Atlas Air Worldwide Holdings Inc (AAWW) 2002 Q2 法說會逐字稿

Please stand by. We are about to begin. Good day, everyone. And welcome to today's Atlas Air Worldwide, 2nd quarter earnings release conference call. Today's call is being recorded and now for opening remarks and introductions, I would like to turn the call over to the Chief Executive Officer of Atlas Air Worldwide, Mr. Rick Shuyler, please go ahead.

Thank you, Operator. Thank all of you for joining us today for Atlas Air Worldwide Holdings 2nd quarter 2002 earnings conference call. As the operator said this is Rick Shuyler and with me today is Doug Carty, our Chief Financial Officer. Doug will review for you our financial results for the quarter, and then I will make a few brief comments, and then we will open up the lines for any questions that you may have. So I will now turn it over to Doug.

Thank you, Rick. Let me also add my welcome to all on the call. Obviously, we appreciate you joining us. Let me also say at the outset we need to emphasize certain information discussed in today's conference call may contain forward-looking statements that involve a number of risks and uncertainties. These risks and uncertainties may cause actual results to differ materially from our expectations. The company's SEC filings detail those risks and uncertainties. Let me move on. Let me also say that a number of members of my team are with me. David Lancelot, our Vice President and Controller who was on the call this last time joined us about that time and has taken over the accounting function for the entire group. Delighted to welcome Bill Bradley our new Vice President and Treasurer who has been with us 2 or 3 weeks, as well from his team is Jason Grant from Investor Relations. Finally Paul Wolf of financial planning and I may well in the question and answer period ask these guys to come in and add to my answers or bail me out, frankly. Like others in aviation, the 2nd quarter was a difficult one for Atlas from an earnings perspective, but despite these earnings challenges we had a number of positives in the quarter. As we announced last night, we reached an agreement on our first contract with the Atlas Air pilot group.

A couple of weeks ago we announced the finalization of favorable lease financing for the three Atlas 747-400 2002 deliveries, two of which have now delivered, the third one comes in November later in the3rd quarter. And as we have said in an earlier release, we improved our liquidity position over the 1st quarter. We released as you all now know our financial results for Atlas Air Worldwide Holdings this morning in the form of a press release. We currently expect to release the queue for Holdings likely tomorrow morning. It will probably be out before market opens tomorrow. As for our numbers, on revenues of $235 million, we recorded an operating loss before impairment charges of $32.4 million. EBITDA of $38.3 million, or 16.2 percent. And after tax loss of $34.2 million. Year-to-date basis which equates to a $24.8 million loss, EBITDA of $114.6 million, or 24 percent EBITDA margin, and a net loss of $49 million. The current $34.2 million loss in the quarter translates into 89 per share. Now, included in the loss for the quarter were a number of special or one-time charges. Let me sort of amplify those. We took an additional impairment charge of $7.9 million on our held for sale aircraft at Atlas. Remember that these aircraft were originally parked a year ago and designated as held for sale.

Accounting rules only permit you to carry the held for sale designation to be used for a year. And obviously, this was a pretty difficult year particularly after 9/11 to try to sell these assets. They are now, therefore, taken out of that categorization. We have taken a further impairment. They now basically reflect appraised value. And they will be depreciated going forward to the tune of a little north of $100,000 per [INAUDIBLE] per month. So somewhere between 300 and $400,000 per month per quarter for these airplanes will be added. We also had a change in purchase price accounting for Polar, which allocated additional value to the 747-100 fleet. When we acquired Polar based on our planning at the time, we assigned a zero value to the aircraft. Now, as we reviewed this, along with the accounting department at Ernest and Young, given the ongoing military flying, purchase accounting rules forced to us look backwards and validate the assignment of value at the time.

Given it's been highly profitable, we are under -- (indiscernible) put an appraised value back on and accordingly, we will now be depreciating those airplanes, $4.2 million this quarter, almost $4 million more, $3.6 next quarter at which time they will be fully retired and actually deappreciated and gone. So we have this kind of unusual bump-up in depreciation. Really as a consequence of purchase accounts. Excluding these special charges, principal drivers the bottom line results in the quarter were mixed related revenue reductions, combined with increased operating expenses. Our total consolidated operating revenues were $235 million, versus $149 million for the same period last year. The inclusion of Polar this year, added $94 million of revenue in the quarter. It's worth noting what was an impressive 27 percent growth in Polar's scheduled revenue over the 1st quarter, as Polar benefited from an improving demand environment in Asia. Despite this growth, both Polar and Atlas experienced reduced charter demand, and most notably, military flying was down 44 percent versus the 1st quarter. And commercial charters which you may remember were very strong late in the 1st quarter, did not really pick up again until very late in June this quarter. The reduction in higher yielding charter hours, more than offset the growth in Polar's scheduled business and Atlas's[INAUDIBLE] hub businesses.

On the operating expense side, total operating expenses, excluding the restructuring impairment charges, increased in the quarter to $268 million, 2001's $150 million, or $118 million increase. The inclusion of Polar this year added $101 of that $118 million increase to these costs. Atlas' operating costs prior to eliminations increased $16.9 million, or 11.3 percent. Other than those special charges I've outlined, primary drivers of the cost increases were fuel and ground handling, which increased primarily because of the greater degree of all-inclusive charter and hub flying in the quarter. Other expense drivers included a periodic maintenance settlement at Atlas for our power by the hour contract which -- (indiscernible) outlined in the quarter as well as other increases, pilot training increases. Pilot training expenses. The liquidity front we were pleased to close the quarter with an improved cash position versus the 1st quarter. Closed the quarter with consolidated cash and short term investments of $278 million which represented a $12 million growth for the 1st quarter. Now, the growth in our cash balance is primarily attributable to the timing of our semiannual double EPC payments. These are mostly off balance sheet leases in which the debt is[INAUDIBLE] to the aircraft or actually on the balance sheet. As was mentioned in the 1st quarter call these payments are approximately $160 million annually, and are paid in January and July each year. Payments in the 1st and 3rd quarters -- the payments in the 1st and 3rd quarters lead to lower ending cash balances in those quarters.

