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Executives

Matthew Dallas - Investor Relations Manager

Colm Barrington - Chief Executive Officer, Director

Steven Zissis - Chairman

Gary Dales - Chief Financial Officer

Analysts

Daniel McKenzie - Credit Suisse

Andrew Light - Citigroup

Richard Shane - Jefferies & Co.

Analyst for Michael Linenberg - Merrill Lynch

Babcock & Brown Air Limited (FLY) Q2 2008 Earnings Call August 13, 2008 9:00 AM ET

Operator

Welcome everyone to the Babcock & Brown Air second quarter 2008 earnings conference call. (Operator Instructions) I will now turn the call over to Investor Relations Manager, Matthew Dallas.

Matthew Dallas

Babcock & Brown Air which we will refer to as B&B Air or the company throughout this call issued its second quarter 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 of the company’s future business and financial performance. Forward-looking statements are based on current expectation and assumption 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 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 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 call is available from today, Wednesday, August 13, until midnight Wednesday, August 27, 2008. A webcast of this call will be archived for one year on the company’s website.

I will now hand the call over to our Chief Executive Officer, Colm Barrington.

Colm Barrington

B&B Air has had another excellent quarter producing net income of $11.1 million and earnings per share of $0.33. We have maintained our quarterly dividend at $0.50 per share with the Q2 dividend due to be paid on August 20.

As importantly, we’ve continued to strengthen the company through further prudent additions of modern fuel-efficient aircraft and through other initiatives including a share repurchase program. These measures will strengthen the company going forward while enhancing shareholder value both now and in the future.

We’ve also begun to report our available cash flow which we refer to as ACF including a per share measure. In the quarter our ACF was $0.99 per share. Gary Dales, our CFO, will take you through the ACF analysis and these figures in more detail later in this call. A reconciliation of ACF to net income is available in today’s earnings release.

Since April 1 we have acquired five more aircraft for approximately $180 million. Two of these aircraft were brand new from the manufacturer, two are 2007 vintage aircraft, and one is a freighter. Since our IPO last September we’ve increased our portfolio by 17 aircraft at a cost of approximately $700 million. The acquisition of these additional modern fuel-efficient aircraft has also had the effect of retaining the low age of our portfolio at 6.3 years. Our diversifying our lessee base only further broadened the geographic spread of our business. We continue to look for attractive acquisitions and have over $500 million remaining in our aircraft acquisition facility to fund such opportunities. This remaining funding capacity can be drawn down without the need for B&B Air to contribute any more of its own equity funds.

Through a combination of additional aircraft and higher rentals from the new aircraft we have re-leased B&B Air’s contracted annualized revenues are now $228 million as compared to $153 million at the time of our IPO last year. This is an increase of 49%.

We’ve also made significant progress in dealing with the premature return of four Boeing 757 aircraft from ATA Airlines in April. We have re-leased and delivered two of the aircraft to a new lessee on attractive terms and at a relatively low cost in terms of our requirement to repossess and remarket the aircraft. We are in discussions with several parties regarding the other two aircraft.

We’re also evaluating potential claims against ATA’s parent company to cover losses associated with the lease terminations. This company is the guarantor of the leases and is not the subject of any insolvency proceedings.

I would like to further address the ATA situation in order to put it in context. Two of these aircraft have now been re-leased at monthly rentals that are higher than the amounts of the ATA leases. As a result B&B Air’s aggregate monthly rentals are only approximately $400,000 less than they would have been had ATA not faulted. These lost rentals which we plan to cover through a combination of new transactions and calls under our lease guarantees currently represent approximately 2% of our aggregate monthly rentals of $19 million. While this is not a loss about which we are complacent, it is one that is not too significant in the context of B&B Air’s overall operations.

It was in the context of the continuing strong performance in our portfolio that we felt comfortable in continuing with our $0.50 per share quarterly dividend. Our dividend represents 51% of our available cash flow for the quarter and is comfortably supported by the cash and cash equivalents B&B Air has available to it. Overall we remain committed to maximizing shareholder value through a combination of dividends, share repurchases, aircraft acquisitions, and sales.

