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Executives

Ryan McKenna - Assistant Vice President, Head of Strategic Planning and Investor Relations

Steve Udvar-Hazy - Chairman and Chief Executive Officer

John Plueger - President and Chief Operating Officer

Greg Willis - Senior Vice President and Chief Financial Officer.

Analysts

Michael Linenberg - Deutsche Bank

Jason Arnold - RBC Capital Markets

Arren Cyganovich - Evercore

Scott Valentin - FBR Capital Markets

Joseph Abboud - JP Morgan

Air Lease Corp (AL) Q22012 Earnings Call August 9, 2012 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2012 Air Lease corporation earnings conference call. My name is Fab, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Ryan McKenna, Head of Strategic Planning and Investor Relations. Please proceed.

Ryan McKenna

Good afternoon, everyone, and welcome to Air Lease Corporation's second quarter 2012 earnings call. This is Ryan McKenna, Assistant Vice President, Strategic Planning and Investor Relations. I am joined this afternoon by Steve Hazy, our Chairman and Chief Executive Officer; John Plueger, our President and Chief Operating Officer; and Greg Willis, our Senior Vice President and Chief Financial Officer.

Earlier today we published our second quarter results for fiscal year 2012. A copy of our earnings release is available on the Investors' section of our website at www.airleasecorp.com. This conference call is being webcast and recorded today, Thursday, August 9, 2012, and an audio replay will be available on our website. At this time, all participants to this call are in listen-only mode. At the conclusion of today's conference call, instructions will be given for the question-and-answer session.

Before we begin, please note that certain statements in this call, including answers to your questions are forward-looking statements within the meaning of the Private Securities Litigation Reform Act, including without limitation, statements regarding our future operations and performance, revenues, operating expenses, other income and expense, and stock-based compensation expense. These statements and any projections as to the company's future performance represent management's estimates of future results and speak only as of today, August 9, 2012.

These estimates involve risks and uncertainties that could cause actual results to differ materially from expectations. Please refer to our filings with the Securities and Exchange Commission for a more detailed description of the risk factors that may affect our results. Air Lease Corporation assumes no obligation to update any forward-looking statements or information in light of new information or future events.

In addition, certain financial measures we will use during this call, such as adjusted EBITDA and adjusted net income are non-GAAP measures and have been adjusted to exclude charges relating to discounts on certain convertible notes and stock-based compensation expense among other charges. A description of our reasons for using these non-GAAP measures as well as our definition of them and their reconciliation to corresponding GAAP measures can be found in the earnings release we issued today.

This release can be found in both the investors and the press section of our website at www.airleasecorp.com. Unauthorized recording of this conference call is not permitted.

I would now like to turn the call over to our Chairman and Chief Executive, Steve Hazy.

Steven Udvar-Hazy

Thanks, Ryan. Good afternoon and thank you for joining us today. I am very pleased to report that Air Lease Corporation achieved a 250% increase in second quarter 2012 earnings per share over 2011 second quarter results. We also recorded a 315% increase in the first half of 2012 EPS versus the first half of 2011, demonstrating execution of our strong growth plans.

During the second quarter, ALC saw stable lease demand for our new advanced technology aircraft, despite financial issues affecting Europe and the potential slowing of growth in China. The vast majority of our lease placements reflect airline aircraft replacements versus growth.

It is important to take a long-term view of industry fundamentals rather than to be overly optimistic when the market is robust or overly concerned when the market is softer. The nature of our business is to sign long-term leases on aircraft that provide stable multiyear cash flows, which allows for consistent profit generation through the cycles.

Over the past 18 months, Air Lease chose to place our new aircraft as soon as possible as opposed to waiting for spot shortages of aircraft that might increase lease rates. This strategy has proven to be successful as we have locked in attractive lease rate on long-term contracts with less potential volatility resulting from forced placements in choppy economic environment. This gives ALC the ability to pursue incremental growth transactions and seize upon well priced opportunities. Air Lease's business plan is based on a diverse but highly efficient mix of aircraft types to constitute an optimized commercial airliner portfolio that will maximize long-term profit generation.

