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Fly Leasing Limited (NYSE:FLY)

Q2 2012 Earnings Call

August 2, 2012 9:00 am ET

Executives

Matt Dallas – Manager, Investor Relations

Steve Zissis – President and Chief Executive Officer, BBAM

Colm Barrington – Chief Executive Officer and Director

Gary Dales – Chief Financial Officer

Analysts

Gary Liebowitz – Wells Fargo Securities

John D. Godyn – Morgan Stanley & Co. LLC

Jamie Baker – JPMorgan

Victor Zajdel – Maxim Group

Glenn Engel – Bank of America/Merrill Lynch

Operator

Good morning. My name is Christy, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the FLY Leasing Limited Second Quarter 2012 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)

Thank you. Mr. Matt Dallas, you may begin your conference.

Matt Dallas

Thank you, operator. Good morning, everyone. I’m Matt Dallas, the Investor Relations Manager of FLY Leasing and I’d like to welcome you to our second quarter 2012 earnings conference call. FLY Leasing, which we will refer to as FLY or the company throughout this call, issued its second quarter earnings press release on July 25, which is posted on the company’s website at www.flyleasing.com.

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.

I’d like to begin the call today by reading the following Safe Harbor statement. 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 of the company’s future business and financial performance.

Forward-looking statements are based on current expectations 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 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.

This call is a property of FLY and cannot be distributed or broadcast in any form without the expressed written consent of the company. A replay of this conference call is available for two weeks from today. An archived webcast of the call will be available for one year on the company’s website.

I’d now hand the call over to Steve Zissis, the President and CEO of BBAM, for an update on the aircraft leasing industry. Steve?

Steven Zissis

Good morning, everyone. I’d like to make a few remarks regarding the health of the overall leasing market. In general, I’d describe the dynamics in the industry to be relatively healthy notwithstanding the uncertainty in Europe and slowing of the economic recovery in the United States and certain other jurisdiction. In particular, the demand for used Boeing narrow-body remains relatively active with good demand coming from Russia, Central Asia, Latin America and certain parts of Southeast Asia.

Lease rates remained stable with a slight uptick for the 737-800. On the other side, demand for used A319s and 320s is slowly recovering as many airlines keep bargaining these rates at levels attractive enough to replace older and less productive aircrafts. We see this is a healthy development as airlines are reacting to the marketplace.

We believe that lease rates for A319s have reached the bottom and we expect to see rates slowly improve over the next 12 months. For the more popular A320s, we’re seeing a slight improvement in the lease rates as demand continues to improve, while supply has been reduced to a more normal level. As we grow our fleet and evaluate investment opportunities, we continue to see still lease back interest from the lesser community, very strong for new equipment for both Boeing and Airbus.

We are pursuing these acquisition opportunities aggressively; however, our ability to win these bids will be tempered by our desire to ensure that we are earning attractive equity returns on any investment. We continue to see good relative value in the mid-aged equipment, but prefer to invest in newer equipments as long as the return profile meets our requirements.

With flight fleet now well in excess of 100 aircrafts, we have been focused on selling aircraft opportunistically to make gains relative to our book values and to take advantage of proposals that we believed offer full value for the equipment. Two of the aircrafts that we sold in the prior quarter were 17-year-old and one aircraft was 11 years old. The sales of these aircrafts is also consistent with our desire to improve the average age of our portfolio and to refresh with this new investment.

Finally, I’m pleased to report that FLY’s 15% ownership in BBAM yielded another quarter of attractive returns. BBAM’s asset management business continues to grow profitably and we expect its contribution to FLY’s bottom line to continue in the foreseeable future.

Now, I’ll hand over the call over to Colm.

Colm Barrington

Good morning, everyone, and thank you all for joining us on this morning’s call. We are obviously pleased to report very strong financial results for the second quarter following our strong first quarter earnings. Our second quarter net income is $25.7 million or $0.99 per share brings our six month earnings to $46.1 million or $1.77 per share as compared to $6.9 million or $0.26 per share in the same period of last year.

Our adjusted net income for the half was $57.7 million or $2.23 per share. Our income and EPS have been possibly impacted by the increased size of the company’s fleet, following the acquisition of a 49 aircraft portfolio late last year, which represents an 82% increase in our fleet size.

Our strong earnings demonstrate the inherent value of that acquisition for FLY, which was truly transformational for the company. You will recall that the $1.4 billion transaction was funded with approximately $1.2 billion of assumed debt and $142 million of the company’s free cash, and so did not require any new equity capital. As a result it was particularly enhancing to shareholder value.