At its meeting in late June our Board of Directors authorized a $30 million share repurchase program through June 2009. We believe that our share price represents a significant discount to the true value of the company and that by repurchasing our shares at the current price shareholder value will be increased. To date the company has repurchased 153,000 shares at an average price of $10.09 per share for an aggregate amount of $1.54 million. At our current quarterly dividend rate $0.50 this results in an annual dividend savings of $306,000 representing an annual cash return of nearly 20% on the amount spent on the share repurchases. We expect to continue with this program although the timing of the share repurchases will depend on a variety of factors including market conditions and may be suspended or discontinued at any time.

The condition of the airline industry particularly as result of the rise in the cost of fuel and slowing economic growth has continued to cause concern. Despite these concerns our portfolios continue to perform well. We are not directly subject to conditions that airlines face and have options available to us to mitigate any concerns about the credit of our lessees because we are properly structured and financed aircraft leasing company with a fleet of popular efficient aircraft with an experienced management team and with a strong global presence.

As shown by our ATA experience, albeit an experience that is not yet complete, aircraft can be moved quickly from one market to another and can be redeployed profitably even in difficult market conditions. Higher fuel prices make our modern fuel-efficient aircraft comparatively more attractive than older aircraft types. It is because of this superior fleet aligned to our strong management team and broad global marketing base we are confident that we can continue to achieve high utilization of our aircraft and on continuing rentals from them even when conditions are difficult for airlines.

The final factor worth mentioning is that B&B Air is conservative in finance with no refinancing obligations under its credit facilities until 2012. We have no commitments to purchase aircraft or other assets or to make predelivery payments. Since we have no current commitments we are uniquely positioned to make opportunistic acquisitions with a fully equity funded available facility of approximately $500 million. As a result we remain confident in B&B Air’s success.

I’m now going to hand you over to Steve Zissis our Chairman and CEO of Babcock & Brown Aircraft Management to give you his perspective about our current market environment.

Steven Zissis

As I discussed in our last earnings call in May, our airline customers continue to face record high fuel prices and we remain concerned about the impact on travel from the softening global economic environment. Airlines have responded to record high fuel prices by cutting marginal capacity and retiring older gas-guzzling planes in favor of more fuel-efficient aircraft. These same aircraft types make up 98% of B&B Air’s fleet. Despite these conditions global demand for air travel continues to expand with low passenger traffic growing a bit more than 4% during the first three months of the year and the demand for our aircraft is holding up well. In fact we’re continuing to see strong pockets of demand for aircraft, particularly new generation aircraft, from Eastern Europe and Russia.

We believe the difficult capital market environment will allow companies with available funding capacity like B&B Air to make attractive aircraft acquisitions from distressed or liquidity-driven sellers. Our $500 million in existing acquisition capacity allows us to take advantage of these opportunities. Babcock & Brown Aircraft Management, servicer of B&B Air, has over 20 years of experience and has successfully managed through a number of industry cycles including after 9/11. Our business model is designed to perform through economic cycles and we’re confident that our underlying business is healthy and our long term outlook remains positive.

I will now turn the call over to Gary Dales who will provide a review of the second quarter financials.

Gary Dales

As Colm mentioned we had another strong quarter from a financial and operational standpoint. Let’s start with the income statement. Our revenues for the second quarter were $57.2 million an increase of $5.3 million or 10% over revenue reported in the first quarter. Operating lease revenue was $56.3 million in the second quarter up from $48.4 million in the first quarter. This increase reflects the additional aircraft we added to our portfolio during the first and second quarters along with increases associated with 2008 remarketing.