Our recent launch order for the Boeing 737 MAX and the favorable economics associated with being a launch customer will complement our well-balanced order book which now includes the A320, A321ceo's and a significant order for 50 neo's. A330-200's and 300's, Boeing 787-9 Dreamliner's, Boeing 777-300ER's, Boeing 737-800NG's and of course, the Boeing 737-8 and -9 MAX aircraft along with Embraer 190's and ATR 72-600. Our order book now includes approximately 300 of the most highly in demand aircraft delivering over the next 10 years.

John Plueger, our President and Chief Operating Officer, will now expand upon ALC's results and strategic positioning.

John Plueger

Thanks Steve. During the second quarter, we took delivery of 20 aircrafts from our pipeline and acquired three planes on lease to strategic customers finishing the quarter with 137 aircrafts spread across a diverse and balanced operator base of 65 airlines based in 37 countries.

Our average fleet age decreased to 3.3 years from 3.4 years at the end of Q1. Our order book is designed to match the industry demand for aircraft and therefore the second quarter is heavy on deliveries due to the heightened demand prior to summer for airlines in the Northern Hemisphere and conversely the third quarter is light as demand in mid-summer trails off.

Excluding future prop up transactions, we have 15 aircrafts in our pipeline delivering during the remainder of this year with a majority coming during the fourth quarter. We are happy with our success in securing forward lease placements of new aircraft. As of June 30, we were 100% placed for 2012 deliveries, 93% placed for 2013 deliveries, 96% placed for 2014 deliveries.

Our marketing team's ability to place aircraft years ahead of their delivery serves as an important risk mitigator for the company. During the past three quarters, the majority of our newer aircraft lease placements were in Asia, including our two largest lease placements to-date with Air China and China Southern. With these placements, we expect that our fleet distribution will continue to shift more heavily towards Asia over the next several years.

The average remaining lease term for our fleet has increased now to approximately 7 years. Longer leases provide greater earnings visibility and stability with a slight trade-off in future recognition of overhaul revenue for accounting purposes due to a higher number of reimbursable maintenance events that occurred during the lease term.

Our lessees are performing well. We successfully removed our single A320 from Kingfisher without incurring a credit loss and that aircraft has been re-leased. Situations like this exemplify the importance of a strong and proactive management team.

With that let me now turn the financial review over to Greg Willis who will walk you through the financial results in more detail. Greg?

Greg Willis

Thank you, John. During the second quarter, our fleet generated $155 million in rental revenue of which 4.4% was overall revenue. This is compared to rental revenue of $74 million of which 3.4% was overhaul revenue in the second quarter of 2011.

During the quarter we successfully closed an unsecured $853 million syndicated bank facility. This is a three-year facility priced at LIBOR plus 175 with no LIBOR floor. Subsequently, we have grown our aggregate unsecured revolving bank facilities to $1 billion.

The success of these transactions is to help drive our composite cost of funds to 3.84% at the end of second quarter, down from 4.05% at the end of the first quarter. We continue to execute on our plan to increase our debt-to-equity ratio at a measured pace but not to exceed 2.5 to 1. This will enhance the return on equity for our shareholders, but with a dampening effect on pre-tax margin.

As John mentioned our business strategy is to order and deliver a large number of aircraft in the first half of the year. Accordingly, we put funding in place to finance these aircraft through numerous transactions including our successful $1 billion unsecured notes offering in March.

This creates a timing difference where we have a full quarter of interest expense, but only a partial quarter of rental revenues due to the timing of the aircraft deliveries taking place throughout the quarter. Therefore the full impact on the bottom-line of these aircraft will be reflected in Q3 and beyond.

Our SG&A was $14.3 million for the quarter and continues to decline as a percentage of revenue as we continue to add aircraft to our fleet. We will continue to build a conservative and robust balance sheet to allow us the financial flexibility to deal with dynamic market conditions.