Looking forward, we expect to see a decline in cash balances again in the 3rd quarter, primarily related to the semiannual payments. Our cash burn will be substantially less than that experienced in the 1st quarter. And as we have previously said, we expect to make up that decline and more by year end. In other words, we currently expect to see our cash balances be somewhat ahead of our 2nd quarter balance that was reported today. Recent revenue improvement has given us some cause for optimism as we look forward. In fact, consolidated block [INAUDIBLE] declined only 1 percent in the 1st quarter versus the 4 percent guidance we have given in early June, due to significant strengthening in commercial charter pickup in the last couple of weeks of the month. The good news has been that this strengthening revenue has continued into the 3rd quarter. Although this gives us reason to be more optimistic in the back half of the year, we have a lot of ground to make up from the 2nd quarter. Our expectations are the 3rd quarter operated block hours will increase to the 36 to 38,000 range, with the4th quarter block hours increasing to 39 to 41,000 range, on a consolidated basis, in each case consolidated block hours. These are operated hours. Now, this growth will come from an increased schedule and charter business as we head into our peak season.

Our ACMI business we expect to see actually a modest dip in the3rd quarter, but for total second half hours, we expect our ACMI hours to approximate the total ACMI hours we flew in the first half, if that helps. We expect our total dry lease block hours historically have been in the 1100 to 1200 block hours per quarter, to continue to grow in the third and 4th quarter as existing wet lease -- as an existing wet lease converts to dry lease and we add incremental dry lease contracts. The third and 4th quarters will also include additional operating costs for the maintenance necessary to reactivate the parked aircraft that we are reactivating we announced this morning, as well as additional pilot salary costs come out of the agreement, and the additional rent on our new deliveries. As I spoke earlier since we last met with you, we have resolved several important issues that were outstanding at the time. Obviously, the first issue was the resolution of the Atlas pilot deal. We were pleased to announce ratification of the deal yesterday. We're also pleased to resolve the financing issue of the Atlas 3 747-400 in 2002. The first two aircraft have been delivered under release and financing terms I would characterize as favorable.

Importantly Atlas has already received $6 million in July as a refund of purchase funds, and will receive an additional $6 million in November when we deliver the next airplane. As well as part of our arrangement with Boeing, $15.6 million in predelivery payments that were due in 2002 are now deferred into 2002 -- 2003. Both the cash and book rents are more favorable than the million-dollar a month guidance I had given you previously. Let me add one last final point. A number of you are asked us to provide you with our 2001 actual results by quarter, and the new 2002 P&L format, we have that presentation available now both for Atlas Air, Inc., and Holdings and we will be making it available on our investor relations site over the next couple of days, the website. Rick that covers the quarter. Obviously, I know you'd like to make some comments and then all of us will be pleased to answer any questions that listeners have.

Thanks, Doug. As Doug said, it does go without saying that this was a disappointing quarter from an earnings perspective for Atlas. Nevertheless, we had several grounds for encouragement and perhaps even optimism, in the trends that we saw emerging during the quarter, starting quite frankly with the performance of our two core businesses at each of Atlas Air and Polar. And when we were prereported six weeks ago, we cited a reduction in charter flying, particularly on the military side of the business, or our lower block hour expectations for the quarter. And in fact, military flying ended up about 44 percent below 1st quarter levels, and the surge in charter activity that we and most other carriers saw in the market in March, disappeared again in April and May. But as the quarter closed, however, two interesting things happened. First, the charter market began picking up again in June. In fact, pretty substantially. Particularly out of Asia.

Demand actually strengthened to the point, that we have now seen a number of rate increases put into place, in sharp contrast to what's happening obviously on the passenger side of the business. Northwest as an example raised various of their Trans-Pacific rates between 5 and 15 percent, Cathay Pacific instituted two back-to-back increases of 5 percent each. Korean Airs rates went up 10 percent, and even Polar took a 15 percent increase coming out of Japan. In fact, with the increases that we saw in Hong Kong, it has now brought back the yield levels to about where they were a year ago or so, after having fallen about 25 percent in the period of time between then and now. And that strength in the market has continued thus far through July, and looks to hold up into the start of the peak season. Secondly, we started to see improvement compared to the 1st quarter, in both the ACMI and hub operations at Atlas, and the scheduled service operations of Polar. And, of course, that's exactly where we want to see those improvements. Sequentially, Atlas Air's core revenues, were up about 4 percent and Polar's core revenues Rose about 27 percent. Atlas' results reflected year-over-year traffic increases, from a number of its customers during the quarter, and it was really the first sustained increases that we have seen in the last year.

Asia clearly led the way in that regard, with carriers such as Korea Air, China Air, China Southern, and Cathay Pacific, reporting monthly traffic increases ranging from 7 percent to 24 percent. Indeed, Hong Kong airport's cargo volumes were up about 25 percent for the quarter, and even European carriers began to report positive cargo comparisons, although in the single digits. In the partnership hub program continued to progress, as well. Three aircraft are now operating at the Miami hub with a fourth to be added this quarter. And an additional African operation will soon go into service at Liage, with new service destinations also being evaluated. Now, on the Polar side, both scheduled service yields and load factors firmed, with yield up over 10 percent at Polar, and load factors up over 3 percentage points. And what's really nice to know is that this performance has continued on into the3rd quarter. In fact, when we closed the books on July, it will be the first month since February of last year that Atlas Air's operated block hours will be higher than they were for the previous year. That should hopefully mark an important turning point for us as we work to restore Atlas to its previously levels of profitability. Of course, the economy here in the U.S. continues to be the wild card, and that will be the key to a truly sustained cargo recovery and by extension to a full return to profitability at Atlas.

