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Fly Leasing Shs Sponsored American Deposit Receipt Repr 1 Sh  (NYSE:FLY)
Q4 2018 Earnings Conference Call
March 07, 2019, 9:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the FLY Leasing fourth quarter earnings call.

(Operator Instructions) It is now my pleasure to hand the call over to your host, Matt Dallas with Investor Relations. Please go ahead, sir.

Matt Dallas -- Investor Relations Manager

Thank you and good afternoon everyone. I'm Matt Dallas, the Investor Relations Manager of FLY Leasing, and I'd like to welcome everyone to our Fourth Quarter 2018 Earnings Call. FLY Leasing, which we will refer to as FLY or the Company, issued its fourth quarter earnings results press release, which is posted on the Company's website at flyleasing.com.

We have a slide presentation that accompanies today's call, which is available to participants on the webcast. If you are not accessing the webcast, you can find a copy of today's presentation in the Investor Relations section of our website on the Events and Presentations page. If you are listening to both the live call and the webcast, you may want to mute your computer as there will be a slight delay in the webcast audio.

Representing the Company today on this call will be Colm Barrington, our Chief Executive Officer; Julie Ruehl, our Chief Financial Officer; and Steve Zissis, the President and CEO of BBAM, the company that manages and services FLY's fleet.

This conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, statements regarding the outlook for the Company's future business and financial performance. Forward-looking statements are based on the current expectation and assumptions of FLY's management, which are subject to uncertainties, risks and changes in circumstances that are difficult to predict. Actual outcomes and results may differ materially due to factors that are summarized in the earnings press release and are described more fully in the Company's filings with the SEC. Please refer to these sources for additional information. An archived webcast of this call will be available for one year on the Company's website.

And with that, I'd now like to hand the call over to Steve Zissis, the President and CEO of BBAM. Steve?

Steven Zissis -- Chief Executive Officer and President

Thanks, Matt, and welcome everyone. The fourth quarter results are out and I can assure you, it's very difficult to not spend the next 20 minutes talking about the progress FLY has made and the tremendous results we are delivering for our shareholders. But I'm going to resist that urge and let Colm and Julie walk you through FLY's fourth quarter results in greater detail later on this call. Instead, I'd like to spend a few minutes discussing industry fundamentals and our competitive landscape.

During our third quarter earnings call, we discussed some of the industry conditions that we were watching carefully. This included rising fuel prices, growing trade tensions, higher interest rates and a strengthening US dollar against many emerging market currencies. I'm pleased to report that during the fourth quarter of last year and into the first quarter of this year, those conditions have improved significantly and our concerns have moderated. Of course, we will continue to pay very close attention as conditions change quickly.

Given these favorable industry conditions, it's no surprise that IATA is forecasting worldwide airline profits of over $32 billion for last year and over $35 billion in 2019. Notably, they forecast many key markets like North America, Asia-Pacific and the Middle East to have higher net profit and/or earnings before interest and tax margins in 2019 as compared to 2018.

In addition, passenger traffic growth remains robust with three largest markets, North America, Europe and Asia-Pacific, reporting 5%, 6.4% and 8.5% growth, respectively, in 2018. And more importantly, airlines in these markets were able to improve their load factors to record levels by controlling capacity growth.

With a consistent forecast for traffic growth in 2019, I think it's fair to say that the industry outlook for 2019 remains very positive. At the lessor level, we are seeing strong demand for new and used aircraft, a growing secondary trading market for used aircraft, and ample available debt capital being offered at very attractive rates. The one downside is that these favorable conditions have attracted a significant amount of new capital, which correct -- which correctly sees the aircraft leasing as an attractive investable asset class. Much of that capital has been earmarked marked for new aircraft on lease to top tier credits pursuant to sale-leaseback transactions, which have resulted in lease rates on those deals falling to historic levels.

FLY has avoided participating in these type of sale-leaseback campaigns because we didn't believe they offered us an appropriate investment return. Instead, FLY has used be BBAM's global platform to originate privately negotiated deals. We will continue our successful strategy of growing prudently and positioning FLY's fleet to improve its profitability, cash flow and return on equity. As I've stated many times on previous FLY earning calls, we simply refuse to grow for growth sake and we will continue to be highly selective in capital allocation decisions.

