Aircastle Q3 2007 Earnings Call Transcript

Aircastle Ltd. (AYR)

Q3 2007 Earnings Call

November 09, 2007 11:00 am ET

Executives

Julia Hallisey - Investor Relations Contact

Joe Adams - Deputy Chairman

Ron Wainshal - Chief Executive Officer

Mike Inglese - Chief Financial Officer

Analysts

Jamie Baker - JPMorgan

Mark Streeter - JPMorgan

Rick Shane - Jefferies

Frank Boroch - Bear Stearns

Presentation

Operator

And welcome to the Aircastle third quarter earnings conference call. As a reminder, today's conference is being recorded. Now, at this time, I'd like to turn the call over to Julia Hallisey of Investor Relations. Mr. Hallisey, please go ahead.

Julia Hallisey

Thank you, Dwayne, and good morning everyone. I'd like to welcome all of you to the third quarter 2007 earnings call for Aircastle Limited. Joining us today are Joe Adams, Aircastle's Deputy Chairman; Ron Wainshal, our Chief Executive Officer; and Mike Inglese, our Chief Financial Officer.

Before I turn the call over to Joe, I would like to mention that this call is being recorded, and the replay number is 888-203-1112 from within the US or 719-457-0820 from outside of the US, with the replay pass-code of 2603948. This call will also be available via webcast on our website, www.aircastle.com.

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 Joe Adams. Joe?

Joe Adams

Thanks, Julia. And I'm very pleased to be here today to talk about Aircastle's successful third quarter results. I'm going to start off and talk a little bit about the status of the overall aircraft leasing market and then the investment activity of recent and talk a little bit about the capital markets activity and expected financings for the Company.

Ron is then going to talk about, specifically, recent performance of leasing and industry trends and some of the specific examples of our recent investment activity. And then Mike Inglese, our CFO, is going to finish up with a discussion of the financial results for the quarter.

Just signing off, I would say that despite the financial market instability in the United States, the fundamentals of the aircraft leasing business are really very strong. There is tremendous demand for airplanes, both passenger and freighter, around the world, particularly in non-US markets.

And it's primarily driven by the increasing consumer wealth in many of these large emerging economies that have significant population basis with increasing disposable and consumer income. And so we see across the board strength in demand for our fleet and for aircraft, passenger and freighter, in general.

And our fleet is largely an international fleet. We have over 90% of our aircraft by network value are outside of the US or, conversely, 10% of our assets are actually leased into the US. So Aircastle, very much a global business with excellent diversification spread out, geographically, quite well.

Turning to the investment activity. At the end of September and the third quarter, we owned 109 aircrafts, or $3.3 billion in asset value. And during the last earnings call, we had expected or estimated that we would make about $2 billion in acquisitions for the calendar year 2007.

And currently, we are running a bit over that in that we expect that we have committed or closed, will have committed or closed about $2.3 billion in new assets added for 2007. So this amount, as people may remember, roughly, $1 billion of that was related to this single portfolio acquisition that we announced earlier in '07.

And the remaining $1.3 billion would be through what we consider our regular way transactions or 17 different single or multiple aircraft acquisitions with different counter-parties and different lessees.

Said a slightly different way, since the IPO, we've actually closed over $2 billion in asset acquisitions, which has been able to allow us to increase the dividend four times or an 86% increase over the dividend we had a year ago or at the IPO.

So we've been able to very successfully execute on our investment strategy. And I think it underscores the strength of our management team, the origination network, and the capabilities, both legal and technical, that we have within our group. And it's an excellent squad of people with, I think, an origination and a capability that's unmatched in the industry.

Today, we see pretty active secondary market. Ron will talk a little bit more about that in terms of the number of deals we are looking at. And it's attractive, economically, in terms of the returns. So we've not seen or we've actually probably seen a little bit more attractive yields in the market in the last month or so, which relates to the next topic, which is the sort of the well publicized capital markets disruption or contraction.

It's no secret that that's sort of a big issue facing every company today. We were very successful on emplacing or raising $338 million of equity in early October with an offering of stock of 10 million shares plus a greenshoe option.