While the increased volumes that we're seeing out of Asia are certainly a very positive sign, the air cargo industry still needs to see a corresponding economic pickup here, in order to return to its historic growth pattern. Nonetheless, as we begin to enter our peak season period, we are now looking for a very nicely profitable second half of the year. We're also quite pleased with the other developments that we saw during the quarter. I think it's safe to say that at least 4 issues were clouding the outlook for us as we entered the 2nd quarter, certainly from an investors' point of view. Number one, our negotiations with our Alpha represented pilot workforce. Two, the new 747-400 aircraft coming from Boeing. Three, our overall liquidity levels, particularly as they might be affected by the first two issues, as well as our ability to meet our required bank covenants. And, four, the ability of Atlas to renew contracts in the -- in this particular economic environment, much less to sign up new business. As we sit here today, I believe that we have very successfully dealt with, or seen great progress on all four of those issues. As to the first, again, we're very happy to report that yesterday our crew member workforce ratified our first-ever labor agreement with them. Happily, as we had hoped, without any disruptions or confrontations. We and our NBC union leaders, and national alpha worked tirelessly to tweak the initial preliminary agreement to make it one that is good for both parties, while staying within the overall economic confines of that initial agreement.

Our crewmembers in the process will deservedly become the highest paid pilots in the ACMI cargo business, while at the same time Atlas will preserve its ability to offer a cost-effective and reliable product to its customers. Moreover, it's important to note that the economic impact of the ratified contract on Atlas Air's ongoing financial results for this year, and for future years, will not differ at all from our earlier expectations and guidance that we gave at the beginning of the year. I'm proud of the professionalism demonstrated by our crewmembers throughout this lengthy and often frustrating process, and I salute their leadership for their hard work to reach a fair and affordable deal. With respect to Boeing, the second issue, we have now reached both a delivery schedule, and a financing agreement that meets the objectives of both parties. Atlas has agreed to take delivery of three of the four new 747-400s scheduled to be delivered this year, with the fourth aircraft moved to4th quarter of next year. And in return, Boeing has agreed to provide full financing for two of the three aircraft, with GCAS providing the other full financing, under true market-based terms. Not only will the effective monthly rental expense be considerably less, almost 20 percent, than earlier predicted, but Atlas will see an additional cash benefit in the second half as Doug described of $27.6 million from a combination of return deposits and deferred deposits on the 2003 delivery. We have now taken delivery of the first two of the 747s, and the third will be delivered in November.

So we're really pleased with the resolution of this matter, and we thank Boeing for working with us to reach this very happy outcome. Perhaps the overriding issue in investors' mind has been Atlas's liquidity. When we reported an $85 million drop in our cash levels in the 1st quarter on about a $7 million loss, certainly some investors became concerned. And no matter how many times we tried to explain the uneven and 1st quarter front-ended nature of our cash flows, that concern continued. Well, hopefully we have now addressed that concern. Were a 2nd quarter ending balance of $278 million above that of the 1st quarter despite a significantly greater loss, and with the liquidity enhancements that we have negotiated with Boeing, we can confidently state that Atlas is facing no liquidity issues this year or next. We expect our year-ending cash balances to be yet higher than the 2nd quarter balance period. At the same time, we sat down with our bank group and negotiated additional room in our covenants for the rest of the year. As a result, even with the expected dip that Doug talked about in cash in the 3rd quarter, due to the same uneven cash outflows that we saw in the 1stquarter, we will be in full compliance with our liquidity covenants, and expect the same with our other financial tests, even though they are a bit tighter and will need to be more closely monitored. And our bank group has continued to work cooperatively with us[INAUDIBLE] and we believe that that spirit will continue to prevail as we move into next year. And then finally, on the fourth point, we believe that we have now demonstrated that the Atlas Air business model, continues to be as viable as ever even in this economic environment.

Last quarter, you may recall, we told that you we had signed three new customers to ACMI contracts, two of which are long term, and had other possibilities for additional contracts. At the same time, we said that we were somewhat less sanguine about prospects for [INAUDIBLE] contract renewals, believing that only one of three customers would renew this year. Well, I'm happy to report that it now looks probable that two of our three customers will continue the use of their aircraft this year. On top of that, we have now signed a short-term contract with China Eastern, which is expandable to a one-year agreement, and also happy to say that we have entered into a 15-month contract with an Asian customer, one that would be new to Atlas, that is subject now only to pending governmental approval. And that contract will be flown by one of the just-delivered new 747-400s. All this activity and the likelihood of a strong peak season, has given us the confidence to reactivate at least three of the six aircraft that we have had parked. They will operate throughout the 4th quarter, and they will boost block hour production accordingly. So in sum, we're very pleased with the progress that we have made on these various fronts this past quarter, and we look for continued improvements to our operating results as we now enter the second half of the year. So now with that, Operator, we'll be happy to open up the lines to any questions that our participants may have.

Thank you. The question-and-answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star or asterisk key followed by the digit 1 on your touch tone telephone. We'll proceed in the order that you signal us, and will take as many questions as time permits. Once again, please press star 1 on your touch-tone telephone to ask a question. Our first question will come from Adam Zirkin with RBC Capital Markets.

Hi, guys, Congratulations first of all in getting a lot of these issues resolved. It nice to see that happen. Rick, with regard to the what are the issues, you made a comment that you saw no liquidity issues this year or next year, right?

Right.

I'm particularly interested--with regards to the $200 million minimum liquidity covenant in the banks, and given the big double EPC payment in the 1st quarter of '03, I mean, have you guys been able to avoid any issue that might come as a result of that? That's a $100 million payment, right?

Yeah, no, as we have said all along, we will undoubtedly be talking to the bank group once again as we begin our 2003 planning process go back and see how that -- how the business plan for 2003 syncs with the covenant requirements that are currently there. And we have every reason to believe that we will sit down with the banks at that time, and take a look at where we are from a covenant point of view, and if there are changes that need to be made, then we would expect to make those changes.

Gotcha.

But, yeah, but we're going to be -- we're going to be ending the year, obviously, considerably --

Above 200.

Considerably above the 200 Mark.

Absolutely. With regards to the 15-month lease on the new 400 plane, is that an ACMI type agreement or dry lease type agreement?

Initially, a dry lease agreement and then we'll see where it goes from there. The carrier involved has adequate crews right now. They're in the position that a lot of carriers are in, in this particular environment in which they got -- they have crews, don't have business.