In fact, while Colm and Julie will address FLY's results in greater detail during their prepared comments, I will simply note that despite a general compression and lease rate yields over the past several years, FLY has, over the same period, been able to improve its net leasing margins. We have done this by calling (ph) our fleet of weaker performing assets, finding attractive acquisitions, and lowering our financing and operating costs.

Moving to the FLY remarketing front, there's actually very little to share at this point. FLY has six aircraft to remarket during 2019, none of which are scheduled to come off lease before the fourth quarter. However, given the current health of the airline industry and the strong demand for aircraft, I see no issues placing these aircraft for lease or selling them profitably.

Before handing the call over to Colm, I want to remind everybody that BBAM shareholders represent, by a significant margin, the largest shareholder in FLY. Collectively, we own 17% of FLY stock, which ensures that BBAM and FLY shareholders are highly aligned with FLY's success. We continue to believe that BBAM is a strong partner for FLY and I continue to believe that FLY is on the right track. I'm very proud of what we've accomplished at FLY and how well we've positioned FLY for the future.

Thank you again for your support. And I'd like now to turn the call over to Colm Barrington, FLY's CEO.

Colm Barrington -- Chief Executive Officer and Director

Thank you, Steve, and thank you everyone for joining us this morning. In a few short words, FLY had another excellent quarter and our best year ever. Initial steps that we've taken at FLY over the last few years, which is -- include disposing of older and underperforming aircraft, optimizing our capital structure, repurchasing shares at significant discounts to book value, and perhaps most importantly, growing our fleet prudently, have all combined to produce another very positive quarterly financial result and a significant increase in FLY's book value per share.

For the quarter, we earned $0.94 adjusted earnings per share and produced a 17.8% adjusted return on equity, both very positive numbers that were based on our 26% growth in operating lease rental revenue combined with a lower growth in expenses. The growth in operating lease rental revenues in the quarter was based on our larger fleet along with a 100% fleet utilization.

In the quarter, we were pleased to complete the acquisition of 33 aircraft in the portfolio deal that we contracted earlier in the year. These aircraft along with the seven CFM56 engines that we acquired as part of that portfolio deal will have a positive impact on FLY's ongoing earnings. We also sold three older aircraft in the fourth quarter, generating a total sales gain of $7.9 million. FLY has consistently sold aircraft from its portfolio, and mainly older aircraft, at gains to book value. We expect to continue to do this in the future, demonstrating the hidden value in our portfolio.

FLY's Q4 results showed a significant uplift from the same quarter of the previous year. The 26% growth in operating lease rental revenue to $112.2 million, a $24 million growth in adjusted net income to $30.8 million and a 68% (ph) growth in adjusted earnings per share to $0.94 per share, all very positive figures and very positive trends.

For the 12 months through December 31, FLY produced adjusted net earnings per share of $3.06 and an adjusted return on equity of 14.8%. Our net spread after depreciation was 3.3% of average net book value, which has improved from 2.9% in 2017 and 2.5% in 2016. These positive earnings also added significantly to FLY's net book value per share, which at the end of the year stood at $21.50. This net book value represents a 95% premium to our current share price.

As mentioned earlier, we believe that our fleet will continue to trade as premium to net book value. Premium that we expect will be reflected in the steadily growing net book value per share. Our excellent results in 2018 was based on the solid growth in operating lease rental revenue, based partly on the 34 aircraft to be acquired in the year, a high fleet utilization and significant gains from the sale of six older aircraft.

These full year results mirrored quarter four with significant increases in operating lease rental revenue to $389.4 million, adjusted net income growing to $91.2 million and adjusted earnings per share of $3.06. With our per share book value, we are also seeing a disconnect between FLY's share price and our earnings. Our shares currently trade at less than four times 2018 net income.

