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Executives

Matthew Dallas - Investor Relations Manager

Steve Zissis – President and CEO

Colm Barrington - Chief Executive Officer

Gary Dales – Chief Financial Officer

Analysts

Richard Shane – Jefferies & Co.

Andrew Light – Citi

William Mansfield - Barclays Capital

Babcock & Brown Air Limited (FLY) Q1 2010 Earnings Call May 5, 2010 9:00 AM ET

Operator

Good morning. My name is Rashira and I will be your conference operator today. At this time I would like to welcome everyone to the first quarter 2010 earnings conference call. [Operator instructions]. At this time, I would like to turn the call over to Mr. Matt Dallas of Investor Relations.

Matthew Dallas

Thank you. Good morning everyone. I’m Matt Dallas, the Investor Relations Manager of Babcock & Brown Air and I’d like to welcome everyone to our first quarter earnings conference call. Babcock & Brown Air, which we will refer to as B&B Air, or the Company throughout this call, issued its first quarter earnings results press release earlier today, which is posted on the Company’s website at www.babcockbrownair.com.

Representing the company today on this call will be Steve Zissis, the president and CEO of BBAM, 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, 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. Pease 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 views 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 earnings 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 will now hand over the call over to Steve Zissis, the President and CEO of BBAM, the company that manages and services B&B Air’s fleet, to give you his view on industry conditions.

Steve Zissis

Thank you Matt, and thank you everyone for joining us on our first quarter earnings call. As many of you are already aware, the BBAM management team in partnership with B&B Air has recently completed the acquisition of Babcock & Brown’s aviation franchise. As the President and CEO of BBAM, it is with excitement that I continue to lead the business forward into this new chapter of growth and expansion.

Our team built a fantastic franchise in aircraft leasing at Babcock & Brown over the past 20 years, and we have successfully preserved the business in its entirety as part of this transaction. While the BBAM sales process took longer than any of us expected, it’s worth noting that throughout this period of uncertainly, the business was consistently profitable and generated significant amount of positive cash flow.

We’ve kept substantially all of the BBAM management team and core employee groups together, and the same team will lead the business forward in the years to come. The BBAM management team has contributed a significant amount of its own capital into the transaction and is fully invested alongside B&B Air.

We will be growing our aircraft leasing and management business and we couldn’t be better positioned to continue providing class leading services to B&B Air in the years ahead. As part of this transaction, and adopting best practices in corporate governance, I’ve handed the role of Chairman of the Board of B&B Air into the capable hands of Joe Donavan, our former lead independent director.

Joe has been on the board since our IPO and continues on as an independent director and Chairman of the audit committee. I will continue on as a director of B&B Air and will remain President and CEO of BBAM. With the uncertainty that hung over B&B Air as a result of Babcock & Brown’s financial distress now behind us, we intend to renew our focus on growth.

Activity in the commercial aviation business continues to improve. We are seeing strong demand from the emerging markets, particularly for Boeing next generation narrow body equipment. As I mentioned on the last call, the emerging market demand is being underpinned by the positive economic growth underway in these jurisdictions and the lack of over-ordering for the new aircraft in recent years. These trends are continuing and there are not enough aircrafts on order to support the growth.

Conversely, for the most part, airlines in the developed are coping with slower economic growth, historically low premium passenger traffic and high cost of capital. This has limited the amount of demand we are seeing from the developed regions. Not only have aircraft values stabilized in recent months, but they have also started increasing along with overall recovery in the sector.

Significant amounts of private equity capital are coming into the aircraft leasing business looking for opportunities to ride the cyclical recovery and aircraft values and lease rates. In addition, many existing players in the aircraft leasing business have finally stabilized in the post credit crisis era and are at various stages of beginning to grow their respective businesses for the first time in the last few years.

The combination of new private equity capital entering the sector, an increase in the number of transactions, and the stabilization of existing players is generating data points in the market about increasing aircraft values, and underpins our positive view of B&B Air’s portfolio.