This concludes my remarks. I will now turn it back to Ryan.

Ryan McKenna

Thanks Greg. This concludes management's remarks. For the question-and-answer session, each participant will be allowed one question and one follow-up. Now, I woul like to hand the call over to the operator. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Michael Linenberg with Deutsche Bank.

Michael Linenberg - Deutsche Bank

A couple of questions here. This is more of a big picture question for Steve and this may be less relevant to you since you have a young fleet and a lot of new aircraft, but Steve, there is a decent number of anecdotes out there about the lifespan of an aircraft and over the years there has been this view that whether a 25 year asset down to 15% residual value, whether or not that makes sense, and I would say that over the last 12 months or so it seems like there has been growing evidence or a growing number of anecdotes about aircraft maybe being broken up sooner than what people thought and those averages have been coming down.

I am just curious if is that more of a near-term blip. Over the years you have seen lots of airplanes go through these cycles or is it really a step function given the quadrupling of fuel prices over the last five, six, seven years. When we think about the assets and the lifespan of these assets, are we actually in a period where maybe we are seeing a permanent shortening of the lifespan. Your thoughts on that?

Steven Udvar-Hazy

That's a good question. Let me answer that in two parts. Let me answer sort of the macro picture and then talk about our policy with respect to how long we hold on to these assets which have obviously less of an impact on us because we hold these assets for shorter periods than a typical lessor.

If you look at the number aircraft that have been scrapped or removed from service in the last say 24 months, probably less than 2.5% of that was consisting of aircraft like Boeing 737-600's, a few 737-700's, some early model A320's, 97.5% of the aircraft that were scrapped were 727, 737-200, DC-9, older MD-80, older DC-10, L-1011, 747-100 and 200.

So, the number of aircraft that, I would say, are currently in favor that have been removed from service is very minimal. In fact, the number of aircraft part of those categories is also very minimal. There were certain circumstances in 2011 and 2012 where a run out, for example a 737-600 had more value if you breakup the airplane and take the engines, CFM56-7 engines and the associated systems, APU, landing gear. If you aggregate the values of those different components, it was worth more than the aircraft run out condition.

So I would have to characterize that this is more the exception than the rule. We have seen no evidence that modern day aircrafts that are built today would have a useful life of less than 25 years or 80,000 to 100,000 flight hours. There's just no evidence pointing to that.

Now, obviously if fuel prices go up, the pressure will be greater to replace the older aircraft, the non-fuel efficient airplane and less pressure on the existing generation 737NG, A320 family airplanes. So, I would not consider it as a panic condition and at the last several conferences, including ISTAT this issue was addressed by the appraisers very effectively.

There are short-term aberrations because of few airplanes that sort of fall into this unique category can change people's mindset, but I think overall, we don't see really a significant change in the useful lives of these assets. Now those airplanes that are ultimately eligible for cargo conversions even have longer life spans than 25 years.

Now speaking about our strategy. We generally try to enjoy the useful life and earning productivity of these airplanes for the first third of their lives. So somewhere around 8, 9, 10 years these aircraft are going to be removed from our fleet through disposition. So we are less vulnerable to these type of residual value impacts in the latter stages of an aircraft's life.

John Plueger

This is John Plueger. Let me just add from depreciating perspective. We use the 25 year old life. If we were to purchase a three year old aircraft or a four year old aircraft, we simply depreciate that aircraft out to its total life of 24 years.

So, let's say we brought a five year old aircraft, we would only depreciate it over 20 years. So, when we first started our company and we did buy some used aircraft and say lease it back to prime the pump, so to speak, I just want to make sure you and everybody understand we don't start the clock at 25 years from a used aircraft purchase.

We actually start from wherever it is in its life. So again if we brought the five year old airplane, we would only depreciate it for 20 more years.