It is also worth noting that the portfolio acquisition was resourced and completed by BBAM, our Manager and Servicer on behalf of FLY. This is another example of how FLY continues to benefits in BBAM’s global footprint and extensive relationships with airline investors and financial institutions around the world. BBAM has recently confirmed by Air France Journal as the world’s third largest aircraft lease manager, and FLY certainly continues to benefit from that scale.

Our $8.75 million investment or 15% in BBAM transaction which we completed in April 2010 has not been fully recouped from distributions from BBAM. Our earnings in BBAM continue to have a very positive impact on FLY’s financial outcome. In Q2 these earnings have contributed $2.3 million and for the year-to-date, it contributed $4.1 million. Our BBAM interests have also diversified FLY’s income sources, adding income from aircraft management to FLY’s core earnings from aircraft ownership.

Due to the strong earnings in the first and second quarter’s FLY has increased its quarterly dividend by 10% to $0.22 per share. We are pleased to be able to return further value to our shareholders in the form of an attractive and increased quarterly dividend. This dividend will be paid on August 20. FLY has now paid 19 consecutive quarterly dividends since it went public on the New York Stock Exchange in 2007. These dividends have totaled more than $5 per share, a track record that speaks for itself. FLY’s strategy is to provide our shareholders with both growth and income and FLY remains committed to growing the company while also returning capital to shareholders in the form an attractive dividend.

As Steve mentioned, during the second quarter FLY sold three aircrafts. We were particularly pleased we’ve sold all of these three older aircraft for premiums to their book value producing an aggregate pre-tax gain of $8.5 million, also helping our deleveraging and generating free cash.

FLY has now sold a total of 11 aircraft, every single one is a gain to its book value and for an aggregate gain of $42.5 million above book value. These sales continue to demonstrate inherent value in FLY’s fleet. These three recent sales also demonstrates continuing to invest and interest in aviation assets, and there is also financing available for aircraft purchases.

We expect to continue to sell aircrafts with the aim of reducing our fleet age and generating cash to reinvest in newer models and to enhance our income. Following the sale of the three aircraft, FLY now has a fleet of 108 aircrafts on lease to 52 airlines in 28 countries.

During the second quarter, our fleet utilization was 97% and this was significantly influenced by the return of aircraft from an Indian airline. We’ve now repossessed three of these four aircraft with this lessee and have arranged a new lease on one with letter of intent on another. As we get these aircrafts back to work, we expect to see a positive impact on our leased revenues and on our net income.

We currently have two aircraft remaining to remarket in 2012. In addition, we are in the process of repossessing two aircrafts from an eastern European carrier which has just filed for bankruptcy protection. The airlines have cooperated with the return of these aircrafts and we will immediately begin remarketing efforts.

In the quarter, we grew our total unrestricted cash by $31 million to a balance of $189 million at the end of the quarter. The increase of unrestricted cash was primarily as a result of cash being generated by our larger portfolio. This high level of cash held by FLY gives a significant flexibility of the near-term, including for the pressures of more aircrafts and deleveraging our portfolio as we replace some of our credit facilities.

We announced our earnings early this quarter in connection with our current refinancing activity. On July 19, we announced our intention to raise new senior secured term loans to approximately $395 million. Obviously, we will be commenting on the transaction as marketing continues, but we will update you as we have more definite news. FLY is also in an excellent position to take advantage of market opportunities to continue to grow the company. We expect to continue acquiring aircraft prudently during the remainder of 2102 and beyond with the focus continuing to be on maximizing shareholder returns.

I’ll now hand over to Gary Dales, who will take you through the financials in some detail.

Gary Dales

Thank you, Colm. We are reporting net income for the quarter of $25.7 million or $0.99 per share. This compares to net income of $4.1 million or $0.16 per share in the second quarter of 2011. For the six months ended June 30, 2012, our net income was $46.1 million or $1.77 per share, as compared to net income of $6.9 million and $0.26 per share for the same period in the previous year.

Second quarter 2012 results include pre-tax gain from selling three aircraft of $8.5 million. In addition, the second quarter and six months results for 2012 include end of lease income of $14.1 million and $30 million respectively, whereas there was only $2.9 million of end of lease income for the same period in the previous year.