B&B Air is very well positioned to grow in the immediate future. We believe that this is the right time to deploying cash for aircraft acquisitions. The company has $130 million of unrestricted cash on the balance sheet and it generates a significant amount of positive free cash flow on a monthly basis. The price of the securitization debt that the company re-purchased over the last 12 months has increased and when combined with the company’s existing cash balances, there are significant financial value embedded in the company alongside the long-term value of our aircraft portfolio.

As you know, financial leverage is an integral component of the aircraft leasing business and it is necessary if we’re going to deliver our target returns to our shareholders. The credit crisis has significantly disrupted the non-recourse debt market for aircraft but there is a recovery in the market as well. More and more banks are re-entering the sector and fixed income capital market conditions have improved dramatically. While the debt available today is expensive relative that available in the period before the credit crisis but it is becoming generally available and gives us further confidence in the prospect of growth and recovery in aircraft values.

I will now hand the call over to Colm Barrington, our CEO of B&B Air.

Colm Barrington

Thanks Steve and welcome everyone. B&B Air is reporting another strong quarter with net income of $16.7 million and EPS of $0.55. These figures are below the first quarter 2009. Last year’s figures were [hand] significantly by a major gain on the purchases of notes payable. Gary Dales will explain the figures and the variations in more detail.

What I can highlight here is that both are revenue and income from leasing were ahead of last year. Our available cash flow of the quarter was $45 million, or $1.49 per share. This compares to $35.3 million or $1.09 per share in the first quarter of 2009. The reconciliation of ACF to net income is available in today’s earnings release.

At quarter end, as Steve said, we had a total cash balance of $270 million of which $130 million was unrestricted. These figures compare to $235 million and $96 million at the end of 2009. We’ve declared a dividend of $0.20 per share for the quarter representing 13.4% of available cash flow. This dividend will be paid on May 20 to shareholders of record on April 30.

Our fleet of Martin widely used fuel efficient aircraft enjoyed a strong performance in the quarter. At quarter end, all but one of our 62 aircraft were on lease with an average age of 7.5 years and average remaining lease term of 4.7 years, both figures being weighted by net book value of each aircraft.

At quarter end our annualized lease rentals were $209 million. Our quarter end lease receivable balance of $6 million was approximately $2 million higher than the end of 2009. I’m happy to be able to report, however, that since month’s end approximately $2.3 million of this balance has been collected.

We had no lessee bankruptcies during the quarter. Of the nine scheduled lease returns in 2010, we have already leased and delivered two aircraft, agreed to [ford] sale of a third and have agreed terms of extension of two more leases. We are marketing the remaining four aircraft right now of which one has already been returned and are hopeful of completing the arrangements with respect to these aircraft during the coming months.

Overall, as again Steven said, the demand conditions for aircraft leasing remains stronger than they were a year ago. During the quarter, we continued to work on our program of shareholder value enhancements. In particular, we decided to sell an option to acquire $50 million face value of our securitized notes at 48% value for a price equivalent to 73% of face value. This transaction resulted in a pre-tax gain of $12.5 million or $0.31 per share. As importantly, it generated 12% million in extra cash which has assisted us in completing two major transactions that were completed after the end of the quarter.

On April 29, we invested $8.75 million to acquire an interest in BBAM, LP, the newly formed private company that on the same date acquired substantially all the aviation assets of Babcock & Brown. Simultaneously, BBAM assumed the management agreement related to B&B Air’s portfolio and the BBAM management team acquired 1 million B&B Air shares from Babcock & Brown.

The management and staff at BBAM are substantially the same people who have successfully managed Babcock & Brown’s aviation business for nearly 20 years and who have managed B&B Air’s portfolio since the company was established in 2007.

This investment gives B&B Air a 15% interest in one of the world’s leading aircraft management companies. With a managed portfolio of over 290 aircraft including B&B Air’s 62 aircraft. It gives B&B Air an interest in the management income from this large portfolio; along with income from aircraft origination, remarketing, and sales. As a result, it is complementary to B&B Air’s core business and is expected to produce strong returns for B&B Air and its shareholders. The investment along with the purchase of 1 million B&B Air shares by the BBAM management team further aligns the interests of B&B Air as its manager.