So this puts us in an excellent capital position to be able to take advantage of any opportunities that we see that might come out of this turmoil in the marketplace. And Ron will specifically talk a little bit about some of the recent activity we've had there.

That said, we're very focused and we'll continue to be very focused on the returns that we think we see in the market and the yields we would get on a net basis. But net-net, we expect that this period of credit contraction should work to our advantage, given that we think our cost to capital advantage over others should increase.

As we outline the people we talk to on the road show, we do expect to access the long-term debt markets in the second quarter of 2008. And previously, we've done two securitizations, the first when we did in June of 2006 and the second when we did in June of 2007. The first deal was at a credit and that's credit spread of about a 160 over, and the second deal was about a 105 over the swap rate.

In both of those, we're wrapped by monolines. When we did those deals, we looked at in both cases doing those deals on an unwrapped. And we also had other options and proposals from banks or private placement sources at that time.

So when we look at the next transaction, we're obviously going to look at both a wrap deal. Then, we will also study hard an unwrap deal. And we'll also look at different private placement or bank financing options and compare and contrast both the pricing and the terms that we think we can get in those markets.

But again, it's probably six months, nine months out. And we expect that the ability to directly finance aircrafts as opposed to well the disruption we have today in indirect financings of structured deals, which don't involve direct assets but involve securities. It's a far different market.

And we expect that there will be an attractive deal, although probably not as attractive as the last deal we did in terms of spread but, nonetheless, very attractive access to reasonably priced long-term capital, given that we borrow on a conservative 60 to 65% loan-to-value basis. And the assets we own are performing extremely well.

So with that, I will turn it over to Ron Wainshal, the CEO.

Ron Wainshal

Thanks, Joe. We had an extremely productive quarter in many respects. I'll start out by giving you an update on our lease placement activities. So far, this year, we've completed or committed 41 leases on our aircraft. That includes all 24 of our 2007 placement requirements. Here, 17 aircrafts are leases and commitments for our 2008 and 2009.

Breaking that down, as I mentioned during the last call, for the 13 aircrafts with leases expiring this year, these renewals or new leases have monthly lease rates of 18% higher than the previous rentals and the weighted average lease term is approximately five years. We also acquired 11 aircrafts off lease in 2007 and placed each of these with leases having an average term of roughly five years as well.

For 2008, to start with, we have 21 aircrafts placed, 16 of which have leases in place today and the other five are aircrafts to be purchased off lease. The five off-lease purchased aircrafts have been all placed, with a weighted average lease term of more than six years.

And for the 16 roll-offs, taking into consideration where we stand with commitments, unbinding letters of intent and likely renewals, I'd say our remaining placement task for 2008 consist of just one aircraft at this stage, with the lease expiration in the fourth quarter.

I believe it is a pretty good chance we'll have all of our 2008 lease placements firmed up over the next two or three months. Obviously, the results are not all in yet for 2008, but I think we'll see rents on these leases and renewals be up 5 to 10% on a same store basis versus the previous leases, and I'd expect that the new weighted average lease term will be in a six-plus years territory.

The increase in the weighted average lease terms for 2008 versus this year partially reflects the longer lease terms we're getting on our freighters. While it's little early to talk about 2009 with any specificity, we've already placed 4 of the 20 aircrafts we had to place for that year. And we're making pretty good progress beyond that.

Having commitments or even serious placement discussions to use aircraft that far ahead of lease expiration is really unusual and reflects the types of private aircrafts in the market, right now. Our take on it is that airlines are very concerned about losing their capacity, and they're doing what they can to secure key assets.

Now, the absolute increase in rents we're seeing, once again, reflected the strength of demand worldwide. We have not seen any slackening demand, notwithstanding the recent financial markets turbulence. The statistics available, so far, bare this out.

The International Air Transport Association, or IATA, reported a few days ago that September 2007 year-to-date worldwide revenue passenger kilometer miles, a good measure of traffic, increased 7.3% versus last year. And for the month of September, it's up 8.2%.

There is particularly strong growth in the Asia-Pacific regions as well as the Middle East and Latin America. In the freight side, freight ton kilometers or the equivalent measure of traffic increased 4% year-to-date versus last year and 5% in the month of September, also a very good result.