Adjusted net income for the second quarter of 2012 was $30.9 million or $1.19 per share, as compared to the $7.3 million or $0.28 per share for the same period in the previous year. For the six months ended June 30, 2012, adjusted net income was $57.7 million or $2.23 per share. And for the six months ended June 30, 2011, adjusted net income was $11 million and $0.42 per share.

Our total revenues for the second quarter of 2012 were $110.9 million and include operating lease revenue of $98.9 million, earnings from our equity investments of $2.3 million, gains from the sale of three aircraft of $8.5 million, and interest and other income of $1.2 million. The increase in operating lease revenue is due to our larger portfolio as a result of the aircraft acquired in the fourth quarter of 2011. Included in second quarter operating lease revenue is $14.1 million of end of lease revenue.

Total expenses for the second quarter were $80.9 million and consist of depreciation expense of $34.3 million, interest expense of $36.6 million, selling, general and administrative expenses of $9.4 million, and maintenance and other costs of $1.8 million. The increase in lease expenses is primarily due to the increase in the number of aircraft in our portfolio consistent with the revenue increase. Also included in operating expenses is $1.2 million gain, representing the change in fair value of our derivatives that do not qualify for hedge accounting treatment. These interests in foreign currency swaps work for the most part, acquired in the GAAM transaction.

Within second quarter 2012 interest expense is $4.3 million of non-cash amortization expense resulting from the application of purchase accounting to the debt that was assumed in connection with that acquisition. The assumed debt was recorded in the financial statement at less than the face amount, reflecting its then current value. This discount is being amortized into interest expense over the life of the debt. Excluding share-based compensation selling, general and administrative expenses was 8% of total revenues for the second quarter of 2012.

Our provision for income taxes for the second quarter of 2012 was $4.3 million, representing an effective rate of 14.3%. The effective rate for the same period in the previous year was 19.7%. At June 30, 2012, our assets totaled $3.2 billion of which $2.7 billion is invested in flight equipment held for operating lease. Our total cash balance is $480 million of which a $189 million is unrestricted.

With that, let me turn it back to Colm for his closing remarks.

Colm Barrington

Thanks, Gary. Five strong second quarters produced by our larger portfolio and the income in cash total flight. We are very pleased with this positive financial result that allowed us to increase our dividend by 10% and increased returns to our shareholders. Over the coming weeks we look forward to updating on FLY’s refinancing activities that are currently underway and to announcing further positive developments for FLY.

We’re now ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Gary Liebowitz with Wells Fargo Security.

Gary Liebowitz – Wells Fargo Securities

Thank you, operator and good morning.

Colm Barrington

Good morning, Gary.

Gary Liebowitz – Wells Fargo Securities

You mentioned that there are attractive opportunities both on the buy and on the sell side. As we look at the rest of the year should we think of you as a net acquirer or a net seller of aircraft?

Gary Dales

I would think by the end of the year Gary, our fleet would be larger than it is today. We only got seven odd months to go now, so it won’t be hugely larger, but I expect we will have more aircraft in the portfolio by year end.

Gary Liebowitz – Wells Fargo Securities

Okay. And also the two planes that you’re marketing as a result of a recent bankruptcy out of Eastern Europe, those appear to be a 15 plus year old planes. Have you been shadow marketing them, has there been any interest and how soon do you think you can get those either back into the leased service or perhaps sell them?

Steven Zissis

Gary, it’s Steve. We haven’t been shadow marketing them for a very simple reason that the bankruptcy happened very suddenly. So we just got the aircraft back, we’re out of the country in our possessions with all the records. So that happens pretty smoothly. There are older aircraft, so we will be out in the marketplace with them and I would expect these are A320. I would expect that the demand for the older types would be somewhat limited in terms of the desire of these aircraft. But we will get them off, and we’ll probably get them off at approximately the same lease rate that we currently had them on lease rate at.

Gary Liebowitz – Wells Fargo Securities

Okay.

Colm Barrington

Gary, these were relatively low lease rates in any event.

Gary Liebowitz – Wells Fargo Securities

And do you have just like the standard two to three months of security deposit associated with these planes?

Colm Barrington

Correct.

Gary Dales

And make them to grow.

Gary Liebowitz – Wells Fargo Securities

Okay. Thank you very much.

Operator

Your next question comes from the line of John Godyn with Morgan Stanley.

John D. Godyn – Morgan Stanley & Co. LLC

Hi, everyone. Thanks for taking my question. I was just hoping for a bit of an update on broader financing market, just given that Europe continues to be in the headline. Are you seeing that way on appetite out there at all?