In a related transaction, B&B Air purchased just over 2 million of its shares, at a price of $8.78 per share, for a total investment of $17.7 million. These shares represent approximately 6.6% of the shares outstanding at March 31, 2010. Since we launched our share repurchase program in June, 2008, B&B Air has now repurchased a total of 5.3 million shares, for a total of $33.2 million; representing an average price of $6.23 per share.

The shares repurchased represent approximately 16% of our shares outstanding at the start of the program, and bring our current share count to 28.3 million. Our board has approved an extension of the program through May 2011. These transactions together add further strength to B&B Air’s business and to our balance sheets, further increasing shareholder equity on a per-share basis.

While the first months of 2010 were positive for B&B Air on several fronts, they’ve also been positive for the aircraft leasing industry generally. During the last six months we’ve commented on positive trends amongst airlines, which represent the demand side of our business. But, more recently, we’ve also seen more positive trends on the supply side.

Whereas in late 2009, there were concerns about the possibility of the entire portfolios of three large aircraft lessors hitting the market, and possibly at distressed prices; we understand that these portfolios have now been withdrawn. At the same time, we’ve seen new equity capital come in to the aircraft leasing sector.

The presence of this new capital, along with a decrease in the number of distressed sellers, should have a positive impact on aircraft values and mitigate one of the major concerns in which investors in B&B Air have been expressing over the last two years. We expect that these trends will result in a decrease in aircraft values during 2010 and beyond.

I’ll now hand you over to Gary Dales, our CFO, for a deeper look at the financials.

Gary Dales

Thank you, Colm. We are reporting net income for the quarter of $16.7 million, or $0.55 per share. This compares to net income of $47 million, or $1.45 per share for the first quarter of 2009. As Colm mentioned, our first quarter of 2010 earnings include a pre-tax gain of $12.5 million, resulting from the sale of our remaining option to purchase $50 million principal amount of our notes payable.

The first quarter of 2009 results, including a pre-tax gain of $49 million associated with the purchase of $100 million of principal amount of our notes payable, for $48.7 million plus associated expenses. And a gain of $6.5 million, representing a partial settlement in respect of aircraft repossessed in 2008. The debt purchase transaction in 2009 contributed $1.12 to the first quarter of 2009 earnings-per-share. I will now discuss the results in more detail.

Our total revenues for the quarter were $67.7 million and include operating lease revenue of $54.2 million and a gain associated with the sale of an option to purchase our notes payable of $12.5 million. Operating lease revenue for the first quarter of 2010 of $54.2 million compares to operating lease revenue of $53.4 million for the same period in the previous year. The increase is primarily due to end-of-lease revenue recorded in the first quarter of 2010 partially offset by lease rentals.

Total expenses for the first quarter of 2010 were $47.1 million compared to $48.1 million for the same period in the previous year and consist of depreciation expense of $21.3 million, interest expense of $19.1 million, selling, general and administrative expenses of $5 million and $947 thousand of amortization expense associated with the options to purchase our notes payable. Total expenses decreased $1 million or approximately 2% compared to the same period in the previous year.

Depreciation expense for the first quarter of 2010 was $21.3 million compared to $20.6 million for the same period in the previous year, an increase of $700,000 or 3%. Interest expense for the first quarter of 2010 was $19.1 million compared to $20.6 million for the same period in the previous year, a decrease of $1.5 million or approximately 8%. The decrease is primarily due to the decline in our overall interest costs on outstanding debt and a reduction in a total amount of our debt outstanding.

Selling general and administrator expenses were $5 million in the first quarter of 2010 compared to $6.2 million for the same period in the previous year. For the first quarter of 2010, selling, general and administrative expenses were 7% of total revenues.

Our provision for income taxes for the first quarter of 2010 was $4 million representing an effective rate of 19.3%. The effective tax rate for the same period in the previous year was 23%. The effective rate in both periods reflect the recognition of deferred taxes at a 25% rate on a gain associated with the sale of the option and the purchase of the notes payable.

Our balance sheet remains strong. At March 31st 2010 we have total assets of $2 billion of which $1.7 billion is invested in flight equipment held for operating lease. Our total cash and cash equivalents is $270.3 million of which $130.3 million is unrestricted.

