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Executives

Matt Dallas – Investor Relations Manager

Steven Zissis – Chairman of the Board

Colm Barrington – Chief Executive Officer & Director

Gary Dales – Chief Financial Officer.

Analysts

Michael Linenberg – Bank of America Merrill Lynch

Dan McKenzie – [Next Generation Equity Research]

Bill Ullman – [Bear Stearns]

[Chris Trauble]

Babcock & Brown Air Limited (FLY) Q3 2009 Earnings Call November 4, 2009 9:00 AM ET

Operator

At this time I would like to welcome everyone to the Babcock & Brown Air third quarter 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) Mr. Dallas you may begin your conference.

Matt Dallas

I’m Matt Dallas, the Investor Relations Manager of Babcock & Brown Air and I’d like to welcome everyone to our 2009 third quarter earnings conference call. Babcock & Brown Air which we will refer to as B&B Air of the company throughout this call, issued its third quarter 2009 results press release earlier today which is posted on the company’s website at www.BabcockBrownAir.com. Representing the company on this call today will be Steve Zissis, our Chairman; Colm Barrington, our Chief Executive Officer; and Gary Dales, our Chief Financial Officer.

I’d like to begin the call 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 for the company’s future business and financial performance. Forward-looking statements are based on current expectation and assumptions of B&B Air’s management which are subject to uncertainties, risk 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 release and are described more fully in the company’s filings with the SEC. Please refer to these sources for additional information. B&B Air 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 view or expectations or otherwise. This call is the property of B&B Air and cannot be distributed or broadcast in any form without the express written consent of the company.

A replay of this call is available for two weeks from today. An archived audio webcast of this call will be available for one year on the company’s website. I will now hand the call over to Steve Zissis, our Chairman and CEO of B&B Air to give you his view on industry conditions.

Steven Zissis

Thank you everyone for joining us on our third quarter earnings call. Those of you who have been following B&B Air closely over the last several quarters will have noted that our comments on past earnings calls pertaining to the state of the industry have been consistently bearish. While there are still plenty of reasons to be concerned about the conditions in the commercial aviation business, I’m pleased to say that for the first time in many months we are beginning to see some signs that the sector is in the very early stages of a recovery.

While industry demand statistics for passenger and freight traffic are beginning to show some stabilization, the factor giving rise to our optimism is better measured from the tone of our discussions with our airline clients. Since the beginning of the global economic downturn, airlines have been focused on cutting capacity, thinning inefficient and underutilized aircraft from their fleet and they have been dramatically slashing airfares in an effort to support their passenger load factors.

For the first time in several quarters however, our airline clients have started talking to us less about fleet retirements and more about growing their capacity. It has been our experience in other cycles that the first signs of the recovery come in the form of pure request for lease restructurings. Similarly, we have learned from our experience in past airline cycles that another sign of recovery is increased levels of interest from existing leasees in renewing their existing leases.

I can confirm that B&B Air’s portfolio is benefitting from both these trends. While there will undoubtedly be more financial distress in the sector over the coming winter months as a result of the inability of some of the more thinly capitalized airlines to build significant cash balances over the seasonally stronger summer months. We are encouraged by our leasees projected fleet growth beginning in the spring and summer.

I should also mention that we continue to feel strongly about the long term growth prospects for the business. While the main pillar supporting the projected long term growth in the sector remain in place, there are additional potential benefit of higher levels of inflation and a prolonged weakness in the US dollar. The combination of inflation and a weak US dollar have the potential to create tail winds for owners of US dollar priced hard assets like aircraft.

On the cautionary side, I will say that we remain very concerned about the price of oil and the impact of high oil prices on airline profitability. While higher oil prices are somewhat offset by the weakness in the US dollar for our airline clients based outside the US, should prices move above $70 to $80 per barrel level in the current market, we expect that the incremental financial squeeze imposed by these higher oil prices may cause airlines to rethink their fleet growth plans.