At year-end, FLY had a fleet of 113 aircraft plus seven CFM56 engines. Our fleet comprises almost entirely in production types from Airbus and Boeing, with only 2% by value comprising out-of-production aircraft. We expect to dispose these out-of-production aircraft at a profit during 2019 and in early 2020. At year-end, the average fleet age was 7.2 years and our average lease term was 5.8 years, figures that compare favorably with our industry peers. We'll continue to execute on our active sales program, continuing to delever to reduce lessee concentration, and to contain a young and active fleet. FLY is a well-diversified customer base with 46 airline lessees in 26 countries. It should be noted that our major exposure in the Indian market, which represents 10% of our portfolio value, is to the national airline of India and is fully guaranteed by the Government of India.

In 2018, FLY's aircraft sales program produced very positive results. In the year, we sold six aircraft for total economic gain of $29 million, which represents the premiums net book value of these aircraft. This premium comprise both the book value gain and end of lease income that FLY retained, and that was mainly in (inaudible).

In December, we announced that we had agreed to sell a portfolio of 12 aircraft. We've been transferring these aircraft to the new owners since then. To date, we have transfered 11 aircraft and expect to complete all 12 transfers by the end of the first quarter. These sales along with nine others, one of which has already been completed, are expected to contribute handsomely to our results in the first half of 2019, for which our CFO, Julie Ruehl will be giving positive guidance later in the call.

When we announced our portfolio acquisition last year, we pointed out this would result in bringing our financial leverage to over four times and that we were targeting to bring it to a range of around 3.5 times within two years. We are already well ahead of this target. And expect, by the end of this year, we will have beaten our target, mainly due to positive aircraft sales program, which we announced last year and which we're continuing to execute ahead of schedule. In recognition of this deleveraging success, in January, Moody's confirmed FLY's Ba3 rating and took FLY off credit watch.

FLY continues to provide investors with a real value proposition. We've grown our fleet substantially with attractive aircraft and have produced strong financial results. We expect these results to continue. Our valuable portfolio of modern and in-demand aircraft, and long-term leases to a diverse group of airlines globally provides FLY with a secure stream of income. FLY has demonstrated that it can grow its portfolio without having to place and pay pre-delivery payments on speculative orders from Airbus and Boeing.

We've also demonstrated that we can execute an active sales program, allowing us to recognize substantial gains and reduce lessee exposures. We have a disciplined financing strategy, which is substantially based on long-term and amortizing secured debt. Our current average financing terms of 5.3 years broadly matches our average lease terms. In particular, this financing structure isolates FLY from the vagaries of the capital markets and the need to refinance large tranches of debt at times when the capital markets may be dry.

FLY has no significant refinancing requirements until 2021 when $325 million of our unsecured notes fall due. These notes represent only 9% of our total capitalization, so FLY's financing is indeed robust. Based on rewards and risks, we believe that FLY is currently a very good value stock. A value that our insiders have recognized when last year they purchased more than 1 million shares for $15 per share. As stated earlier, our shares are currently trading at a significant discount to net book value and a very low multiple of reported 2018 and prospective 2019 earnings.

And with that, I'll hand you over to our CFO, Julie Ruehl, to take you through our financial overview.

Julie G. Ruehl -- Chief Financial Officer

Thank you, Colm. FLY is reporting net income of $31 million for the fourth quarter of 2018, a $24 million increase from the year ago quarter. Earnings per share increased from $0.25 a year ago to $0.95 in the current quarter, nearly a four-fold increase. Overall, we are very pleased with our improved financial results. FLY achieved ROE of 17.9%, the third consecutive quarter of double-digit ROE.

For the full year, FLY is reporting net income of $85.7 million, an increase of $83 million from fiscal 2017. Earnings per share increased from $0.09 in 2017 to $2.88 in 2018. ROE for 2018 was 14%, a tremendous improvement from 0.5% in 2017. These strong results for 2018 reflect the growth of the fleet and the higher level of gains on aircraft sales as well as no aircraft impairment in the year.

FLY's operating lease rental revenue in Q4 2018 increased $23.2 million or 26% to $112.2 million due to the growth of the fleet and higher lease rate factors. Double-digit growth occurred in every quarter of 2018 and annual operating lease rental revenue grew by 16% to $389.4 million. Total revenue increased 13.3% to $122.3 million in Q4 2018 from $107.9 million in Q4 2017. In Q4 2018, FLY recognized $4.3 million of end-of-lease income related to the expiration of two leases and release of those aircraft to other airlines.