Our book value per share is $16.18 at March 31, 2010. Our available cash flow or ACF was $45 million for the first quarter of 2010 compared to $35.5 million for the same period in the previous year. On a per share basis, ACF was $1.49 in the first quarter of 2010 compared to $1.09 for the same period in the previous year, an increase of 37%.

We define ACF at net income plus depreciation, amortization of lease incentives and dead issue costs and deferred income taxes, all non-cash charges. Non-cash gains resulting from the purchase of notes payable are 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 may differ from our ACF major because of other cash expenses that are not reflected in that income. You will find a 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 over to Colm for his closing remarks.

Colm Barrington

Well in summary we are delighted with the developments of B&B Air during the first four months of 2010 and believe that they will continue to add value to our shareholders. We’re also encouraged that the development that we have seen in the aircraft leasing industry this year particularly with the withdrawal of the threat of major distressed portfolio sales and the announcements of new participants will have a positive impact on aircraft values and on the confidence of the investor community in B&B Air and in its peers.

So we’re now ready to take your questions. Operator would you please open up the lines?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Richard Shane – Jefferies & Co.

Richard Shane – Jefferies & Co.

I’m not a big fan of complimenting management teams on conference calls but I will say that you guys have done a great job over the last 12 months using financial structure to add value for your shareholders and it’s actually a segue as much as compliment to my next question or to my actual question.

The one thing that really stands out at me to me when I look at the presentation is the fact that now basically four or five quarters there’s been no change in the fleet size. Obviously defending the fleet during the downturn was incredibly important, holding on to the assets was the number one goal. Looking forward I think you’ve added the value you can by managing your existing portfolio.

What’s it going to take now to start adding planes and I guess the real question is what do you think needs to structurally happen in the debt market to reinvigorate growth and what are the levels to cost the funds that you think you need to see in order to able to make creative acquisitions using debt?

Steve Zissis

Thanks for that compliment. We appreciate it, especially in light of the fact that the last 18 months to 24 months have been a difficult period given that we had to deal with the financial distress of Babcock & Brown, the parent company, and now we’ve finally exited that situation and we’re on to a kind of a more focused growth in our business.

So, having said that I do think it is probably a really good opportunity now in this marketplace to originate deals. There are several airlines out there that are either looking to bolster the balance sheets through sale lease-back transactions or have new deliveries.

And so we do think that the way that we will probably try to grow the portfolio is on a one-off basis where we will originate deals directly with the airlines and probably to answer your question more specifically. The type of debt that is available out there and we think that will work is one-off non-recourse debt that is currently priced in the 300 to 400 [dips] range and that is supportable in our transaction but obviously depends on what we buy the aircraft for and what type of leaseback terms we can originate with the airline.

So, kind of a way to answer your question is it always goes case by case. We do see good opportunities to start enhancing our portfolio by adding new aircraft.

Richard Shane – Jefferies & Co.

So, realistically the way you’ll grind us forward is a plane or two at a time individually financed as opposed to portfolio the planes financed on secure ties portfolio basis?

Steve Zissis

Yes for the short-term definitely one-off transactions we’ll be looking at very closely. But there are few portfolio transactions out there that we wouldn’t say we’re not looking at. I mean they are out there but they are few and far between so it’s hit or miss with the portfolio deals.

Richard Shane – Jefferies & Co.

And then one last question. Are there any material changes to the debt covenants following the changes in structure and management company?

Steve Zissis

No, none at all.

Operator

Your next question comes from Andrew Light – Citi.

Andrew Light – Citi

Just a question, well I’ve got a couple of questions. The first one on the BBAM deal. Are you able to disclose roughly what net income BBAM made last year? I’m just trying to get an idea of the expected contribution of that 15% in the future?

Steve Zissis

Yes Andrew we’re not disclosing any numbers but obviously whatever numbers are in the annual report from Babcock & Brown last year are available. To tell you the truth I don’t know if they were broken down by the different business segments of Babcock & Brown but you can take a look. But we’re not disclosing any of those type of numbers.

Andrew Light – Citi

Yes I did at that and there’s like a pretax profit of $150 million in ’08 so I can’t really reconcile that with the effective price paid of $58 million which would appear less than 1 so that’s why I was asking the question.