Further, I’d like to say that lease rates on current aircraft models have stabilized and in some instances have increased off the volume. However, we remain somewhat concerned that the financial weakness of many of the leasing companies will slow any significant increase in lease rates until these companies are placed in the hands of more disciplined financial owners.

Finally, I’d like to turn my comments briefly to B&B Air’s financial performance and the transparent nature of the business model prior to handing the call over to Colm. We all know that it’s been a difficult market but B&B Air’s financial performance has been strong. In the third quarter we produced $0.96 of available cash flow or approximately $4.00 per share on an annualized basis. When combined with the company’s existing cash balances and the value of the debt securities that the company has repurchased in recent months, there is significant value embedded in the company even excluding the long term value of our aircraft portfolio.

The ongoing cash flow being generated by the business is sufficient to allow us to cover current dividends while at the same time buying back significant amounts of the company’s debt, equity securities and selectively adding attractive aircraft to our portfolio. I will now turn the call over to Colm.

Colm Barrington

B&B Air is reporting another strong quarter having produced net income of $14.4 million and earnings per share of $0.48. This brings our net income to $75.4 million and our EPS to $2.43 for the nine month period ended September 30, 2009 as compared to $38.8 million and $1.16 respectively in the same period of 2008. In the quarter, our available cash flow which we refer to as ACF was $29.1 million and $0.96 per share as compared to $40.2 million or $1.20 per share in the third quarter of 2008. For the nine months, ACF was $96.7 million or $3.12 per share as compared to $103.3 million or $3.08 per share in the same period of 2008.

Gary Dales who follows on from me will take you through these numbers in more detail later in the call. A reconciliation of ACF to net income is available in today’s earnings release. Despite a weak global economic climate, our portfolio of 62 aircraft leased to 36 airlines in 19 countries has continued to perform well. All but one of our aircraft were on lease throughout the quarter and this aircraft is now leased and is scheduled to be delivered to the new leasee in December so our portfolio had a utilization factor of 98% in the quarter.

As Steve has said, conditions in the airline markets remain difficult as we head in to the winter months. The Air Transport Association of America reported that passenger revenues for US airlines in September declined to 19% compared to the same month in the previous year. This is the 11th consecutive month in which US passenger revenues declined in the same month from prior year fueled by the 10th consecutive month of declines in ticket prices.

Meanwhile IATA reports that September international passenger traffic remains stable with growth of 3% year-on-year while cargo traffic was down 5.4% year-on-year. However, you will recall that September 2008 was itself the beginning of a significant down turn in passenger demand following the demise of Lehman Brothers. IATA reports that September yields however were down 14% for economy passengers, down 18% for premium traffic and down 20% for cargo all compared to the September 2008. However, a positive indicator is that as load factor stabilized this may help to temper the decline in yields going forward.

However, as we head in to the winter months we are expecting that we will continue to have to actively manage receivables. Since the end of September we have in fact collected more than $2.8 million of our $8.6 million receivable balance that was outstanding at the end of September. Our portfolio remains young and predominately modern next generation narrow body aircraft. At September 30th the average age of our 62 aircraft weighted by value was 7.1 years and our average remaining lease term again, weighted by value was 4.9 years. On September 30th our annualized contracted lease rentals were $219 million.

Although the availability period under our acquisition facility will end on November 6th, we continue to actively seek out aircraft acquisition possibilities and examine alternative financing options. As we have said on previous calls, the primary objective of B&B Air’s management and board remains the maximization of shareholder value through a combination of dividends, share and debt repurchases in addition to aircraft acquisitions and sales.

In this regard, we have maintained our quarterly dividend at $0.20 per share bringing our total dividend for the nine month period to $0.60 per share. The Q3 dividend was declared on October 15th and will be paid on November 20th and this dividend represents 21% of ACF for the quarter. During the third quarter we also continued to enhance shareholder value by repurchasing $25 million of our notes payable for approximately 50% of the principal amount. So far this year B&B Air has repurchased $144 million of its notes payable at an approximately 50% discount. This initiative alone has increased shareholder value by approximately $2.30 per share pre-tax.