Right.

And need to put their crews to work. So they are looking for us for a dry lease at least initially for the aircraft.

Gotcha, and then sort of as a housekeeping matter, just if it's possible to get it. I can back into the revenue number but with regards to Atlas, Inc., do you guys have cash balance EBITDA numbers on that?

Yeah, we can give you cash balance at Holding was 278. And Atlas, Inc, number will be out in our queue which will follow the [INAUDIBLE]by a day or two but it currently has 257.

Can I ask about the EBITDA number, as well?

Sure. It's about 20 -- just under $24 million, Adam. Sorry, that's before the impairment. So it would be north of that, it would be 31, 32.

Great, 31, 31does the impairment is entirely at Inc. right now?

Impairment is entirely at Inc, Adam.

Just sort of as an over arching question maybe you can help us a little here because you guys, you know, are well acquainted with what I'm thinking here. But just, you know, with regards to sentiment issues and so forth, given all the pessimism about a lot of the domestic passenger carriers and the freight carriers with you know, UPS lowering (indiscernible) items and so forth, from a global perspective, what can differentiate you guys? How do we try to remain optimistic in that sort of environment? [ poor audio ]

I'll try to answer that question for you. Number one, we're optimistic simply because we are seeing the market beginning to turn back to a bit healthier state than it has been in quite some time. Not only did we see a nice pickup in March but which is went away in April and May, but has now now regenerated itself, at the end of June it was very, very strong, particularly out of Asia. The same has been true throughout all of July, in fact as we have watched our own block hour production, uhm, it has literally gone up in terms of our projections. -- every, single day through the month of July. And as I said, it's going to be the first time that we are going to have a positive comparison on a year-over-year basis. So that's obviously very good. The Asian economies do appear to be doing relatively better. Particularly Korea, particularly Hong Kong, but certainly others of the economies. Even Japan is beginning to show signs of life which would have surprised me if you had told me that several months ago. So we are seeing those signs of life out there, the comparison you made was basically with some of the other carriers, UPS and others who have had a somewhat gloomier out look for the year. It has been our thesis all along that when the turn came, that we on the international cargo side of the business would see it first. We were the first ones to see it as you will well recall. For us, April of last year was a month in sort of which the lights went out in the cargo business. We saw that well ahead, I think, certainly in the passenger, U.P.S., FedEx, and we believe that similarly we will see the rebound when it comes before they do. Now, am I declaring victory? Absolutely not. It's way too early to do that. On the other hand, the signs that we are seeing right now are certainly good and positive signs. And if they continue on as they are, then in fact it may be that we are now seeing the leading edge of that recovery.

Great. And just finally and I'll get back in the queue, with regards to you know, speaking about the economies, the one that sort of helped behind has been the European economy. Given that one of the hubs is in Liage, does that affect the prospects for the hub business at all? Or is [INAUDIBLE] [ switching to webcast audio. Please stand by ] And if they continue on as they are, then in fact it may be that we are now seeing the leading edge of that recovery. And then finally and I'll get back in the queue, with regards to speaking about the economies, the one that sort of held behind has been the European economy. Given one hub is in Lee age, does that affect the prospects of the hub business at all or --

Yeah, I think it's a little early to try to determine what impact if any the European economy may have. I mean, you're absolutely right. I think there are a lot of conflicting signs and in fact, you know, what happens in the German elections and so forth may say what happens with the economies in general. But, yeah, I think it's too early to judge that and again, part of what we are creating in Europe is not necessarily intra European traffic, but obviously is traffic that's going to be going from Europe -- from Asia to Europe and between Europe and the U.S. And in fact, in a poll that we took of our customers just about a month ago at this time, they indicated that they thought that the South Atlantic in fact was going to be a merging as a new focus for them in terms of freight. That is, coming over from Europe into South America and back.

Right.

So again, just a -- it's a little hard to tell at this point what the impact may be, if any.

Great. And Rick, just quickly on the leases, you flew through this quickly. Did you say that the terms were approximately 20 percent better, than the $1million previously announced? As much as 20 percent better.

As much as 20 percent better.

Thanks so much, guys.

You bet.

And we'll be taking our next question from Jordan Allenger of Goldman Sachs

Yeah, hi. Couple questions. One, on the Polar scheduled service side, the available ton miles which I think were around 400,000 miles or so in the 2nd quarter, is that a sort of number that we should be looking at? I'm just not sure of the timing of planes, or what in terms of that moving on up from the first and sort of looking out.

Well, it is going to move up. You know, the -- you know, in some ways, we are- we are looking afresh at this as well because obviously, this is -- you know, we're only, what, seven months into the acquisition of Polar. So we ourselves are learning about their business. But two things will happen in general. Number one, the second half of the year is always by far the strongest period of the year in the scheduled service business. Certainly it is in the ACMI business, as well. But I think that's even more accentuated in the scheduled service side of the business. Charter activity picks up, extra sections, unscheduled service, et cetera. Secondly, Polar did take delivery of their new 747-400 just day before yesterday, I believe it was. So they will even with the retirement of the two 747-100s that continue to operate in their fleet, and they will be retired at the end of this month, they will still have a steady fleet size going forward. In fact, we'll be operating about 15 aircraft in the second half of the year. So I would guess that they are going to be up very nicely in terms of their traffic, but I'm not sure if anybody else has any color on that, but clearly you are going to see a boost in both third and 4th quarters. [ audio going down again ]

The next question, you had mentioned maintenance, uhm, you know, you had some periodic maintenance, and then I know on a going-forward basis, I think you indicated that as you bring a few planes, the three planes back into service, can you give some sense, I mean, are we talking sort of a maintenance expense sort of on par with the type of number in the second, or, you know, does one outweigh the other in terms of directionally looking at maintenance?

