that maybe sold in the fourth quarter. We expect to generate gains of $12 million to $14 million provided they all close.
Depreciation expense is expected to be between $30 million and $32 million. We expect interest expense of between $30 million and $31 million. In connection with the repayment of debt associated with the aircraft sales. We expect to incur $2 million to $3 million of in debt extinguishment costs.
Maintenance and other expenses again are expected to be $1 million or less. And SG&A expense will be between $7 million and $9 million. Before I turn the call back to Colm I want to call your attention to the appendices, where we have our cap table, and reconciliations of our adjusted net income and adjusted SG&A.
With that, let me turn it back to Colm for his closing remarks.
Thank you, Gary. Well, we are pleased to be wrapping up a solid quarter for the massive transformation of our fleet and the shift to newer higher earning aircraft is having a positive impact on the financial results and on shareholder value. We have now completed many of the initiatives which we commenced last year and the strong market for purchasing midlife aircraft allowed us to move on some of our older and less profitable assets, which generated gains to book value and generates the significant liquidity.
We've also been repurchasing our shares to be trading at a discount to book value. We’ll continue to execute on these initiatives going forward, including selling older aircraft, prudently investing in newer aircraft, managing our liabilities and reducing our cost of debt and repurchasing our shares while that continues to be a disparity between our book value and the share price.
There is a strong value in FLY’s portfolio of aircraft and leases. Our fleet is now one of the youngest in the sector and is fully utilized on leases that have longer-terms in most of our peers. This value is being reflected in our steadily growing book value per share which is now just under $20 per share. Looking ahead we have the firepower to acquire more than 2 billion worth of new aircraft directly but prudently pursuing deals with a focus on new generation aircraft types.
With that, I think we’re ready to take your questions.
[Operator Instructions] We’ll be taking our first question from the line of Jason Arnold from RBC Capital Markets. Your line is open.
Hi, good morning, guys. As you mentioned you have plenty of capacity to add more to the fleet. So just curious if you could talk about the acquisition pipeline in a bit more detail and maybe comment on where you're seeing the most appealing opportunities right now?
It's a good question Jason. We're not seeing a lot of good opportunities. I would say that our pipeline going forward looks relatively thin at the current moment, but it probably trend around the $500 million range which is slightly below our $750 million target that we have. Well look things could change and with interest rates increasing recently and the stronger dollar we do expect to see a lot more opportunities now pop up in the marketplace.
Super. And then I guess maybe related to that you know maybe you can talk about the appetite for buybacks. I guess presumably with maybe slightly fewer fleet acquisition opportunities if that ends up being the case that you would be able to perhaps put that money towards buybacks?
Well, yes, we said on our call Jason we got very significant liquidity and firepower to both acquire aircraft and to buy shares. In the last year our net book value per share has gone up by $2.50 to just $20 a share today. So we are certainly enthusiastically repurchasing shares in the market and hope we expect to continue to do so.
Okay. Thanks very much guys.
Thank you. Our next question comes from the line of Helane Becker from Cowen & Company. Your line is open.
Hi, guys, thank you for the time. I just have a couple of questions. One on the SG&A since I'm not sure why it's such a big percentage of the - your revenue like on Slide 17 it's shows adjusted SG&A 9.5% up 6.9%. And I'm kind of 100% certain why it's increasing given the size of the fleet?
Well, Helane in the last quarter you have noted we purchased nearly $500 million worth of aircraft and we had acquisition expenses related to those purchases. So that is the most significant increase in SG&A for that quarter. We expected to trend downwards as the year goes on and in 2017.
Okay. Maybe that was really my question, how we should think about it going forward, so it is like getting back to 7% of revenue something that we should think about?
7% to 8% revenues we expect, yes.
Yes, okay. That's better. And then my other question is…
Sorry, one more point in that Helane you know that we do have quite considerable thought process, so as we grow the asset base and the revenues as we invest in additional aircraft then obviously SG&A will trend downwards as well.
Right. That's true. But I mean theoretically you should be able to handle more aircraft with the same number of people.
That's right, yes.
Right, getting back to at least the size of the fleet before you started to sell older aircraft.
You are right.
And then the aircraft I think you said you had seven more aircraft to sell, two already closed. Can you say what those aircraft are and I think you have some A340s, A319s and 757s in the fleet are those the ones that you're selling?
No these are mainly narrow-body. They're all narrow-body aircraft older 737, 800s and A320s.
Okay. What about those like the A340?
Well the A340s are still on relatively long-term leases, those leases still have about three years to run so those are still in our portfolio.
Gotcha. Okay. All right. Well that's - those are really the questions I had and the first person actually asked my other question.
Thank you. Thanks guys.
Thank you. Our next question comes from the line of Gary Liebowitz from Wells Fargo Securities. Your line is open.
Thanks, operator. Good day, gentleman. Can you tell us how fourth quarter utilization is shaping up? I only ask as I thought you’ve had a couple of planes that you’re expecting extensions on, but those might not have been happening?