Michael Linenberg - Deutsche Bank

Then just my second question, just then maybe it's more of an observation. There was a time where the majority of airlines that used the operating lease model were lower credit carriers and it does seem that the operating lessors have really broken into the ranks of the investment grade or the higher credit carriers. Some of that may be that these companies are just much more comfortable in pursuing or utilizing the operating lease model but some of this may just have to do with the fact that it may be the best source of financing available. So just any thoughts on that? Steve or John?

Steven Udvar-Hazy

I think you are absolutely right. It's a combination of the two. I think most of the large sophisticated airlines want to have a balanced fleet between ownership and lease. We have also seen some of the financing sources become a little more cautious. Particularly the European banking situation has basically took a lot of players out of the marketplace.

So, recent placements that we have done like with Air China and Cathay Pacific and Emirates and Norwegian and China Southern and Vietnam Airlines, these are all solid companies. So, obviously, our fleet will include airlines of the highest quality. We will have airlines in developing countries. We will have airlines that have different business strategies but we see more and more of a trend among the large successful airline toward the operating lease as a viable alternative to just owning the aircraft or doing long-term leveraged leases or types of structured financing.

Operator

Your next will come Jason Arnold with RBC Capital Markets.

Jason Arnold - RBC Capital Markets

I was just curious if you could update us since the last call on your views on opportunistic portfolio adds? You obviously had a couple here this quarter. Just curious if you are seeing the more muted macro environment is offering more opportunities or perhaps less. Just an update would be helpful.

Greg Willis

Yes, Jason. We certainly are evaluating more opportunities. We are kind of in the slow days of summer in terms of a lot of the industry takes a lot of August off et cetera, but we continue and in fact as we speak are evaluating a few of those opportunities. They are there but, again, our focus will be on very, very low priced attractive assets and we are constantly on the prowl for those.

So, a nice part of our business, as you know, is we have got our core business already we are specked out for the foreseeable future and now management's focus is to continuing to source very, very low priced attractive transactions that will have good returns and a strategic value of the company. As you have now seen we were able to do three of those airplanes this past quarter and we are looking for more. So it's very much a focus of our team.

Jason Arnold - RBC Capital Markets

Excellent. Thanks for the color on that. Just one quick follow-up. This one's for Greg. It looked like there was a sequential uptick in the interest income, other category I was just wondering what drove that?

Greg Willis

There was a combination between management fees recorded during the quarter as well as the cash that we were earning in our bank accounts resulting from the bond related to the end of March.

Steven Udvar-Hazy

On that same point I think you will continue to see the management fees grow because as we add more aircraft to the aircrafts that we manage for third parties, that number will grow over the next several years as sort of supplemental revenue to core leasing business.

Operator

The next question will come from the line of Arren Cyganovich with Evercore.

Arren Cyganovich - Evercore

We have seen some mixed results on credit from some of the leasing companies. One was saying that they saw delinquencies at the lowest level they have ever seen and we have seen one large player that had almost a doubling of their delinquent accounts. Can you address where you are seeing the credit quality of your fleet?

Steven Udvar-Hazy

Sure. Actually the credit quality of our portfolio, we are very happy with. We have seen no increase in any arrears. In fact what we call our sin list, there is very few people on it and the amounts are de minimus, and those amounts have not been changing, growing of any magnitude whatsoever.

So, that's why in my remarks we said all of our leases are performing. We have a very active and robust process for monitoring that, but we are very happy with where we are so far.

John Plueger

Also, I just want to add that we stay in very close touch with our clients. It's kind of a hands-on approach. So we are monitoring all of our lessees very, very closely, and as a result not seeing any difficulties in our portfolio.

Arren Cyganovich - Evercore

Great, that's helpful. Then my next question is on your debt capacity. You have increased debt capacity very well over the past couple of quarter. Could you give any idea of how far you're current debt capacity and cash takes you through your order book right now.

Greg Willis

It's pretty much through the end of next year. We have significant amiability that's still there under our warehouse facilities. We have the revolvers, the three-year revolvers where we have had one large European bank come in just a few weeks ago. We have another institution that is coming in.