Colm Barrington

Well John, we are seeing ongoing availability of one off financings in the European markets, not in huge amount, but one off transactions are available. And we’ve done that for our own recent acquisitions and then we obviously will see this in the three aircrafts we sold whereby the investors are able to source financing for those aircrafts.

So I think more importantly, from our point of view we’re seeing strong interests in U.S. debt markets and that’s where we’ve announced recently we’re targeting our term loans definitely and that’s where we’re working right now.

John D. Godyn – Morgan Stanley & Co. LLC

Okay. And, there has been a lot of talk about financing for new aircrafts getting tighter as we look into 2013, just with upfront costs and uncertain ECI availability going up. How do we think about what impacts that could have on the market? Is there kind of a framework that you could help us think, I mean generally we’ve just sort of put it as all right, it’s going to tighten things up, but is there can we put a finer point on it? Is there any thoughts that you could elaborate on?

Gary Dales

I think in terms of export credit financing, I think the market is getting little more realistic. I mean I think we found in 2011 that export credit financing was actually more competitive than general open market financing, which struck up being a bit crazy, as export credit lenders supposed to be lenders of last resort effectively. So I think the marketing is returning to bit more of equilibrium with the higher rates from those lenders. As you know John, the U.S. debt markets are pretty hot at the moment and we see great capacity in those markets going forward.

John D. Godyn – Morgan Stanley & Co. LLC

Okay, that’s helpful. And how important in your view is sort of having or maintaining a decent credit rating going forward, going to be for less source just broadly in the sort of financing environment that we face over the next couple of years?

Colm Barrington

I think it’s going to be very important as always, yeah. Again coming back to FLY, FLY is in a very enviable position and thus we do not have forward order commitments. So, we don’t have big financing requirement out into the future. And so, we can actually look at what the markets are offering right now and then decide whether or not we buy aircraft into those markets. We’re not committed to taking large numbers of deliveries from the manufacturers over the years, and we think a very important difference in FLY’s business model, I think, makes FLY a much safer company and gives us much better chance of earning good returns for our shareholders.

John D. Godyn – Morgan Stanley & Co. LLC

Okay, that’s helpful. And, just last question on leverage targets overtime you’ve been doing a great job with sort of monetizing some of these aircrafts with very large gains and growing sort of cash. How do we think about debt-to-equity ratio over time? How much debt should we expect you guys pay-off like in the next couple of years? Is there any kind of metrics that you’d like to offer us just to kind of make sure that we’re thinking about the trajectory of leverage over time in the right way?

Gary Dales

Well, I think if you look at our balance sheet today, we have relatively higher leverage, but if you look at it nine months ago before we did the major transaction, we were relatively conservatively leveraged. And then, we took this opportunity to buy this portfolio of 49 aircraft with significant debts attached and we didn’t have that much equity, which was I think reflected the fact that we got a very good deal and you’re seeing that’s now coming through in our financial statements. I think over the next two to three years we would like to return to less than 4 to 1 and probably in the range of 3.5 to 1 debt-to-equity.

John D. Godyn – Morgan Stanley & Co. LLC

Okay, that’s really helpful. Thanks a lot.

Gary Dales

And that’s where we’re working seriously towards right now.

John D. Godyn – Morgan Stanley & Co. LLC

Okay, thank you.

Operator

Your next audio question comes from the line of Jamie Baker with JPMorgan.

Jamie Baker – JPMorgan

Hey, good morning gentlemen. It’s our understanding just based on some feedback from clients that you might be in the market already with some secured financing, any feedback on that topic?

Colm Barrington

I mean we are in the market Jamie, but we obviously it’s in the market, we are not in a position to talk about it right now, but we are in the market yes.

Jamie Baker – JPMorgan

Okay, fair enough. I’m sure you thought Allegiant’s embrace of A319s in [Amstelveen] this week, obviously a pretty silvering phenomenon when one starts drawing economic parallels between MD-80s and 319s. You talked about a slow recovery in 319 values and 320s. Just wondering if you could add some color on where that demand improvement might be coming from?