On the supply side, the story remains strong. Supply is tight. If somebody wanted to order a new narrowbody- aircraft, like a Boeing 737-800 or an Airbus A320, they probably have to wait about five years or so. For Boeing's new technology 787 midbody aircraft, it's more like seven or eight years and maybe longer given the recently announced production delays.

And on the subject of these delays, taking into conjunction with the delays for the Airbus A350 and its redesign, we believe, we'll benefit through better demand for the 12 midbodies, that 737s and A330s. So they're coming off lease between now and 2011, given the lack of alternatives and given the continuing growth in this market segment.

The tightness of supply in the passenger also continues to limit the availability of the aircrafts available for freighter conversion. And that's where is a sidelight where a majority of the freighter fleet comes from. Indeed, such a level of overall freighter conversion is very low and it's much lower than we'd expected.

This means that the already old worldwide fleet of air freighters, and nearly half of the world fleet is 25 years or older, will continue to grow older in the absence of more modern replacement or growth aircraft.

We believe these factors together with the continuing high fuel prices will increase the opportunities for more modern freighters, particularly in the longer-haul, wide-bodied models, and we're continuing to explore this space from an investment standpoint. I'll give you a short update in this regard in a moment.

Turning to our investment activity. During the third quarter, Aircastle acquired nine aircraft for approximately $382 million, bringing the total for the first three quarters of this year to 41 aircraft for approximately $1.5 billion.

Of the aircraft we acquired during the third quarter, roughly, $950 million were for the large portfolio transaction Joe mentioned. And so far, during the fourth quarter, we've closed $368 million in acquisitions and expect to complete a total of somewhere between $600 million and $700 million for the total of the fourth quarter. That will bring the total for the year 2007 $2.3 billion.

Among the aircraft we've acquired so far during the fourth quarter is the third of the three off-lease 747s we agreed to buy as a large passenger-to-freighter conversion play, and I discussed that during our last call.

This particular aircraft was inducted last week into the freighter conversion shop and will emerge as a freighter some time during the first quarter of 2008. We've secured a long-term lease commitment for this aircraft, when the conversion process is completed. All of our other aircraft are currently on lease.

As you know, we successfully completed a follow-on equity offering, which raised net proceeds of approximately $338 million a few weeks ago. That was, in part, driven by our view that the current market conditions would lead to attractive investment opportunities.

I'm pleased to say that during this timeframe, we've opportunistically secured new commitments to acquire seven jets for over $210 million, all of which we expect to close by the end of the year. Now, it's still too early to properly gauge the effect of the financial market difficulties on the market for aircraft, but I'll make the following observations.

The level of transaction volume, which we've seen slow down during August and September, has picked up a little bit, although there is still a hesitancy among sellers to come to market amid all the financial markets turbulence. Of the deals that are coming to market, however, I'd say that it feels like there's a little less competition.

Looking ahead, we believe, there will be a good opportunity, a good supply of attractive and accretive investment opportunities, and we're going to continue to apply a very disciplined approach to finding the best available transactions.

With that, I'll turn it over to Mike Inglese.

Mike Inglese

Thanks, Ron. I'd like to spend a few minutes, covering our business results for the quarter, as well as updating you on our recent financing activities.

First, regarding third quarter business results, Aircastle earned net income of $32.5 million, or $0.49 per diluted share, on revenue of $105.3 million for the third quarter of 2007 compared to net income of $15.2 million, or $0.32 per diluted share, on revenue of $51.4 million in the third quarter of '06.

Q3 '07 net income from continuing operations was also $32.5 million, or $0.49 per diluted share, versus $14.7 million, or $0.31 per diluted share, for the third quarter of 2006. These results include non-cash charges for share-based compensation expense of approximately $1.2 million in Q3 '07 and $1 million in Q3 2006.

Revenue and income from continuing operations for the third quarter '07 were up 105% and 121%, respectively, compared to Q3 '06 and were up 24% and 20%, respectively, from the second quarter of '07.