In addition, FLY recorded a $7.9 million gain on the sale of three aircraft. These three aircraft are part of the 12 aircraft portfolio sale that we announced in December and the aggregate gain on the sale of the entire portfolio is being prorated across the 12 aircraft and is being recognized as the individual aircraft sales close. These three aircraft were sold out a 12% premium to net book value.

For the full year, FLY's total revenue increased $65 million or 18% to $418.3 million. In comparing expenses to the prior year quarter, depreciation, interest expense and SG&A are all up due to the growth of FLY's aircraft portfolio, although on a combined basis these expenses grew by 22%, a lower growth rate than the operating lease rental revenue growth rate of 26%. There were no impairment charges recorded in the quarter.

Also in Q4 2018, FLY incurred $1 million of debt extinguishment costs, consisting almost entirely of non-cash write-off of debt costs related to the 12 aircraft portfolio sales that I mentioned a moment ago. For the full year, depreciation, interest expense and SG&A on a combined basis grew by 10%, a lower growth rate than the operating lease rental revenue growth rate of 16%. There were no impairment charges recorded in the year.

Now I'd like to cover our guidance for Q1 2019. For the first quarter of 2019, we are expecting operating lease rental revenue of $102 million and $104 million. We expect amortization of lease incentives of $1 million to $2 million. Gain on sale of aircraft will be approximately $30 million. We expect no end-of-lease income. Depreciation expense will be approximately $37 million to $38 million. We expect interest expense of $38 million to $39 million, debt extinguishment costs are expected to be $2 million to $3 million. Maintenance and other costs are expected to be less than $1 million. We expect SG&A expense of $8 million to $9 million without consideration of any foreign exchange gains or losses that may occur.

I'll turn it back to Colm now for his closing remarks.

Colm Barrington -- Chief Executive Officer and Director

Thank you, Julie. Before we move to your questions. Let's have a quick recap of 2018. During the year, we grew our fleet by 34 aircraft or 33%. We achieved a 16% growth in operating lease rental revenue to nearly $390 million. We sold six aircraft for a total economic gain of $29 million, 17% above our net book value. We produced $3.06 of adjusted EPS and a 14.8% adjusted ROE. At year-end, our net book value was $21.50 per share. And finally, we have given pre-tax income guidance of over $45 million for the current quarter. These outcomes, as you'd see, are all highly positive and have established a trend that we expect to continue in 2019.

And with that, we're ready to take your questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from Jamie Baker of JP Morgan. Your line is open.

Jamie Baker -- JP Morgan -- Analyst

Hey, good morning, everybody and thanks for a very thorough set of prepared remarks. Couple of high level questions. So a number of your competitors, both public and private, I've been on the road this week meeting with investors. One subject that came up is whether depressed lease rate factors, and you've called this out in your remarks, whether the depressed lease rate factors are a permanent phenomenon, a secular development and perhaps that investor hopes for firmer future rates in the future -- firmer future rates should be abandoned. And I think this chatter was a contributing factor behind the weakness that you saw in this space yesterday. Just curious about your thoughts on this topic.

Steven Zissis -- Chief Executive Officer and President

Yes. So, I think in our industry there's sometimes confusion about lease rates, right. If you're talking, Jamie, about lease rates with respect to sale-leaseback of new aircraft, then I would tend to agree that directionally they reached a new level and are most likely to stay within that band for a very long time. And the reason I say that is I think aircraft leasing has become now an accepted asset class. You have very diversified capital sources around the world, whether it's pension programs, credit funds, infrastructure funds, Japanese capital, Chinese capital, Middle East Capital, public sector capital, we have all different types of sector of capital that want to play. So the way that we look at is, we think the asset class has reached a different level and the out (ph) lease rates may come off the bottom, but they're not going to return to the levels that they were 10 years ago.

