Aircastle Q1 2008 Earnings Call Transcript

Aircastle Limited (AYR)

Q1 2008 Earnings Call

May 9, 2008 12:00 pm ET

Executives

Julia Hallisey - Investor Relations

Ron Wainshal - Chief Executive Officer

Michael J. Inglese - Chief Financial Officer

Presentation

Operator

Good afternoon. My name is Cara and I will be your conference operator today. At this time, I would like to welcome everyone to the Aircastle quarter one 2008 conference call. (Operator Instructions) Ms. Hallisey, you may begin your conference.

Julia Hallisey

Thank you, Cara and good morning, everyone. I would like to welcome all of you to the first quarter 2008 earnings call for Aircastle Limited. Joining us today are Ron Wainshal, our Chief Executive Officer; and Mike Inglese, our Chief Financial Officer. Before I turn the call over to Ron, I would like to mention that this call is being recorded and the replay number is 800-642-1687 from within the U.S., or 706-645-9291 from outside of the U.S., with the replay pass code of 43220638. 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 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 reports. I direct you to Aircastle Limited’s earnings release for the full forward-looking statement legend.

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

Ron Wainshal

Thanks, Julia. I first would like to talk about Aircastle's financial results. I will then review what is going on in the aircraft lease market, talk about our portfolio, discuss dividend and our new growth initiatives.

From a shareholder’s point of view, the first quarter was a great one for Aircastle financially. The two things that matter are cash flow and the value of our assets. To that end, first quarter net income before non-cash depreciation was $83 million, or $1.07 per share, which is up 49% from the first quarter last year. We think this is the best measure of our cash flow to equity.

Annualizing the first quarter would produce a $4.28 per share, or 25% yield on yesterday’s closing price. Obviously we feel that over time there will be depreciation in the value of the assets but even taking this into account, we are earning a very high return on shareholders equity.

Secondly, with regard to the valuation of the portfolio, the 136 aircraft we owned at the quarter end were purchased for about $4.2 billion and had a net book value of approximately $4.0 billion, and we believe they are currently worth more than we paid for them, considerably more.

The portfolio has contracted monthly lease revenues of approximately $46 million, with the remaining weighted average lease term of 5.2 years. So on that basis, Aircastle is currently generating over 25% cash return to shareholders and has assets that have appreciated in value, not depreciated.

I would like to put our results in our portfolio performance in the broader context of the market for air travel, which is what drives demand for leased aircraft. Air travel growth around the world has generally been quite healthy, particularly outside the U.S. in markets where demand for operating leases is higher.

While there has been some modest slowing after a very robust 2007, the overall picture looks reasonably strong to us. More specifically, air travel levels during the first quarter of 2008 were 6.6% higher than the same period a year earlier, according to IATA, the international air transport association. Load factors were actually higher as well but we did see somewhat weaker results for March.

Though this growth rate is a little bit slower than last year’s 7.4% increase, we should put it in perspective against the long-term annual growth trend of around 5% per year.

In contrast to the positive worldwide picture, the results in the U.S. were much weaker. The U.S. air transport association showed domestic travel dropping by 2.3% during the first quarter of 2008 versus the year earlier period, though this was offset by a 7.1% increase in international travel. In this regard, I point out that 92% of our portfolio is on lease to airlines outside the U.S., thus limiting our direct exposure.

I think the big story in our sector is the high cost of fuel. In U.S. dollar terms, jet fuel costs there are nearly two-thirds higher than a year ago and almost twice the level at the beginning of 2007. This affects airlines all around the world but the U.S. carriers are hurt the most since they don’t have a strong local currency to buffer them from this effect and they are also affected by the slowing U.S. economy.

Another very important factor is the weak U.S. dollar, which continues to be a plus for aircraft leasing demand, given that the vast majority of operating lease demand comes from outside the U.S. and lease rates simply look cheaper to airlines in non-U.S. dollar markets.

Taking all these factors together, demand for modern fuel efficient aircraft remains strong worldwide, though we are seeing a softening for the less fuel efficient, older technology aircraft.