The company also owns options to acquire and additional $75 million of its notes payable for $36 million. At September 30th B&B Air had unrestricted cash of $77.9 million. While we didn’t repurchase any shares in the September quarter, B&B Air has already repurchased more than $2.2 million shares this year at an average cost of $4.08 per share. In the September quarter the company has an average of 30.2 million shares outstanding as compared to $33.5 million shares in the same quarter a year ago and we continue to evaluate share repurchase opportunities.

While business conditions remain uncertain in the world generally and in the aviation business in particular, B&B Air remains well positioned to avail of new opportunities that may arise and to continue our program of shareholder value enhancement by various means. With that said, I will now hand it over to our CFO Gary Dales to take you through the numbers in more detail.

Gary Dales

We are reporting net income for the quarter of $14.4 million or $0.48 per share. I will now discuss these results in more detail. Our total revenues for the quarter were $67.8 million and include operating lease revenue of $54.3 million, a pre-tax gain on the purchase of notes payable of $12.5 million and proceeds from a lease termination settlement of $600,000. Operating lease revenue for the third quarter of 2009 was $54.3 million, a decrease of $6.2 million or 10% over operating lease revenue reported in the same period of the previous year.

The decrease is due to the recognition in 2008 of $4 million of end of lease revenue with no comparable amount in the current period. The absence of revenue associated with aircraft sold in the third and fourth quarters of 2008 and decreases in rents on leases that adjust with LIBOR. Also included in 2008 total revenues is a gain of $5 million associated with the sale of an aircraft in September 2008.

Total expenses for the third quarter of 2009 were $50.2 million compared to $47.9 million for the same period in the previous year and consist of depreciation expense of $21.1 million, interest expense of $20.4 million, selling general & administrative expenses of $4.8 million, amortization of $3.4 million associated with an option to purchase our notes payable and maintenance and other costs of $500,000.

Depreciation expense for the third quarter of 2009 was $21.1 million compared to $20.1 million for the same period in the previous year, an increase of $1 million of 5%. Interest expense for the third quarter of 2009 of $20.4 million compared to $21.5 million in the same period the previous year, a decrease of $1.1 million or 5%. This decrease is primarily due to the decline in LIBOR.

Selling, general and administrative expenses were $4.8 million in the third quarter of 2009 compared to $5.4 million in the same period in the previous year, a decrease of $600,000 or 11%. The decrease is primarily due to costs associated with repossession of aircraft taken place in the prior year. There were no similar costs in the third quarter of 2009.

As Colm mentioned, we paid $7 million for an option to purchase up to $100 million of our notes payable at a 48% of par value. In September 2009 we repurchased $25 million of par value of the notes payable under the option. The costs of the options are being amortized under the terms of approximately six months and 10 months.

Our provision for income taxes for the third quarter of 2009 is $3.2 million representing an effective rate of 18%. The effective tax rate for the same period in the previous year was 12.9%. The increase in the effective tax rate reflects the recognition of deferred taxes at 25% rate on the gain associated with the purchase of the securitization notes.

Moving to the balance sheet we have total assets of $2 billion of which $1.8 billion is invested in flight equipment held for operating lease. Our total cash and cash equivalents are $208.3 million of which $77.9 million is unrestricted. The book value of our company has increased to $463.4 million, an increase of $74 million from December 31, 2008. This is an increase of over $3 per share to $15.30 per share.

Our available cash flow or ACF was $29.1 million for the third quarter of 2009 compared to $40.2 million for the same period in the previous year. On a per share basis ACF was $0.96 in the third quarter of 2009 compared to $1.20 in the third quarter of 2008. Third quarter 2008 ACF includes approximately $4 million of end of lease income and a gain of $5 million associated with the sale of an aircraft. We define ACF as net income plus depreciation, amortization of lease incentives and debt issue costs and deferred income taxes; all non-cash charges.