Total expenses for the second quarter were $44.9 million an increase of $6.4 million over the first quarter and consists of depreciation expense of $18.9 million, interest expense of $19.7 million, selling, general and administrative expenses of $5.3 million, and finally maintenance and other costs of $1 million. The depreciation expense of $18.9 million was $3.8 million or approximately 25% greater than in the first quarter and reflects the increase in the size of our portfolio and the commencement of depreciation on the four aircraft that were previously accounted for as direct financed leases and incurred no depreciation expense. The interest expense of $19.7 million was $1.8 million or approximately 10% greater than in the first quarter and reflects the increased borrowings under our aircraft acquisition facility. The proceeds of these borrowings were used to purchase additional aircraft. Selling, general and administrative expenses were $5.3 million in the second quarter and represent 9.3% of total revenue as against 9.7% of total revenue in the first quarter. Our provision for income taxes for the second quarter is $1.3 million representing an effective rate of 10.3%. Our effective rate for the first quarter was 13.3%. We expect our cash tax to be significantly less than our tax provisions.

Now let me summarize the impact of the termination of the ATA leases on our second quarter results. First, as previously mentioned the ex-ATA aircraft were classified as direct financed leases and shown separately in the income statement. In April the leases were terminated and we recorded no financed lease revenue in the second quarter. The loss of this revenue was offset by approximately $4 million of end-of-lease revenue representing maintenance reserve liabilities relieved after termination of the leases. In addition, these aircraft are reclassified as aircraft held for operating lease and we commenced depreciation which totaled approximately $600,000 for the second quarter. During the quarter we incurred approximately $800,000 in costs associated with the repossession, maintenance and remarketing of these four aircraft. Of this $800,000 approximately half is reflected in maintenance and other with the balance in selling, general and administrative expenses. Two of these aircraft have been re-leased and are now generating rentals at levels that are higher than under the previous leases. The other two are still being marketed and will incur costs while off lease. Potentially offsetting these and future costs is our claim against ATA’s parent under the terms of the parent guarantee. Any costs and expenses associated with the off-lease aircraft will be recorded as and when occurred.

To sum up, our net income for the second quarter was $11.1 million which equated to $0.33 per share. Our balance sheet reflects the additional aircraft that have been acquired and total shareholders’ equity of nearly $500 million. Finally, we are reporting available cash flow for the first time. We define available cash flow as net income plus depreciation, amortization of debt issue costs, and deferred income taxes, all non-cash charges. We believe that ACF provides a meaningful measure of B&B Air’s capacity to pay dividends and to reinvest in the business. For the second quarter ACF was $33.2 million or $0.99 per share. This was an increase of 11% over the first quarter of 2008. You will find the reconciliation of ACF to net income, the most comparable GAAP measure, at the end of our press release issued this morning.

With that I’ll turn the call back to Colm for his closing remarks.

Colm Barrington

Before taking questions, I would like to add that we continue to be very positive about B&B Air and its prospects. Despite many people’s concerns about the airline industry generally, B&B Air has shown very positive financial results and is a much stronger company today than it was at the time of our IPO last September. Our colleagues at Babcock & Brown Aircraft Management provide us with a strong experienced management team. We are generating attractive cash flows to support the company; we have no non-funded commitments; we have no refinancing requirements until 2012; and we have a credit facility in place to avail as purchasing opportunities will arise. We’re also in a position to execute other initiatives that will enhance the value of the company for its shareholders.

We’re now ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Daniel McKenzie - Credit Suisse.

Daniel McKenzie - Credit Suisse

Last quarter I believe you mentioned the cost to remarket the four aircraft would be roughly $500,000 to $750,000 and it looks like this quarter it was $800,000 at least for all four. How should we think about the timing of these expenses in the second quarter versus the third quarter?

Gary Dales

During the second quarter we had $800,000 of expenses. As we mentioned the two aircraft are still off-lease and will incur costs until they are re-leased again and we’ll just incur those costs recognize them when they incur. I think the estimates are still $500,000 to $700,000 per aircraft to remarket.