Jamie Baker -- JP Morgan -- Analyst

That is very helpful, thank you for that. And second, I think the pace of -- everybody is debating the depressed multiples, significantly depressed in your case, still depressed elsewhere. And I think one issue is the pace of recent bankruptcies is -- it's tough to discern whether airline bankruptcies are in fact elevated relative to this point point in prior cycles? I think that is weighing on your valuation, or maybe just in the day of, I don't know, social media, media press coverage, there is the impression that bankruptcies are running higher than average. What are your thoughts on this?

Steven Zissis -- Chief Executive Officer and President

Well, look, I think in Europe there has to be some consolidation, right. The market is still too fragmented and therefore you are seeing probably a higher level of bankruptcies in Europe than in the past and I think that will continue for a while until the market reaches a firmer level like in the US. But I would just say, Jamie, in general that the aircraft leasing market is broader, more dense and more resilient than the way we thought about the market again 10 years ago. So, these bankruptcies as you've seen over the years have been absorbed quite easily across the industry. Now, if there is a major bankruptcy with an airline that has a massive order book, that could change things temporarily. And so those will (inaudible)

Jamie Baker -- JP Morgan -- Analyst

All right. Yes, trust me, (inaudible) wholeheartedly agree. It's shocking to me how much time in regards to the leasing names I'm confronted with this question from investors. So it would be nice to push it aside and get people to focus on fundamentals. I'll turn it over to somebody else. Thank you very much everybody.

Steven Zissis -- Chief Executive Officer and President

Thanks, Jamie.

Operator

Thank you. Our next question comes from Helane Becker of Cowen and Company. Your line is now open.

Tyler Scott -- Cowen and Company -- Analyst

Hey guys. This is actually Tyler (ph) on for Helane. So I'm just curious, clearly there is -- mid yield in the secondary market is strong for the mid-life narrowbodies. So I'm curious if you think that given how active most of your peers are in that market and so are you guys, if you think that there could potentially be over saturation in the secondary market as the year progresses, and that could potentially lead to lower lease yields in the secondary market as the year progresses?

Steven Zissis -- Chief Executive Officer and President

Yes, look, there's a lot of capital in that secondary market and what we've seen is as people and/or the aviation space who want to deploy capital, Tyler, that they see what's going on in kind of the front end of the market, so the Tier 1 new-ish sale-leasebacks and realize that the only place that really can get returns is in the mid-life market, and so you're seeing a lot of capital kind of revert to the higher yield, if you will, mid-life market. So, I think we see that as being a market that continues to be very liquid and for people to probably bid up assets, and, yes, I think it continues for quite a long time.

Now I think for the public lessors, right, keep in mind that all of us are long aircraft in a massive way, right. So, anytime you starting to bid up prices along the spectrum of the industry, it's just increasing the book values of all these public lessors. And that's one of the things that we're frustrated with is like, we're selling a lot of aircraft way above our book values and we get no credit in the market for it.

Tyler Scott -- Cowen and Company -- Analyst

Got you. And then my follow-up question is just regarding Jet Airways. I think you guys have three aircraft on lease with them. Do you intend to take back those assets or do you -- are you waiting for more color regarding their restructuring and what the State Bank of India does and if Etihad decides to increase their investment in that company?

Steven Zissis -- Chief Executive Officer and President

Yeah. So we have three fairly young 800s there that represent about 3% of our revenue at FLY. And we've been a long time lessor to Jet and to Etihad, and we're a big believer in the Indian aviation market. I mean, you look at the metrics of that market, it's phenomenal. So any major lessor has to play in that marketplace. It's -- long term, it's the place to be. So we have grounded our aircraft, we have control over our aircraft, but we have not terminated the leases and we are waiting for the airline to approve all its restructuring with the State Bank of India. And if that goes through at the end of the month, obviously, we will stay with Jet. If they can't get that done, then we'll take our aircraft back and redeploy them.

Tyler Scott -- Cowen and Company -- Analyst

Awesome. Thank you. Congrats on a good quarter.

Steven Zissis -- Chief Executive Officer and President

Thank you.

Operator

Thank you. Our next question comes from Scott Valentin of Compass Point. Your line is now open.