There is a huge base of these approximately 4,000 economically obsolete aircraft still in service around the world and we believe current industry conditions will force many of these to be retired soon. This list includes over 1,000 MD80s, more than 1,000 third generation technology aircraft, such as Boeing 737 200s and DC9s, and approximately 1,300 soviet area units. Also, the average age of the world air freighter fleet is approaching 25 years.

Given higher fuel prices, there is growing pressure on airlines to shift to newer generation aircraft. However, given Boeing and Airbus’ being sold out for several years, we believe demand for modern aircraft remains quite tight and if capacity becomes available due to order deferrals or bankruptcies, has been and will be absorbed efficiently. With 86% of our portfolio by value consisting of the most modern generation aircraft currently in production, we believe our portfolio is well-positioned relative to the increasing fuel price environment.

We have taken care to build and manage a well-diversified aircraft portfolio with a good spread of risk. At the end of the first quarter, we owned 136 aircraft leased at 59 customers in 31 countries. Nearly a quarter of our portfolio is invested in air freighters, a market which we believe is less susceptible to event risks and where longer term leases, longer aircraft lives, and lower transition costs between operators typically apply. Also, the freighter conversion market has been starved of product for several years, given the strengthened passenger demand, and to the extent that passenger rental levels weaken, it will shift aircraft in this direction.

We capitalized on the strength in demand through our placement efforts and as of March 31st, the average remaining lease term for our aircraft portfolio is 5.2 years, providing good cash flow visibility. Lease receivables are in very good shape. Currently all of our aircraft are subject to signed leases with one exception, a 14-year old Boeing 757 that we expect to place shortly. Otherwise, all our aircraft coming off lease in 2008 are placed or with signed letters of intent, as are about half of our 2009 aircraft.

We started working on 2010 lease roll-off as well. I expect we will have most of our 2009 placements completed by the end of the summer and overall rental levels for 2009 look comparable to the favorable levels we are achieving this year.

Among our placement highlights for this past quarter is the delivery of our first freighter conversion aircraft from Israel Aerospace Industries, a Boeing 747 400 freighter which we placed on a 10-year lease. We continue to see interesting opportunities in the freighter conversion market and we will look to take advantage of these opportunities in the sector as they arise.

With a team of seasoned pros with hands-on experience managing through several cycles, we feel our team provides us with an important competitive advantage in this market.

The past several weeks has brought about some extraordinary developments, including the collapse of Bear Stearns, significant write-downs by major financial institutions, and continuing distress in the U.S. capital markets. Since our last call, we’ve taken several measures to enhance our financing and liquidity position in the face of these very difficult market conditions, including the completion of a $786 million term financing facility, which Mike Inglese will elaborate upon.

With respect to our dividend, last quarter our board took a difficult but prudent decision to reduce the payout to $0.25 per share by paying out approximately one-third of our cash available for distribution. This action positions the company more conservatively in a still volatile environment. The company’s operating cash flow remains strong and we will seek to deploy it in the most accretive manner possible for shareholders.

We believe there will be increasingly attractive new investment opportunities, both as airlines and other aircraft owners feel the effects of the credit crunch and the economic slowdown. We also believe there is considerable investor appetite to invest in this sector, provided a capable and experienced partner. In this regard, we continue to look for ways to grow our earnings by leveraging our capabilities, including through managed funds to invest in additional aircraft. A fund structure would allow us to earn money not only through our invested capital but also through management fees and incentive income.

Organizing an institutional fund is not an easy task and there is no guarantee of success. However, what we have going for us is a great investment track record and an accomplished management team. Our staff of nearly 70 people around the world have significant in-house capabilities to originate and manage investments in this sector. Since forming in 2004, we’ve made approximately $5.6 billion in committed and completed investments through 54 transactions with 45 counter-parties, while also putting in place new leases or extensions on approximately 90 aircraft. We believe Aircastle can emulate the success of companies in other asset classes, such as real estate and shipping that have transitioned from being very good owners to being successful owners and asset managers. We hope to provide you with good news on this initiative later this year.

I will now turn it over to Mike Inglese.