Daniel McKenzie - Credit Suisse

How should investors think about the dividend policy looking ahead at the dividend payout ratio this quarter, that 51%? What do you need to see to give you confidence about raising that or just in general? Is that a steady run rate? Any perspective you can provide there?

Colm Barrington

Our objective is to maximize shareholder value from B&B Air and we’ll do this through a combination of dividends, share repurchases, new acquisitions, potentially sales of aircraft from our portfolio. So we will look at the dividend payout per quarter based on the conditions that we see at the time. So we’re not giving any indications about raising the dividend at this point in time. But we feel very comfortable with the $0.50 dividend that we are currently paying in the current environment.

Daniel McKenzie - Credit Suisse

How should investors think about growth as we move into the back half of the year?

Colm Barrington

We are being prudent in our acquisitions at the moment. We are seeing opportunities arising but we are wondering if better opportunities will arise as the year goes on. So we have approximately $500 million of capacity which we expect will carry us into 2009 at our current pace of acquisitions. But we don’t actually give any market lead on our acquisition policy.

Operator

Our next question comes from Andrew Light - Citigroup.

Andrew Light - Citigroup

I have a question on the ATA planes you’ve placed. Can you be more specific about the outlets in the lease rates? And I understand obviously that these leases are on a much shorter duration. And secondly, do you expect to get a similar rate level for the two remaining planes and what’s your best estimate on the time of getting those back in the air?

Colm Barrington

I don’t think we can actually give you an indication about what the new lease rates are but they are in excess of where we were before. I think the new lease rates are about market and we expect to get similar rates from the remaining two aircraft. We are looking at various options for the remaining two aircraft which could include a potential sale of the aircraft, so it’s a little early to give you any more than that at this point in time.

Andrew Light - Citigroup

Can you give us an idea of how many planes are coming off-lease in 09 and 2010 and those that are still awaiting placement?

Colm Barrington

Planes coming off-lease in 2009, we have approximately three on-lease planes in 2009 as I recall but we haven’t actually got new lessees for at this point in time. They are about 12 months out from now.

Andrew Light - Citigroup

So you hope to place those roughly a year from now.

Colm Barrington

No, no. These aircraft, the first one comes back in about 12 months now I think in the spring of 2009. So we’re in discussions with various parties about them so we’re not sure where they will be going yet but there is certainly interest in the aircraft at this point in time.

Andrew Light - Citigroup

I just have one final question on your funding and [inaudible] result for example resorting to doing long-term funding for individual aircrafts and presumably to protect or preserve the warehouse with more opportunities. I was just wondering if that’s something you’re considering as well?

Colm Barrington

We’re looking at various financing options Andrew. Our facility is fully equity funded at this point in time and as we use more of the facility the average cost goes down. So it’s in our interest to use that facility rather than do alternative funding at this point in time.

Operator

Our next question comes from Richard Shane - Jefferies & Company.

Richard Shane - Jefferies & Company

In terms of acquisitions, obviously there has been a lot of turmoil in the market and the comment was that you will proceed cautiously but you do have $500 million of capacity. What types of planes out there right now do you find to be in terms of both demand but also in terms of price the most attractive? Obviously we realize that there are some planes out there that are really cheap but those may not be the most attractive. What asset class are you going to focus on?

Steven Zissis

Basically we’re going to stay with more of the commodity-type aircraft, so the Boeing Next Generation aircraft, the 737, 700s and 800s and perhaps some 900ERs and also the Airbus Narrow Body Family 8320s. As we mentioned on the last phone call we are looking at some potential wide bodies too so we can [inaudible] relative value.

Richard Shane - Jefferies & Company

So Steve the strategy will be to continue to play in the premium part of the market and not to go for the discount.

Steven Zissis

Well I guess that’s a good way of characterizing it if you want but we are finding some good opportunities even in those commodity-type aircraft from some of the distressed sellers. So even though you would characterize it as the more expensive part of the market, we are finding some good deals there. I think it just takes some patience.