Colm Barrington

Well, look, I think Allegiant’s move into 319 was very smart because of values, and lease rates of those aircrafts have reached the level which that probably the most attractive aircraft for seat mile right now, but they are not the only ones doing it Jamie. There are significant startup airline in Africa that decided to go with 319s, and there’s an airline down in Latin America that switching all of its classic aircrafts over to 319. So you’re seeing it actually around the world and it doesn’t take much demand for aircrafts as you know, it kind of switched the balance from oversupply to kind of a undersupplied aircraft. So we think it’s a good outcome. We do believe as I said in my opening remarks that we think lease rates and values have bottomed for the 319 and now we’ll see them slowly starting to recover. So on the whole we think it’s a positive outcome for the market.

Jamie Baker – JPMorgan

All right. Good color. Thank you very much. I appreciate it.

Operator

Your next audio question comes from the line of Victor Zajdel with Maxim Group.

Victor Zajdel – Maxim Group

Hello?

Colm Barrington

Hello. Yes, it’s me.

Victor Zajdel – Maxim Group

Hey guys, yeah I just have a quick question about revenue recognition specifically the end of lease payments, I know that you guys don’t know the speakers until the actual lease termination, but is there any color or guidance as to how I should be looking at these payments going forward?

Gary Dales

It is very difficult to predict, the end of lease income looking forward, because you collect maintenance reserves on almost all of the aircrafts that we have leased and have security deposits, it’s quite often when a lease ends there is end of lease income. So as we look forward, we talked about a couple of leases that we terminated. So we should expect over the course of the remainder of the year that we would have more end of lease income. Probably it will not be quite the magnitude that we recognize in the first two quarters, but I think you can expect there would be some.

Colm Barrington

Hopefully, as our portfolio grows Victor, over time this will become a more even balance. I mean when we had less than 50 aircraft, you can have one or two aircraft in one quarter and another in the next. Hopefully as portfolio grows you will see a more even balanced this into over time.

Victor Zajdel – Maxim Group

Okay, but just going forward, I should be thinking that there would be a greater end of lease payments in the first half of the year versus second half for the near term?

Gary Dales

Yeah, well for 2012, I think that would be the case, but for future years I think as Colm said that the idea would be even more evenly spread, it’s never going to be levelized through all the periods. So you are going to have lumpiness, but it should end up being more smooth as we go forward.

Victor Zajdel – Maxim Group

Okay. All right. Thank you guys.

Operator

Your next audio question comes from the line of Glenn Engel with Bank of America/Merrill Lynch.

Glenn Engel – Bank of America/Merrill Lynch

Following up on that $14.1 million of leasing income, what are the expenses that are associated with that and where do they show up?

Colm Barrington

Well, there would be two types of expenses associated with that. There would be some remarketing expense that we would have that would go to remarket that aircraft and place it with new lessee. Those expenses show up in the maintenance and other income line in our financial statements, and you’ll see that that is a little higher than maybe historically posted and that’s because of some remarketing activity. The other costs that we incur would be capital improvements in the aircraft to overhauling engine if we need to and then those get capitalized and amortized over the overhaul period.

Glenn Engel – Bank of America/Merrill Lynch

I guess, what surprises me that’s a lot of income, so why the left doors, why do you get such a big bump at the end of the lease income in terms of profits?

Gary Dales

Well, it’s the maintenance collections were attributed to the lease and not necessarily the aircraft. So, when the lease terminates and the lesser no longer has an obligation to return, the amount is collected from the lessee those amounts then get crushed through income.

Steven Zissis

I think, then, also you should look at the accounting policy adopted by some of the other public leftovers whereby they recognize maintenance income as income over the terms of lease. We take more conservative approach and we just recognize maintenance accruals as effectively as the liability to the airline as of paid over to us each month, and then when the lease ends, that liability we have to do something with that liability, so it goes to the bottom line.

Glenn Engel – Bank of America/Merrill Lynch

At the end of the – on your release you said that you had about $345 million of annual rentals at the end going into the third quarter on June 30. What would that number be now with the two OLT planes being returned?

Colm Barrington

It would be over $340 million.

Glenn Engel – Bank of America/Merrill Lynch

Okay. Thank you very much.

Colm Barrington

Gary is getting a calculator I think.

Gary Dales

It reduces by $3 million to $4 million.

Glenn Engel – Bank of America/Merrill Lynch

Okay, it’s plenty. Thank you.

Operator

At this time there are no further questions. Sir, you have any closing remarks?

Steven Zissis

Thank you everyone for joining our second quarter earnings conference call. We look forward to updating you again in the near future.

Operator

Ladies and gentlemen, this does conclude today’s FLY Leasing Limited second quarter 2012 earnings conference call. You may disconnect at this time.

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