Colm Barrington

Well going forward BBAM will be reporting and then we will be reporting our share of BBAM so you will see figures going forward.

Andrew Light – Citi

Oh right okay. And the second question. On the sale of the option was that on the debt repurchase why did you opt for selling the option at 73% rather that just exercising the option presuming at 100%?

Colm Barrington

Yes well I mean our total options Andrew were we bought options on $290 million of debt at $0.43 on the dollar. We’d exercised those options with respect to about $169 million face value for which we paid $73 million. So we had another $50 million left and we decided to take some money off the table effectively and sell that option when we got the opportunity to do so at $0.73 on the dollar, having bought it for $0.48. We just thought it was a good deal and good strategy to take some money off the table.

Andrew Light – Citi

So it wouldn’t necessarily have been more profitable to just exercise the option rather than sell it?

Colm Barrington

It would have been more profitable but then it wouldn’t have used up cash whereas selling the option actually generated cash, so I think the net turnaround in cash was well over $30 million versus what we gained from selling the option versus what it would have cost us to exercise it.

Andrew Light – Citi

You mentioned on a call that you’ve had two major transactions since the end of the quarter. You’re referring to the BBAM share repurchase or are you referring to aircraft deals?

Colm Barrington

We’re referring to the investment in BBAM and then the acquisition of another just over 2 million shares at $8.78 per share.

Andrew Light – Citi

When do you think you’ll start buying planes again? Is it imminent?

Steve Zissis

We’re out there right now looking for transactions and we’ve got a couple offers out there with airlines so we’ll see in the next month or two here if we can originate anything. But just following onto Colm’s comment there about why we exercised the option on the debt, at the end of the day we’re a leasing company and we want to build and grow our business. We felt that the debt had recovered to a significant level where there wasn’t that much more upside so we wanted the cash to invest in aircraft. That’s how we’re going to grow the company.

Operator

Your next question comes from William Mansfield - Barclays Capital.

William Mansfield - Barclays Capital

Just a follow on that last point you just made about selling the option back into the market to generate cash, when I flip through your 20-S, it seemed that the other $169 million of notes that you repurchased, you actually haven’t canceled those notes. You’re holding them in a subsidiary.

Hypothetically, in theory, you could go sell those into the market and at $0.73 you’d generate significant cash proceeds. Is that correct?

Colm Barrington

That is correct, yes.

William Mansfield - Barclays Capital

Is that a potential source of future cash to fund airplane purchases?

Colm Barrington

Yes, potentially. It’s one of the assets we have in the company we could sell and generate additional cash, certainly.

William Mansfield - Barclays Capital

Were you to do that, if you did $169 million at whatever, a hypothetical $0.73 price, you’d have to repay this credit facility of $32 million against that, right?

Colm Barrington

We would, that’s right.

William Mansfield - Barclays Capital

So you would still generate, I don’t know, $90 million if you were to sell that.

Colm Barrington

About that I think, yes.

William Mansfield - Barclays Capital

My other question was on… I still thought there’d be Babcock & Brown still owned a few shares left after all of these share repurchases. Is it a potential to --

Colm Barrington

Babcock & Brown owned approximately $4.4 million shares in B&B Air. The BBAM management team bought 1 million of those shares and BBAIR purchased just over 2 million, so Babcock & Brown still owns 1.4 million shares in BBAIR. We have an option, sort of right of first refusal, with respect to block trades of those shares within BBAIR, so we’d be looking at that over the coming months as Babcock & Brown decides what it wants to do with those shares.

William Mansfield - Barclays Capital

Forgive me, there was a question about any numbers you could give on BBAM and I understand you’re not giving out numbers. Can you directionally comment? Was BBAM a profitable entity last year?

Colm Barrington

Extremely.

Operator

There are no further questions at this time. Are there any closing remarks?

Steve Zissis

I would like to thank everyone for joining this quarter’s B&B Air earnings conference call. We look forward to updating you all again next quarter.

Operator

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

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Source: Babcock & Brown Air Limited Q1 2010 Earnings Call Transcript
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