At the end of September, all of our aircraft were on lease and we had contractual aircraft lease rentals on a monthly run rate basis, which were $36.2 million, or $434.3 million on an annualized basis, up 15% from the end of the second quarter '07, producing a gross yield on our aircraft portfolio of approximately 14.3% on the net book value of that portfolio or about a 1.2% monthly lease rate factor. The lease rate factor on aircraft we purchased in the third quarter was approximately 1.06% per month, reflecting a greater proportion of freighter acquisitions during this quarter.

For Q3 '07, total SG&A was $8.4 million, up from $5.1 million in Q3 '06, including the non-cash share-based compensation expenses of $1.2 million in Q3 '07 and $1 million in Q3 '06. Annualized Q3 '07 SG&A, excluding stock comp expense, was 94 basis points in the net book value of our assets held for lease at September 30 compared to 110 basis points at September 30, '06. Given the expected growth in the portfolio over the balance of the year and into next year, we anticipate that this ratio will continue to trend down towards 75 basis points during 2008.

Interest expense for the quarter, excluding interest income earned on cash balances and capitalized interest, totaled $34 million on weighted average debt outstanding of $2.1 billion for the quarter, for a weighted average cost of funds of approximately 6.54%.

Cash flow from operating activities grew to approximately $253.7 million for the first three quarters of '07, up from $100 million for the first three quarters of '06, reflecting the growth in our business and aircraft portfolio over the last year.

And finally, a liquidity and funding update. Of the 109 aircraft we owned at the end of the third quarter '07, 99 are financed in our first two securitizations. As we mentioned at the end of the second quarter, there were 20 planes left to transfer into our second securitization.

Those transfers did take place during the third quarter, and you can see the effect of restricted cash on our balance sheet has returned to normal levels now that those aircraft have been transferred into the securitization during Q3.

In addition, we raised $338 million of net proceeds from our equity offering in early October. And as of today, we have approximately $336 million outstanding on our aircraft acquisition warehouse, leaving $664 million of availability.

There is nothing outstanding on our revolver other than $9 million of LCs outstanding related to future acquisitions, leaving $241 million of availability from that facility and approximately $27 million of cash on hand, leaving us in a very strong liquidity position.

And with that, operator, we'd now like to open the call up to questions.

Question-and-Answer Session

Operator

Excellent. Today's question-and-answer will be conducted electronically. (Operator Instructions) We'll pause just a moment to assemble the question roster.

And our first question will come from Jamie Baker with JPMorgan.

Jamie Baker - JPMorgan

Hey, Good morning, everybody. It's actually Jamie and Mark. Ron, we've started to hear some chatter about manufacturers approaching customers about being overbooked and potentially pushing out 2009 deliveries, kind of like what the airlines do, I suppose.

I'm curious whether you've heard the same thing and whether you've been approached, say, on your 330 freighters. I mean it seems to be a fairly bullish sign for used demand if, in fact, it's true.

Ron Wainshal

We've not been approached directly by the manufacturers about that. In regards to our freighters, we have very early delivery positions. And so there would be, I think, a tendency or an incentive for Airbus to do so. But at the same time, I know they're very keen to get this aircraft launched and don't want to delay that. So I don't anticipate anything in that regard.

We aren't seeing the same effect that you mentioned, Jamie, directly. But I think there's lots of indirect, anecdotal evidence to back that up. And the demand for newer model A320s and 737 new-generation aircraft continues to be surprising us on the upside. And I think that's all very much in sync with what you're saying.

Jamie Baker - JPMorgan

Okay. That's helpful. And, secondly, Ron, if the credit situation does continue to worsen, at what level of funding cost do you potentially start to rethink aspects of the business strategy?

Ron Wainshal

Fundamentally, we think of this as a margin play. I mean, we look at the incremental return on the incremental investment, and we bear in mind what the cost of capital is. It's something we do each and every deal. We've always done that.

Joe Adams

So we think about it all the time. And if cost of capital were to rise or continue to worsen, as you said, then we would expect to see that reflected in the returns in the market that we would be able to achieve or, if not, we wouldn't buy anything.