So we have about $1.2 billion liquidity plus the internal cash flow generation over the next 12 months, we will probably exceed $600 million. So, I think we are in pretty good shape. We are also exploring the possibility at some point in the next few quarters to maybe sell one or two aircraft at a gain, just to demonstrate liquidity in our assets.

So, I think we are in pretty good share and we can cover all of our CapEx between now and the end of next year from existing facilities as well as the cash flow generation from our portfolio. We are also observing the capital markets, the interest rate environment and obviously we will tap those markets if we see attractive situations to get low-cost financing on a unsecured basis.

Operator

Your next question will come from the line Scott Valentin with FBR Capital Markets.

Scott Valentin - FBR Capital Markets

Just with regard to the A320 that you guys released from Kingfisher. Can you comment maybe on the lease rate that come down from where it was with Kingfisher and then just generally, I think in the first half of the year some of your peers commented that A319 and A320 lease rates were somewhat weaker. They seems to have stabilized, may be improving.

If you could provide any color on that market that would be helpful.

John Plueger

We leased that airplane out at market rates today and since that original lease that was an airplane we bought from another leasing company when we first started. So that lease was done at an earlier time. So, yes, the lease rate was lower as we would expect but it was in line or actually towards the higher end of the marketplace when we placed that aircraft.

Steven Udvar-Hazy

Also, please keep in mind that all of our A320 that we have an order from Airbus have been placed on long-term leases. So, we do not have a backlog of unplaced new A320s. All of our A321-200 are leased in 2012, '13, '14. Right now, we only have two units left in 2015. Those are under negotiation. So, we have locked in long-term lease relates that are above the current market rates because of our advanced placement capabilities.

John Plueger

Yes, let me just offer one just little bit of big overall macro color, Scott. It's kind of something we look at time-to-time here, not regularly, but big picture. If you added it up all of our firmly contracted leases today on the aircraft that we have both in our fleet and on future contracted aircraft deliveries or replace them, just on what we placed the loan today we have something on the order of more than $10 billion in cash revenue coming into this company.

Operator

Your next question will come from the line of Jamie Baker with JP Morgan.

Joseph Abboud - JP Morgan

God morning, guys, it's actually Joseph Abboud here for Jamie. I had two questions for you. The first is, I know in the past you guys have identified the Embraer 190 as one of the strongest components in your portfolio in terms of lease rates. I was wondering is that more a function of the customers or the actual aircraft? If it's the latter, how should we think about the role of that aircraft in the portfolio going forward?

Then just the second question would be, if you could update us at all on your negotiations with AIG or ILFC?

Steven Udvar-Hazy

On the Embraer 190, currently we have 31 aircraft that we have taken delivery of or are yet to be delivered during the balance of this year. They have been leased to a diverse group of airlines all of them outside the U.S.

What we found is that in this 100 seat category, the Embraer 190 family really enjoys virtually no competition at this point because the CRJ family is a smaller size airplane. It's got a much smaller fuselage. It doesn't have the range capability of the 190.

So on a pure lease rate factor, as a portion of our capital investment, the 190-70 has performed really well. It continues to perform very well, and those aircraft were leased to airlines that either need that category of airplanes or airlines that also have larger aircraft on lease from us. So, we continue to see a robust lease rate market for the 190 family, but at this point our current commitment is only for 31 total aircrafts and those deliveries will end in November of this year.

Joseph Abboud - JP Morgan

On AIG or ILFC, is there anything that you could provide us in terms of updates there, or is that just kind of where it was as of the last quarter?

Steven Udvar-Hazy

It's pretty much where it was. There is really now update.

John Plueger

We really are not in a position to comment on negotiations with AIG or ILFC at this point. There is nothing really we can report that would have a financial impact on the company.

Operator

There are no further questions in the queue. I would now like to turn the call back over to Mr. Ryan McKenna for closing comments.

Ryan McKenna

Thank you all very much for joining us on the call today. We appreciate it and we will speak with you next quarter.

Operator

Thank you very much. This concludes today's conference. Thank you for your participation, you may now disconnect. Have a great day.

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