So we have 100% utilization. We've got one aircraft that is transitioning to a new lessee in December and as all these transitions that sometimes they go a little longer than you think, so it might go into the new year, but all our fleet is totally leased out, and Gary we don't have anything available on FLY’s fleet until November and December next year and those six aircraft that we have available and we expect half of those to be extended and the other half to be remarketed. So we don't have much available in the first three quarters of the year.
Okay, great. And then to follow-up on earlier question, Steve can you talk about there's obviously a lot of competition in the sale leaseback market. I wonder if you can just go one step deeper, is it even more competitive when it comes to NEO and 737 MAX competitions versus the current generation aircraft?
Well it really depends on the airline and the size of the deal and when the deliveries are coming. In some cases they are more competitive than the COs and the NGs, but in other cases we've seen kind of trend around the same level as what we're seeing in the NGs today, so it really just depends. The market is pretty competitive, but we're cashed up. We've got a lot of firepower as Colm had said. And we either can buy our shares back, we can delever the balance sheet or if we see good opportunities in the marketplace, we will execute on acquiring aircraft.
We are kind of unlike our competitors and that we don't need to grow for growth sake. We will only grow when we find good opportunities. And so as the market kind of transitions and digest kind of the new elections, international growth, and higher interest rates and a stronger dollar we expect to see more opportunities in a lot of these emerging markets. So Latin America, Southeast Asia, Russia even Ukraine and that's probably where you see us doing stuff, it's not going to be in the western markets.
The two narrow bodies that you're looking to close on the fourth quarter, are they current gen?
Yes. Those NGs are approximately 2008 vintage aircraft.
Okay and then just a couple of clean-up questions for Gary. Have you repurchased any shares at the end of the third quarter?
Yes. We have been in the market subsequent to the quarter end.
Can you give us those numbers?
I don't have those handy with me Gary.
Okay. And also tax rate we should be assuming for the fourth quarter and beyond?
Yes. I think the tax rate you should be considering would be just slightly above the 12.5 that higher statutory rate. We had an unusual item this quarter which created a significant benefit that was one-time and it’s not continuing.
Thank you very much.
Thank you. Our next question comes from the line of Richa Talwar from Deutsche Bank. Your line is open.
Hey, everyone. Good morning.
Good morning, Richa.
So first I wanted to ask if you care to comment on one competitor’s observations of Asia sale leaseback deals offering very low yields I think 5% to 7% was the range indicated. I know you said for a while now that the market is fiercely competitive and you said that again today. But curious if you are surprised by the numbers turn out there or if they were roughly in a ballpark of what you're seeing as well?
Look we're in the market constantly looking at these transactions and as you know BBAM has a $19 billion portfolio. So we see a lot of stuff that a Company the size of FLY would not see, right. And we do syndicate a lot of transactions into the Japanese market. And so we could say that the yields on some of those deals that we're seeing are in that range which we think is this is a very competitive type of transactions.
Okay. Thanks for that Steve. And then my second question is on the change in the political landscape. And, Steve did allude to this numerous times during the Q&A. But with the new U.S. administration making it clear it's financing engaged in fiscal stimulus and given that could mean a prolonged period of higher interest rates, higher US dollar and perhaps even higher fuel prices.
I know you're making a point that, that creates more opportunities for you on the one hand but on the other, wondering if you're concerned more bigger picture about the impact that recipe may have on demand for aircraft more broadly and particularly out of emerging markets, which are the primary source of the industry's revenue. How should we be thinking about the puts and takes of some of those changes?
So I think it's just too early to make a call on any of this stuff. I would just say that less regulation higher growth in the U.S. market is a good thing for all of us, right and it should also prove to the benefit of the emerging markets. The one thing I guess I would caution everybody to keep your eye on the dollar. If the dollar gets a lot stronger from here, it will hurt a lot of these low cost carriers that are operating in these emerging markets. Oddly enough probably will present opportunities for us in our competitors because they will need capital and will be more likely to do sell leasebacks or do other stuff to raise capital.
Okay. Thanks for that perspective. And then the last one given the strong bids for aircraft that FLY and other lessors are seeing with significant buying interest from non-traditional aircraft investors, curious if BBAM actually sees a greater opportunity to increase its aircraft leasing management business and if so, what does that mean for FLY?
Well, look we're the third largest aircraft manager lessor in the space; we've got $19 billion of assess above 400 aircraft under management. FLY is the only public vehicle that we manage. We do manage as you know our Japanese joint venture with Nomura and we also have an institutional fund that we manage, but those traffic and kind of different type of deals than flying.
So we don't see any conflict there, but we do think there are a lot of opportunities in the marketplace and certainly from FLY’s perspective the more liquidity that comes into the market the better off for FLY and also all the other public lessors because we honestly believe that everybody is undervalued in this space especially where you see that aircraft can be traded at. And I think we've proven it. If you look at our track record, over nine years we've sold 93 aircraft for $155 million gain above book value.
All right. Thank you.
[Operator Instructions] And I'm seeing no other questioners in the queue at this time. I would like to turn the call back over to management for closing comments.
Thank you everyone for joining us for our third quarter earnings call. We look forward to updating you again next quarter. You may now disconnect.
Ladies and gentlemen, thank you again for your participation. You may now disconnect at this time.
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