Mark Streeter - JPMorgan

And Joe and Ron, it's Mark here, just real quick and then we'll turn it over. In all the other financing options that you're looking at, is there anything that incrementally just restrains you from operating your portfolio in terms of where you can move assets, anything in terms of country limitations or anything like that that you might potentially be bumping up against as you shift away from securitizations, assuming that that market stays in the state it's in right now?

Joe Adams

Well, let me just say the first thing, in regards to securitization, there are country limits in each of these structures…

Mark Streeter - JPMorgan

Yeah

Joe Adams

… whether it's our deals or anybody else's.

I think most of the options we look at will be the same type of a leverage range as we're in right now. And given that and given the kind of equity cushion that exists, lenders generally are pretty accommodating, particularly when you've got a track record like ours.

Ron Wainshal

I mean there are some differences. And each time we did a securitization, we went through and updated, we talked to the banks, we talked to the private placement lenders, we looked at unwrapped, and we looked at wrapped. And the first two deals we did wrapped securitizations came out the best.

It's obviously a little hard to say at this point what will happen in the second quarter of '08. But today, you wouldn't think securitizations might not prevail. It may come back. But as I said earlier, the direct financing of assets is far different than indirect financing of securities that back assets.

So this market is still very robust. There is a number of participants who are still actively doing deals today. So we will look at those tradeoffs. None of them are really that big a deal in terms of how we operate the business, because we want diversification, we want long-term leases, we want good assets, and we don't ask for high leverage.

So all those things are fine. It really just comes down to certain subtle tradeoffs in terms of the absolute maturities and the structure and the leverage and the cost. And we'll do the same thing we've done each time we've gone to finance.

Mark Streeter - JPMorgan

Good. Thank you.

Jamie Baker - JPMorgan

Thanks a lot, guys.

Operator

Our next question is from Rick Shane, Jefferies.

Rick Shane - Jefferies

Guys, thanks for taking my questions. A couple of different things here. At this point, when we look at the financials, should we assume that there is some differential between the monthly lease rates that we can calculate for the planes you're acquiring and the contractual monthly lease rates related to innovation of the planes? So for example, when you take ownership, are you immediately recognizing lease revenues or is there a delay because you have to transfer the planes?

Ron Wainshal

Immediate.

Joe Adams

Yeah. It's just that. I think maybe there is an aspect of the question that I'm not sure if I understand, but when you look at the immediate lease rate factor, obviously, it reflects the lease that's in place. Now, a number of the aircraft we bought over the past two or three years had short remaining lease terms.

And what's happened is we've done better, as I mentioned during the opening part of our discussion, in terms of re-lease rates. Plus, the net book value of the aircraft drops as the aircraft depreciates. So you will see for the seasoned part of our portfolio kind of higher lease rate factors on that account and that resets when new leases get done from time to time.

Mike Inglese

But there's generally no lag in between the time we close a deal and recognizing immediate revenue.

Joe Adams

Exactly.

Rick Shane - Jefferies

Okay. And that was my question, because I guess there are some technical issues with that. That's helpful. The second question is, you talk in the press release about $5.7 billion of planes essentially under contract. Obviously, that factors in Guggenheim. It also, I assume, factors in the Airbus purchases in 2010 and 2011.

If you were to project based on your $600 million to $700 million in commitments for this quarter and your commitments through Guggenheim through the end of 2008, what would the portfolio look like without any sort of, in your words, regular way acquisitions at the end of '08, where are you committed through '08?

Ron Wainshal

I think we have roughly $500 million of commitments next year.

Rick Shane - Jefferies

Great. Okay. And then last question on the securitization. My understanding is that you basically term out the funding through the swaps market and that, for example, if you look at the last deal, obviously, your all-in costs came down. With rates falling, yes, I understand that your spreads are going to widen out a little bit. But are your termed out costs necessarily going to rise, given the directionality of rates?

Mike Inglese

No. And that's a good point in that the spreads might be a little bit wider but the interest rate environment is lower. So net-net, it might actually end up being the same or better debt cost.

Rick Shane - Jefferies

Okay. That's what I assumed. Thank you, guys.

Ron Wainshal

Thank you.

Operator

(Operator Instructions) We'll next go to Frank Boroch with Bear Stearns.