The gain on the purchase of notes payable is excluded from ACF. We believe that ACF provides a meaningful measure of B&B Air’s capacity to reinvest in our business and to execute other initiatives designed to create shareholder value. However, actual cash available for distribution made differ from our ACF major because other cash expenses that are not reflected in net income. You will find the reconciliation of ACF to net income, the most directly comparable GAAP measure at the end of our press release issued this morning.

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

Colm Barrington

Thank you everyone for joining us on today’s call. We’re now ready to take your questions so if you’d like to go ahead with questions we’ll do our best to respond to you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Linenberg – Bank of America Merrill Lynch.

Michael Linenberg – Bank of America Merrill Lynch

A couple of questions here, I guess Steve you made a good point about where lease rates seem to have stabilized and maybe there’s an opportunity for them to increase but then you sort of qualified it that some of the leasing companies out there are in a distressed state and that maybe ultimately for lease rates to go up those companies need to be in the hands of more disciplined parents and what I’m getting to is in your campaigns as you look out for potential renewals and I know that you’re placing an airplane later this year, have you come across from what you’re hearing from potential customers that maybe some of these distressed lessors are acting less rational than maybe what you’ve seen in the past? Is there any color or anything that you can provide on that to give us some additional kind of sense where pricing is going?

Steven Zissis

Certainly we are seeing increased activity by some of the weaker lessors and in desperation to lease their aircraft at lease rates of whatever they can obtain in the marketplace. You have to qualify I think that statement that it really does go by aircraft type. Some of the older out of production aircraft are being essentially given away in the marketplace whereas the in production stuff is maintaining its lease rates. But, we see some of the competitors out there being very aggressive in terms of offering their aircraft at what we think are lease rates that don’t make any sense in the current marketplace.

Michael Linenberg – Bank of America Merrill Lynch

Then my second question, this is to Gary, when we look at the numbers and this is going to the back page of the press release where you have the available cash flow, the amortization of debt issuance cost, the $1.8 million, I just want to reconcile that with the income statement. Which line item is that in?

Gary Dales

That would be part of interest expense.

Michael Linenberg – Bank of America Merrill Lynch

So that shows up in the interest expense. The debt purchase option amortization wouldn’t that be non-cash or is that cash?

Gary Dales

It is a non-cash charge but we’re not adding it back.

Michael Linenberg – Bank of America Merrill Lynch

Just because you view it as sort of a non-recurring, it’s going to be like you said it’s amortizing over six and 10 months?

Gary Dales

Yes.

Operator

Your next question comes from Dan McKenzie – [Next Generation Equity Research].

Dan McKenzie – [Next Generation Equity Research]

I guess a quick question, where is the sale of BBAM at? I’m just wondering if you can provide some perspective as to what might be holding up the conclusion of that transaction?

Steven Zissis

We’re still in the process of putting the deal to bed and at this point I would say that we’re looking at perhaps a year end closing on that but it could drag over another month Dan. I would say things are on schedule, they’re progressing as we anticipated and as we indicated to our shareholders during the last call and we expect to have everything concluded shortly.

Dan McKenzie – [Next Generation Equity Research]

Then I guess given Aircap’s purchase of Genesis, how are you thinking about the position of Babcock & Brown? I guess in particular, what is the optimal size for an aircraft lessor to leverage scale in the capital markets? Maybe in particular I’m thinking of B&B Air not necessarily BBAM.

Steven Zissis

Our focus is really operating the company day-to-day and to grow our business as we had indicated to everybody when we initially put the company together. We’re very focused on taking advantages of opportunities in the marketplace to grow the company in the reasonable format and to make sure that we enhance shareholder value as we operating the entity day-to-date. We’re really not focused on what other people are doing with Genesis or Aircap or things of that nature, it’s just a bunch of noise in the market for us.

Dan McKenzie – [Next Generation Equity Research]

Then I guess just one final follow up question here, you mentioned that the business is generating enough available cash flow for the purchases of aircraft. Are there any in particular that you’re considering or that you’re looking at right now?