Richard Shane - Jefferies & Company

In terms of the planes that are being re-leased, are you finding that those are staying with the same lessees or are you finding that the planes are being moved and what does that tell you about the market?

Steven Zissis

I would say right now it’s 50/50 for the aircraft that we’re looking at in 09. We’ve got a couple aircraft that we’ve already extended and then the three that Colm mentioned, two of them are in April and one is the end of October, and we expect those to move from the current lessee to a new family. So obviously as a lot of airlines start to rethink their fleet plans and are not as aggressive in growing, you are going to see more and more of the fleet move to other airlines as we take advantage of where we see pockets of strong demand versus just keeping them with the current airline.

Richard Shane - Jefferies & Company

Is that historically the dynamic in periods of peak demand you see lease extensions and in periods with a little bit more slack you’ll see more planes move around?

Steven Zissis

Correct.

Operator

Our next question comes from Daniel McKenzie - Credit Suisse.

Daniel McKenzie - Credit Suisse

I was just looking at the rents receivable on the balance sheet and it appears to be growing a little bit faster than the business. I was wondering if you could share some perspective about what’s going on there?

Colm Barrington

It was a little bit out of kilter the end of June but for example there was one very large rental from a wide body that actually should have been paid in June and was paid on the 2nd of July so that actually distorted that figure a little bit. Secondly, there was one airline that we’re having a few problems with but they have now been recapitalized so that issue was dealt with also. The majority of that amount at the end of June has now been resolved.

Daniel McKenzie - Credit Suisse

Related to that, the investor concern naturally is just weaker credits in general. In addition to the one weaker credit that’s been resolved, I wondered what you can share about other potential weaker credits today? Any liquidity levers they can pull or any thoughts you can share along those lines?

Colm Barrington

Steve, you want to talk about that?

Steven Zissis

I think we could talk a little about Spice Jet but as you know everybody was talking about the over-capacity in India and the situation there. Spice Jet was in discussions with a possible merger candidate and then out of the blue came Wilbur Ross from the US who decided that it was a good time to invest in an airline in India and has recapitalized Spice Jet with the tune of $100 million. We think that’s the proper way to do it. There is going to be consolidation in India so we don’t think it’s the end of the story with Spice Jet. We think something else will happen after this but I think it’s a vote of confidence to have a strong investor like Wilbur Ross come in and put $100 million of fresh capital.

Operator

Our next question comes from Analyst for Michael Linenberg - Merrill Lynch.

Analyst for Michael Linenberg - Merrill Lynch

I just had a quick question on your strategy behind the Boeing 737 classics. I realize they only represent less than 5% of your portfolio at this point but given what everyone’s doing at least in the US with their 737 classics, I’m just wondering if you guys could just share with me your thoughts on that aircraft?

Colm Barrington

I think the 737 classic, we have three 737 classics of which one is a Frazier, which actually represent 2% of our portfolio by value. We certainly have seen values of 737 classics decline much more than New Generation 737s. It doesn’t concern us too greatly because we’re not exposed to them but we have seen those decline. Steve, do you want to add anything to that?

Steven Zissis

That’s fine. I think the other piece to mention is that our other two classics are leased into Russia so we don’t have any direct exposure on the classics to any of the US airlines.

Analyst for Michael Linenberg - Merrill Lynch

I noticed there was a sequential decline in your other long-term liabilities on the balance sheet going down to $10 million from over $50 million. Can you just kind of reconcile that number?

Gary Dales

The primary cause of decline in the other liabilities is the mark-to-market valuation of our interest rate swap derivatives and you’ll see the other side of that in other comprehensive income in the equity section.

Operator

There are no further questions at this time. Do you have any closing remarks?

Matthew Dallas

We would now like to conclude the call and we thank everyone for joining us. We look forward to updating you again next quarter.

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Source: Babcock & Brown Air Limited Q2 2008 Earnings Call Transcript
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