Frank Boroch - Bear Stearns

Hello, gentlemen. I wanted to ask sort of a follow-up question on that last one. For the Guggenheim commitments for '08, I think, you had last said around 550 million. You already have those placed with customers. Is that correct?

Ron Wainshal

Well, I alluded to having five aircraft that were coming off lease. Four of them were from Guggenheim, yes.

Joe Adams

They're all committed.

Ron Wainshal

Correct.

Frank Boroch - Bear Stearns

Okay. Great. And the question about swaps, given the change in rates, is that causing you to experience any negative impact by having those fixed?

Mike Inglese

No.

Frank Boroch - Bear Stearns

Okay.

Mike Inglese

No. The swaps end up in the trust. And no, it's fine.

Frank Boroch - Bear Stearns

Okay. And a couple of just housekeeping items. Mike, did you have the interest income on the cash balance in the quarter and in shares outstanding?

Mike Inglese

I don't have the interest income number in front of me, but the diluted share count is about 66.8 million for the quarter.

Frank Boroch - Bear Stearns

Okay. Great. Thank you very much.

Ron Wainshal

Sure. Thanks.

Operator

And we'll return to Jamie Baker with JPMorgan.

Jamie, are you there? You might have to un-mute your phone.

Jamie Baker - JPMorgan

Yeah, I am. I think Mark had a follow-up question. Mark?

Mark Streeter - JPMorgan

Hi. Sorry about that, gentlemen. I'm wondering if, Ron and Joe, from your perspective, do you have a sense that the market just doesn't get this. That given this credit crunch, what this is going to do is, perhaps, allow you to be even more competitive. You have a proven business model.

There's lots of other competitors that are trying maybe to come to market and form leasing companies, etcetera, and that may be some of the froth in the market comes off, given that financing is harder to come by for less-established players and that perhaps this supports lease rates further?

I'm just wondering if there's a bull story in here that you buy into that maybe the market's missing. Because, clearly, the market has been viewing the events of the past several months in the capital markets as a big negative for the leasing companies.

Joe Adams

Yes. I would start off and say that I think that in general markets hate uncertainty. So people look at this and say, well, there's uncertainty in the market, in general, and how do I know airplanes will be financable? And so that's kind of my sense of the overarching issue.

Having said that, what it does do is, undoubtedly, it will slow the amount of capital and the capital availability flowing into aircraft leasing, which is a net positive for us and our business model.

So we feel, as we said, I think, when we went around and met with people that it may not seem great at the moment, but this is long-term. This fundamentally should be a good development for Aircastle, given that we have a low-leverage capital structure and a low cost of capital, and our cost of capital advantage should widen, which in an asset-based world is a very good thing.

Ron Wainshal

Hey, Mark, just coming back to the comment I made earlier, just in the few weeks post IPO or IPO follow-on offering, we did manage to secure an additional $210 million or so of new business. And it's a really high quality level of business. So I think that's very much along the lines of what you're suggesting.

Mark Streeter - JPMorgan

Well, I guess, I mean, Joe, your comment about uncertainty, I mean, how much uncertainty sort of is there in the near term, given all the leasing work that you've done at the Company and sort of the visibility that you have over the next certainly zero to 24 months? That uncertainty comes on the back end. And that's what we're struggling with, is how to appropriately value that and certainly the market's struggling with that.

Joe Adams

Yeah. I mean, we don't feel that there's a lot of uncertainty. We've been involved in financing airplanes for 25 years, and I've never seen a market where you couldn't finance on reasonable terms, if you have the right leverage.

But having said that, all of this is sort of a new industry, a new development, a new business, maybe other people don't have the same perspective or history of that. So I think it is a -- obviously, there's a lot of news in the market every week, and it's not been positive for the last six weeks. And so it does create environment. People tend to shoot first and ask questions later.

Mark Streeter - JPMorgan

Thank you. Just wanted to get your thoughts on that. So I appreciate it.

Operator

And with that, there are no further questions in the queue. For closing, I'll turn the call to Julia Hallisey.

Julia Hallisey

Thank you for joining us today. This concludes the Aircastle third quarter earnings call. We look forward to speaking with you next quarter.

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