Steven Zissis

I’m sorry Dan was that in terms of aircraft acquisitions?

Dan McKenzie – [Next Generation Equity Research]

Correct.

Steven Zissis

Well, we’re always in the market looking at potential opportunities and as they come along we’ll take advantage of them.

Operator

Your next question comes from Bill Ullman – [Bear Stearns].

Bill Ullman – [Bear Stearns]

The first question is regarding the decline in operating lease revenues this quarter versus the three months ended September 30th ’08 and I’m sorry if I missed it before but if you could describe the reason for that decline and whether that’s a kind of top line trend that you think is going to continue based on pressure on operating lease rates? The second question relates to your depreciation policy in general. Obviously, you’ve done a magnificent job increasing net asset value of the company through your debt repurchases but to the extent you’re not depreciating your assets in a realistic way that kind of good be a false increase. Can you talk about whether in addition to the revenue question, whether you’re comfortable with the rate of depreciation I suppose of the aircraft assets that you have on your books?

Gary Dales

With regard to the revenue probably the biggest item comparing third quarter 2008 to third quarter 2009 is that there was some end of lease revenue in the third quarter 200/ and that amount was $4 million and 2009 is less because we didn’t have the end of lease revenue. In addition, in the third and fourth quarter of 2008 we sold two aircraft. We no longer have the lease revenue in our 2009 amounts so that’s a decline of a little bit in the lease revenues. As Steve mentioned, lease rates may have bottomed out and flattened and we expect that the trend within the lease revenue line should be consistent going forward particularly as we get all of our aircraft leased.

Colm Barrington

But, it can be quite lumpy Bill as leases end and we do have end of lease revenues come in, several million dollars coming in the quarter that you might not have had in the preceding quarter.

Gary Dales

The second with regard to depreciation, our depreciation policy is to depreciate our aircraft over a 25 year life from their original manufacturer date and we are very comfortable with that life for our assets.

Bill Ullman – [Bear Stearns]

Is that straight line?

Gary Dales

Straight line depreciation.

Operator

Your next question comes from the line of [Chris Trauble].

[Chris Trauble]

A question for you, and you probably already covered this, I know you’ve been focusing on the available cash flow and with the dividend payout being 21% of your ACF will there be a dividend increase in the future or will money be focused primarily on the debt repurchases at $0.50 on the dollar?

Colm Barrington

Chris, I think when we reduced the dividend last year we said we saw opportunities for enhancing shareholder value through a combination of dividends, debt repurchases and share repurchases plus acquiring additional aircraft and we continue to evaluate that on a quarterly basis. So, as markets develop we will look at each quarter and make a decision on dividend and those other initiatives at that time.

[Chris Trauble]

If I can ask another question, regarding the past discount or the past discounted debt repurchases to date, you mentioned how they’ve affected the shareholders today, and I apologize I’m not an analyst for accounting type person but based on the additional amount of debt that’s out there that you can still repurchase at $0.50 on the dollar, how much more would you expect that to affect the [fly] shareholder?

Colm Barrington

Well, we have an option to acquire an additional $75 million for $36 million and that will add another $39 million of shareholder value with approximately 30 million shares so it will be $1.30 per share give or take just in the options that we have at the moment. We are looking at other possibilities, buying debt and shares but we don’t have anything firmed up yet.

[Chris Trauble]

It sounds like the best deal is for you guys to keep on doing that versus going out and growing the business by buying more planes or leasing.

Colm Barrington

There have been certain unique opportunities because of the stress in the financial markets and we try to avail of those. Whether those will last, who knows but we’re certainly looking at everything as we go forward.

Operator

There are no audio questions at this time.

Steven Zissis

Thank you everyone for joining us on today’s call. This now concludes the call. We look forward to updating you again next quarter.

Operator

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

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Source: Babcock & Brown Air Limited Q3 2009 Earnings Call Transcript
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