Uhm... Well, what will happen in the second half, but primarily in the 3rd quarter, is that the three aircraft that we are taking out of the desert will have to go through [[INAUDIBLE]] as you can imagine, obviously, we determined which aircraft we are going to -- were going to be parked by those that needed to have, you know, significant maintenance performed on them. So to bring them out of the desert, you got to perform that maintenance. All that expense will be booked in the3ird quarter. I don't think there will be any carry-over of that into the 4th quarter. So you'll have an interesting kind of situation from your modeling point of view, where you'll see the expense of that in the 3rd quarter, and then all the revenue generated by those three aircraft in the 4th quarter.

So the three planes coming out, just to make sure I understand, they're coming out in the 3rd quarter but they won't go into revenue generation until the 4th?

By and large, that's the case. You know, obviously, they are coming out -- we have -- we literally have the sea checks farmed out to the different -- to different maintenance providers. So they will all come out at various times. But they will not be there fully until the 4th quarter, but all the expense will be in the 3rd quarter.

Okay. And I assume they are going to the charter business?

They will be going into the charter business primarily, yes.

Okay. And then just finally, I don't know to the extent you can discuss this, other than length of contract. Are there any other sort of details you can talk about that from a union perspective in terms of, you know, the wage increases, and benefits and that kind of stuff?

Uhm, actually, what we are doing right now is foregoing doing anything on that front while we work with Alpha to determine exactly what details, if any, that they want to release under the contract. Thus far, they haven't released any details, nor have we, I think we just have to sit down and determine what we do want to release. There are obviously -- they are obviously always a little bit reluctant to put that out because, uhm, it may or may not help them in negotiations elsewhere. You never know.

Great. Thanks very much.

And we'll go next to Alex Brand with BB&T Capital Markets.

Thanks. Can either one of you talk about the other operating expense lines? It seems like that was one area that you didn't address in your comments, that was substantially higher sequentially. Is that related to the hub network investment?

Yeah, that's primarily related I think to several of the one-time charges that we took, but I'll let David [INAUDIBLE] talk about that.

Where that increase comes from one obviously the inclusion that Polar brings additional costs but some of the costs are included in there are indirect pilot training, uhm, communications costs, and, uhm, some bad debt expense. Quarter versus last year, obviously, much more -- much more pilot activity as far as training and transportation costs, Polar in their scheduled service operations does have a fairly significant trucking network primarily in Europe. And as a result of some of the increased traffic, that has -- that number has been up significantly quarter over quarter and quarter versus prior year.

Okay. I guess what I'm getting at, uhm, and again, I'm not sure if it's better for you, Rick, or for Doug, but it seems like we do have some costs here that are one-time in nature, but otherwise, your cost structure is up. You are not getting the efficiencies out that you would hope. And, you know, although the revenue picture is better, it seems like we're a little further behind the 8-ball than we hoped, yet you're optimistic for nice profitability in the second half. And I guess I would like a little more color as to how all those pieces fit together, if you don't mind.

Sure, no problem. Actually, what happens is, that whenever you begin to ramp back up, you've got expenses associated with that. So just as we were talking about with the (indiscernible) maintenance expense on the aircraft, as David alluded to, one of the items that's in the other are the training costs. We have already even though we have not made any particular public announcement, we have already brought back all of the crewmembers that we had furloughed in our very first furlough action of a year ago, and are on our way towards bringing back the second (indiscernible) that occurred at the end of last year. Those folks all obviously have to go back into training. We had training -- have training expense for them, training expense in general that we want to try to keep out of the second half of the year. so whenever we have any kind of training at all for the existing workforce, that happens there. You put vacations as much as possible in the period before the3rd quarter. So in this particular instance, with a lot of ramping up towards what we believe is going to be a pretty nice second half of the year, some of those expenses just plain hit in the 2nd quarter. And, you know, shows a little bit of a blip in that regard, something that we have not seen before, because we have never had furloughs and never had this type of activity before.

So --

It does distort things a little bit. There is no question about it.

So I mean, you are willing to take your cost structure back up because you are optimistic? And I guess that is net-net a good thing? And then the 1st quarter is going to come again, so -- and you can't just flex back down on your costs. So I mean, are we permanently taking the cost structure up here, and we think that's a good thing? Because we need more crews, to supply more aircraft?

Now, there is nothing at all that prevents us from furloughing again at the end of the 4th quarter. If we don't see business materializing in the1st quarter and 2nd quarter. So the costs that we are putting -- that we are now adding both crew costs as well as maintenance costs on the aircraft, are ones that we think either can be reduced once again next year, to the extent that we need to, or in the case of the maintenance costs on the aircraft, now, what we did, Alex, is we went through a very stringent analysis that said that, uhm, if we were to incur the maintenance costs on the aircraft, the revenue generated in the second half of the year, had to be sufficient not only to be profitable in the second half of the year to do so, primarily in the4th quarter but also this to provide enough -- had to provide enough contribution and leads for the 1st quarter of next year to make it worthwhile. So our belief is, is that the revenue that we'll generate from bringing the aircraft out, calling the crews back, will be more than sufficient to take care of any 1st quarter issues in that regard but then we still have the flexibility associated with taking employment levels down if we need to.

Okay. Fair enough on that. Just one last question related to costs. Can you update us as to the efficiencies you expected to get from the merger, sort of where you are in that process, and where you think you can still get to?

Yeah, in fact I'll be very specific about that. Our target for this year was about $9 million in synergy savings, and we are on track to have achieved all of that. In addition to that, we believe there is at least another $20 million available to us on top, literally on top of the $9 million that we -- believe we will have achieved by the end of this year and our goal would be to get most, if not all, of that $20 million next year. And we're pretty confident about that. We have spent a lot of time and effort in terms of -- huge amount of effort in terms of quantifying that and putting together a plan to achieve it.

Okay. Thanks a lot.

Yup.

Our next question comes from Ed Wolf with Bear Stearns.

Hey, Rick, hey Doug.

Hey, Ed.

Couple things. First of all, can you give us a sense how much revenue for military flying was in the quarter, and what that looks like going forward so far this quarter?