Scott Valentin -- Compass Point -- Analyst

Good morning. Thanks for taking my questions. Just with regard to on the fleet size, I think you guys pointed out even a sell probably, I think it's 18 aircraft in '19. I'm just wondering I think recalling from the schedule you have four aircraft coming in from the AirAsia transaction. I know there are some options. Just wondering how we should think about the fleet size going forward?

And then kind of following up on that question to fleet sizes, you pointed out leverage is coming down quicker than you modeled and you talked to be I think just over three times at year-end, one is, is that level of leverage at year-end does that enable you to buy back stock or do you think you have to go lower than that. And I guess, three, if you have to go lower than that, can you accelerate sales of aircraft in order to delever faster and maybe buyback stock sooner?

Colm Barrington -- Chief Executive Officer and Director

Yes. Well, Scott, first of all you're quite right. We're very comfortable with the way our leverage has gone. We're way ahead of our targets in deleveraging following the portfolio acquisition we did last year and we expect to be done very close -- if all else being equal, then we'd be very close to three times by the end of the year. As we do now have capacity ahead of what we thought we had -- going to have to acquire aircraft and buyback shares, we have a program to acquire over $500 million worth of aircraft this year, including those for neos that you mentioned and we have a $50 million share repurchase program, which we now hope we can begin to use again and as we get our -- have our leverage into a more comfortable area.

Scott Valentin -- Compass Point -- Analyst

Okay, thank you for that. And then in terms of the tax rate, it was a year-end true up. The tax rate can in a lot lower than we thought. How should we think about tax rate for 2019?

Julie G. Ruehl -- Chief Financial Officer

We're modeling about 15% going forward.

Scott Valentin -- Compass Point -- Analyst

Okay. And just one final question, on the remarketing, I guess you mentioned there are some aircraft left to remarket by the end of '19. I'm just wondering what those aircraft types are and ages?

Steven Zissis -- Chief Executive Officer and President

Yes. So we got six aircraft, they are all in the fourth quarter, Scott. And two of them are A340-600s, which will go for part out, two of them are A319s and two of them are 737-700s.

Scott Valentin -- Compass Point -- Analyst

All right. Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Koosh Patel of Deutsche Bank. Your line is now open.

Koosh Patel -- Deutsche Bank -- Analyst

Hey guys, good morning. Just had one question here. Just keeping in mind some of Steve's commentary on not growing for growth's sake due to the sale-leaseback market. How should we think about the AirAsia transaction you guys executed last year? Just kind of -- I was hoping you could give us kind of a one-year look back at the transaction, your thoughts around kind of taking on an order book and whether this is a strategy you would consider employing for future growth?

Steven Zissis -- Chief Executive Officer and President

Yes, look, we're still happy about the transaction, we thought was very beneficial to FLY and our ability to grow. If we find another opportunity like that, we'd like to do it. We do see a couple kind of opportunities in the market that have similar characteristics, so we're exploring those. But there's nothing about it that we didn't like about it, except the concentration. But, look, given the size that FLY is, we have to fly hot on a few parameters compared to our competitors, and those areas of concern are always concentration and leverage. And as Colm had mentioned, we brought our -- we're bringing our leverage down sooner than we thought. And we'll reduce our exposure to AirAsia over time. We're definitely on target for '19 and we'll see what 2020 brings.

Koosh Patel -- Deutsche Bank -- Analyst

Great, thanks a lot guys.

Operator

Thank you, ladies and gentlemen, this concludes today's question-and-answer session. I would like to turn the call back over to Matt for any closing remarks.

Matt Dallas -- Investor Relations Manager

We'd like to thank everyone for joining us for our fourth quarter earnings call. We look forward to updating you again next quarter. You may now disconnect.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program and you may now disconnect. Everyone have a great day.

Duration: 34 minutes

Call participants:

Matt Dallas -- Investor Relations Manager

Steven Zissis -- Chief Executive Officer and President

Colm Barrington -- Chief Executive Officer and Director

Julie G. Ruehl -- Chief Financial Officer

Jamie Baker -- JP Morgan -- Analyst

Tyler Scott -- Cowen and Company -- Analyst

Scott Valentin -- Compass Point -- Analyst

Koosh Patel -- Deutsche Bank -- Analyst

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