Michael J. Inglese

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

Aircastle earned adjusted income from continuing operations of $34.9 million, or $0.45 per diluted share on revenue of $135 million for the first quarter of 2008, compared to $20.9 million, or $0.35 per diluted share on revenues of $70 million in the first quarter of 2007. This figure excludes the impact of hedge breakage and ineffectiveness costs of approximately $3 million and a modest loss on the sale of a debt investment of $300,000 during the quarter.

Adjusted income from continuing operations plus depreciation was $83 million, or $1.07 per diluted share, up 95% and 49% respectively over the Q107 results. We use this measure to assess our cash operating performance after taking into account the interest expense on our outstanding indebtedness.

At March 31st, we owned 136 aircraft, of which 135 were on lease. For our 136 aircraft at quarter end, we had contractual aircraft lease rentals on a monthly run-rate basis of $45.5 million, or $546.5 million on an annualized basis, up 6% from year-end, producing a gross yield on our aircraft portfolio of 13.7% on a net book value, or approximately 1.14% per month.

For the first quarter, total SG&A was $11.5 million, up from $8.5 million in Q107, including non-cash share-based compensation expense of $1.6 million in the first quarter of ’08 and $1.3 million in Q107. The increase in cash SG&A reflects higher expenses related to year-end audit activity and higher personnel costs, reflecting our year-over-year growth. Our current expectation for full-year 2008 cash SG&A is consistent with our prior estimates and probably in the neighborhood of $36 million on a full-year basis.

Interest expense for Q108 was $41 million, including hedge breakage and ineffectiveness costs of $3 million previously mentioned, and is net of $1.7 million of interest income and $3.6 million of capitalized interest in the quarter. Gross interest expense excluding the hedge item on our debt facilities was $42.8 million on weighted average debt outstanding of approximately $2.6 billion for the quarter, for a weighted average cost of 6.56%.

In the first quarter, we recorded a tax provision of $1.7 million for an effective tax rate of approximately 5.1%, reflecting the revenue and income sourcing mix from the portfolio. Cash paid for taxes during the first quarter was approximately $650,000.

At the end of the quarter, we had $1.66 billion in outstanding debt from our first two securitization transactions covering 99 of our aircraft. During April, we acquired a 747ERF and currently have $1.03 billion outstanding on our $1.3 billion warehouse facilities covering 38 aircraft. Last week we closed a $786 million term facility covering 28 of these aircraft with pricing at LIBOR plus 175 basis points. We expect the aircraft to be transferred into our term financing over the next few months, which will leave 10 aircraft financed on our existing warehouse facility with outstanding borrowings of approximately $250 million.

We are in discussions with several lenders and expect to complete term financings for these aircraft over the course of the balance of the year. Our all-in cost expectations for our new term facility are consistent with our prior thinking and should be in the low 7% range after factoring in up-front fees and net hedge costs for the new hedges we expect to put in place over the coming weeks.

Once the 28 aircraft transfer into the new term facility, we will have $500 million of committed warehouse capacity through our existing December 2008 expiration date. Currently we have no outstanding borrowings on our $150 million revolving credit facility with approximately $5 million of LCs outstanding.

We expect to refinance or extend our existing revolver and warehouse facilities later in the year before their current December expirations.

As of today, we have remaining cash commitments to fund through the end of 2008 of approximately $105 million, comprised of three aircraft, freighter conversion payments for two additional 747 aircraft, and the pre-delivery payments on the Airbus program.

We expect to establish a pre-delivery payment financing facility to cover a portion of the required payments for the Airbus program over the next several years and we expect that cash from operations in our existing warehouse and revolving facility and our expected extensions will cover our remaining commitments.

In connection with our recent financing, we have terminated or expect to terminate approximately $900 million of notional value of our existing interest rate hedge agreements when we put new hedges in place. And the new hedges will not require any cash collateral posting going forward.

Pro forma for this, we expect that the remaining hedges we have in place that will require collateral posting will have a fair market value of approximately $35 million, with about $15 million of cash collateral posted based on recent rate levels.

And with that, I would like to turn it back to the Operator to open up for questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) There are no questions at this time.

Julia Hallisey

Thank you for joining us today. This concludes the Aircastle first quarter 2008 earnings call. We look forward to speaking with you next quarter.

Operator

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

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