Yeah. We've got it. It wasn't a lot, but we can give it to you. Let me answer the second part of your question. Going forward, as we go into the new craft fiscal year, Atlas and Polar will now be -- will now represent 48 percent of all of the military wide body lift entitlement. And what that will mean is that we will now have a fix reward from the military going forward, that will be absolutely guaranteed to us in terms of revenue. And that level of revenue is a pretty significant one. I'm not sure that we're at liberty to say what that is from a military point of view. But nevertheless it's a pretty significant amount of absolutely guaranteed military [INAUDIBLE] that Atlas and Polar together[INAUDIBLE]

That begins when?

That begins October 1st. This fiscal year for [INAUDIBLE]

And it's a monthly sum that you get paid at the beginning of the month?

Monthly sum that we get paid, and that basically effects whether or not we[INAUDIBLE]

And is it an annual contract?

Yes. Annual contract.

Okay.

Just additionally, Ed, you know I said at your conference that we had a little over 5,000 hours, almost 5300 hours in Q1. We had under 3,000--just under 3,000 in Q2. So that which we set out there at the time --

And would you expect Q3 to be below 3,000?

I would say our current call is pretty flat to Q2.

Okay.

And an increase in Q4 given the new arrangement.

And just to finish that up, Ed, there are two components to the way the craft program works. One is to fix -- the fixed contract and that's one I was just talking about that. And then the second piece of it is the supplemental flying that's over and above that it's called expansion flying in military terms. So that whenever there are military operations that need to be performed, it goes out to obviously the craft team members first and it goes out in terms of who has the most points in effect. And as I said, we at Polar and Atlas together will have 48 percent of all the points available for that flying. Whatever military flying there is, is going to come largely to Atlas and Polar.

Do you have any idea out of 3,000 miles you flew in 2nd quarter what percentage of the mix that was?

I'm sorry, expansion flying?

Yeah. Of your 3,000 that Atlas flew --

Basically all of it because this year is the first year that Atlas has participated in any significant way in the craft --

Those 3,000 hours are consolidated both Polar and Atlas. (indiscernible).

No, no, but my question is 3,000 out of all the different airlines that --

Oh. Sorry. I have no idea.

That's what I'm getting the 46 percent is, right?

Oh, no.

The 48 percent?

No, no, no. The 3,000 represents a -- I think Polar -- I think Polar's portion of the -- Polar's portion of the craft program for this current year is probably 10 or 15 percent. I'm looking across at David Lancelot but it certainly would be no more than that. In total.

Okay. So the big step up any way you look at it? How about FedEx? Is there visit-- [ extremely poor audio ] Is there any visibility into whether FedEx is going to be taking planes again this4th quarter at this point?

Yes. I can say that they will be.

Similar to last year, or do you think that will be different?

I am guessing it will be more than last year, because I'm guessing that this peak season is probably a better peak season than last year from that point of view.

And last year just as a reminder they took three or four planes?

-- (overlapping speakers).

I think it was three. Everybody is telling me three. So....

That's what we are holding up here, too. [ laughter ] Uhm, and then on the interest income this quarter, if you looked at it, it was down quite a bit from the 25 and change last quarter than the 18 1/2 this quarter? What specifically was less in the interest income side (indiscernible). Expense side, I'm sorry.

Obviously some of it was year-over-year declines but David, we also took on a revised way of doing capitalized interest. (indiscernible).

One of the components within our contract with Boeing is we get a deferred interest or a deferred progress payment. Where we do pay cash interest to Boeing for deferring those progress payments. And then in the past we had previously expensed those payments, and as far as the rest of the industry is concerned, any cash payments regarding specific interest on progress payment is usually capitalized, and then depreciated (indiscernible) -- a.m. More [INAUDIBLE] out through some force of lease if it terms out in the form of an praising -- operating release. That's where you see the change in interest.

And what period of time are you depreciating it over?

It will be depreciated over, if it's an owned airplane, over 25 to 30 years. If it's a lease and follows conformity with the other operating leases it will be a 20-year lease.

And that amount totaled $6 or $7 million in the quarter?

It was a catch-up from previous quarters also.

In other words, we were being too conservative in our accounting methodology. We were doing something that the rest of the industry was not doing in terms of expensing it before.

So going forward, what should 18.6 look like in the3rd quarter for the --.

I think it's fair to say if you -- in the 3rd and 4th quarter, a sum of both the Q1 and Q2 interest figures should be indicative of the second half of the year.

Okay. One last question and then I'll turn it over. Rick, you have begin some guidance for block hours, but in terms of earnings visibility, I mean, the range is enormous. Arguably you did about minus 70 cents continuing in this quarter, the consensus is minus 10 for the 3rd quarter. Is there any comments directionally on earnings, positive, negative direction?

Well, as you know, we don't -- we have not and continue to make it a practice not to give specific earnings guidance in that regard, other than to prereport as we did a couple of weeks ago. What I think what we will do, Ed, is just continue to work with you and others, as you kind of work through the numbers for the 2nd quarter and see where that leads the year. But I really don't -- it really would not be appropriate for me to give any earnings guidance right now.

Okay. Thanks, guys, for your time. Appreciate it.

And our next question will come from Robert Ryan with Bank of America Securities.

And I was just wondering if we could reconcile cash sources and uses for the quarter? I'm thinking of EBITDA of $38 million interest, net interest expense around $16, and aircraft rent of more in the $40's, you want to say. How is it at the end of the day that we arrived at a $12 million increase in cash?

Sure, one way to think about it is the operating cash flow. It takes a loss, add back depreciation and the impairment. The difference between book and cash rents is $24, $25 million. We collected a bunch of receivables, most important of which was the tax receivable of $24, $25 million. I think when you wash all those things through, we had about a almost $15 million operating cash flow, about.

Okay.

The rest is the contractual part.

And what are your expectations in terms of tax refunds going forward?

Now, this is the special, you know, special one that [INAUDIBLE]put in.

Okay. And then in terms of the -- I assume that that's the -- those are the Holdings figures that you were referring to. If you just run through the same exercise for Inc.?

Actually I don't have it here. I have a nice little chart that shows me on Holding. Uhm... Got to be close to -- (overlapping speakers) Because most of the sort of big things like either the impairment or the receivables, collection, or the difference in book and cash rent resides in Atlas. And we have given the cash (indiscernible). That came out at 257. So I hope that's helpful.

Yeah.

It will be out -- Inc. Will be out in two days and Holdings later.

And then the line item deposits and other for Holdings and for Inc?

I'm sorry. In the balance sheet? What are you referring to just so we're all clear.

On your balance sheet. In your queues you typically have a line item deposit and others on the asset side. I was wondering -- Just kind of flip over to it.

I'm sorry. Cash deposits for liquidity.

I guess I'll see it soon enough. And did you have guidance for --

Deposits and other, virtually the same as at the year end.

And then finally, if you have cap ex guidance for Holdings and for Inc. this for the second half?

You know, we spent I think in the1st quarter order of magnitude a little less than 15 and this is Holdings a little less than 15 in the first. In the second, we will have spent a little less than $10 million. So in total, $25, $26. I don't know that on the -- (indiscernible). Substantially different, Bob. That's Holdings. Most of that as you know is in Inc, so that's good enough guidance so we are watching that one pretty closely because cash is king, but I don't think second half cap ex will be substantially different than the first half.

Thanks very much.

Okay, Bob.

Our next question comes from Helene Becker at Buckingham Research.

Thanks very much, Operator. Hi, gentlemen. Just a couple of questions. With respect to the pilot contract that was approved last night, were there accruals in the 2nd quarter taken in anticipation of this contract being done?

No, there were not.

Okay. So will there be any kind of a catch-up in the 3rd quarter on -- (overlapping speakers).

That's a good question. That's our first contract, Helene, so it comes in effect on the signing date which is tomorrow or the next day or something.... There is no retroactive pay associated with the contract at all. The new rates will begin to come into effect day after tomorrow on August 1st. And that's it.

Okay. So would you be able to provide us with any guidance in terms of what that line item should look like in the second half of the year?

Uhm, well, we could probably try to do that separately but as I said, in terms of the, terms of the contract itself, at this point, we're not really at liberty to talk about what that number is.

Okay. Well, will you be after it's signed?

I'm sorry, say again?

Will you be able to talk about it after its signed?

We may be able to talk about it in ranges. Again, it really is a question of a decision between Alpha and ourselves as to whether or not we want to release the terms of the agreement.

Okay. And then --

It's not totally within our control.

Okay. And then on fuel, Doug, do you have what the cost per gallon was in the quarter that just ended, and what it will look like on a go forward basis for the 3rd and 4th quarters?

It was in the high 8s, 8 cents for the quarter, looking forward, uhm, I'm -- I don't know.

You don't hedge anything, right,

We don't except, Helene, just remember that some portion of our flying is in the military. And effectively the military hedges the fuel. You don't have to pay over a certain amount and... You know, so it's kind of a fixed fuel built in that military flying. A portion is effectively fixed.

Okay. And then with respect to the increase in business that you are seeing currently, can you talk at all to what kinds of products you may be seeing? I mean, is it a lot of technology? And is the demand for the additional aircraft coming from the hub and the partial ACMI flying, or is it coming as a percent of a total aircraft?

Well, we're seeing strength all over the system. If I understand the second part of your question, we're seeing strength in the hubs. We're seeing strength in the ATMI business, and we're seeing strength in the scheduled service side of the business. So all three of the important components of the business are showing nice increases. As far as what is being carried, you know, Helene, it's really not any different than what it has been in the past. It's consumer goods of all sorts. Are we seeing a big uptick on the technology side? I don't think so at this point. There is nothing that would indicate that that is the case. It's just a nice steady shipment of all the various electronic, some technology, perishables, you know, shoes, clothing, et cetera, all of that is coming over, uhm, and particularly as we are seeing more and more manufacturing coming out of China in particular, we are seeing a lot more coming out of there, just simply because factories are continuing to move out of other parts of Asia into China.

Okay. And then my last question is, Rick, I don't think you're required -- I don't think Atlas Holdings is required as one of the companies that has to sign off on this new FTC rule? Will you do it anyway?

Yeah, no, we're not required, and I'm not even aware of any mechanism for doing it at this point. A lot of companies have asked the SEC if there is a way to do it even if they are not on the list, and the SEC hasn't even provided any guidance in that regard. So there is actually no way to do it, you know. We would be happy to do, it but there is no way to do it.

Okay.

You got to be one of those select 900[INAUDIBLE] companies or whatever the heck it is.

Right, right. Ok, well thanks very much. And good luck in the second half.

Thanks, Helene.

Our next question comes from David Campbell with Thompson, Davis & Company.

Yes, hi, everybody. I just wanted to ask you about clarify the statement you made about depreciation of the aircraft coming out of the desert, the three of them. You said will cost a total of $400,000 a month, Doug, is that right?

Yeah. I think it's just about $400,000, David. $400,000 for all equipment per month, David.

Okay. And the block hours you talked about 36 to 38 in the 3rd quarter, 39 to 41 in the 4th, is that compared to 32.9 in the second? Is that what that comparison is with?

Those are operated block hours.

Compared to our operated block hours.

So you have to compare it to that line on the --

If you look on our press release, Dave, 31, 377 consolidated Atlas Air block hours exclusive to the dry lease -- exclusive of the dry lease hours.

Exclusive of the dry lease hours.

Yes. (indiscernible) in that 1100, 1200 range so should expect to see those things migrate up a little bit in part because the dry lease just referred to and some other dry lease opportunities.

Yeah, that one 747 is a dry lease.

Right. The new 400.

So that dry lease block hours should go up?

Correct.

Okay. Thanks a lot.

Okay.

Our next question comes from Scott Flower with Salomon Smith Barney.

Yeah, good afternoon, gentlemen. Just a couple of quick questions. I wondered, you may have mentioned this before, Rick, but I just wanted to just reverify it in my own mind. Of the three renewals that you had for this year, you have mentioned that you are now positive, or hopeful that two out of the three will now sign back up. Has that third renewing where the aircraft has come off already occurred, or is that yet to occur where perhaps that customer is not going to resign up? I'm trying to get a sense of where you have another aircraft that you would be working and remarketing or is that already occurred this year?

No, it is yet to occur but the good thing about it is that it doesn't occur until almost exactly the end of the year.

Okay. And then can you give us some flavor of the number of aircraft next year that will be rolling over in '03, just ballpark? Is it three or is it four aircraft or is it more?

I'm sorry, can you repeat that again?

Yeah, if you look toward '03, can you give us some sense of what legacy ACMI contracts may or may not be rolling over? Is it three aircraft, is it five aircraft, is it two aircraft?

It's literally at this point the only one that would roll over in that context, is the one that we just signed, which is the 15-month deal. So we put it out at the end of next year. That's it. There are no other contracts --

None of the legacy ones?

None of the legacy contracts are coming due next year. We have a nice [INAUDIBLE] that regard.

Good. And then, uhm, -- year in that regard ] I know you mentioned that July you saw continued strength. I guess some of the things that we have heard from Hong Kong, and I know that only one snippet of the Asiatic market is that, not that things aren't rolling over, but they are not as robust as June has been and it's on a year-over-year basis that the rate of change relative to U.S. exports is up less than what June was, and I'm just wondering, are you seeing or seeing any of that -- obviously, there's been lots of discussion about both inventory rebuild in the U.S. And then secondly, whatever small degree of preshipping there may or may not have been ocean to air or et cetera relative to the longshoremen, I'm just wondering, I know what your comments were, but yet I have heard some disparate things in the marketplace. Particularly relative to Hong Kong.

I can't comment obviously on what you may have heard. My comments are are based on not what we hear but what we actually see. And what I can tell you is that the market out of Hong Kong as well as out of most of Asia, has continued to build pretty continuously since about the third week of June. Thereabouts when really began to pick up nicely. We have also continued to see good activity out of Korea and, as well, very good activity out of China, whereas you know, -- where, as you know, we have a pretty big presence and are seeking to make an even bigger presence.

Right.

So actually, no, we're not seeing any decline, any lessening out of Hong Kong. We along with others, as I was commenting, put in rate increases there and rate increases that have stuck. That's the first time that's happened in two years. So that was very good news. So, no, I'm not quite sure what data you are looking at but literally, from our block hour production, our customers, and our scheduled service activity, it's been continuing along and has not abated at all.

Okay. And then just lastly, and I know that you've mentioned that you're seeing strength in the different areas of your business, but I mean, as we look going forward, do you think there will be a progression between some of the different areas of revenues -- in other words, you know, will we see the strength in chartering less dry leasing lead to more hub activity and then the wet releasing -- is there a natural progression of where you see the strengthening that will lead us to look at this as a building block approach? In other words, will some of the carriers as you mentioned who may have crews, you know, want to do dry leases initially, and then as that builds further, that we should look at the different parts of your revenue portfolio-- Giving us information as to where the next leg of strength may be?

I think you just said it all for me. (overlapping speakers). That literally is, yeah, in terms of building blocks, we have viewed right from the very beginning the what we -- the partnership program which we continued to sort of shortcut by calling hubs, but it's obviously much broader program than that you really ought to think of it as our network program or global network program. But literally, part of what we are intending to do there, and in fact are seeing very nice success already, is sort of bringing new customers into eventually into the ACMI fold. These are by and large carriers that would not on their own be able to fill up an aircraft on an ongoing everyday of the year basis on a long term. But they can at this point in the stage of their development, put 20 or 30 ton on an aircraft on a consistent basis going forward. So part of our strategy is just exactly what you talked about, which is to begin to help those carriers develop their businesses, increase their loads, so that at some point, they can in fact become full-time ACMI customers. So that is part of the developmental process that we are going through, and that I think we're paying very, very good dividends for. I will also say, though, that the other piece of this equation that we believe will take place as we go forward is that the ACMI business will as the economy does begin to improve, and as the air cargo industry begins to go back to a more normal growth pattern, that the ACMI business will see a very nice pickup, and we're already beginning to see that to some extent. We have had an awful lot of our either former or even existing ACMI customers, now coming to us and saying, we want to be prepared for that upturn when it comes, but we don't want to be going out and buying aircraft with which to service that demand when it does arrive. And therefore, wanting to talk to us about either expanded, or a new ACMI arrangement. So I think you'll see both aspects of that business happening. Again, all of that is -- I got to continue to say, it's all tempered by the rate at which the economy does come back but, uhm, at least in terms of what we are seeing in the discussions that we are having, that is what our expectations are. You'll see development of new customers via the Atlas Air partnership program and I think a return to better days in the ACMI business.

Thank you.

Yup.

And we have time for one final question today. And we'll go to Joseph Francois with AIG.

Yes, hi. Good afternoon, gentlemen. Quick question. Actually, two questions. One, can you just tell us the covenant number, I guess the covenant changes that occurred I guess the 2nd quarter? And I guess, two, is on the ACMI business as you were speaking before, uhm, I guess one of the questions we have is basically, uhm, at some point it seemed that the I guess the[INAUDIBLE] business had hit a wall and you are suggesting that it might increase again. Do you think it will go back to the I guess, the, uhm, historical levels that it was at around '99, 2000?

Historical levels of ACMI business?

Yes.

Not -- certainly not immediately. Doug's got his hands up in prayer. [ laughter ]

That would be a good thing.

That that would be a good thing. No, I don't think that will happen immediately, and I don't think we ought to mislead anybody in that regard. I do think it will return and I do think that you will actually find carriers who, today, are suffering extreme buyers remorse from having bought their own aircraft deciding that actually it does make an awful lot more sense to have a combination of own and leased aircraft and that that will actually provide a sort of a new round of ACMI type of activity going forward. But again it doesn't happen overnight. Unless the economy just absolutely just, you know, starts to explode. So, no, I don't think it will happen overnight. But I do think it will happen gradually over time as hopefully some of the carriers who are suffering buyer's remorse now will have seen the error of their ways, and gone back to a more diversified portfolio of product offering. With respect to the covenant changes, I'm not sure that we have publicly disclosed those. But we -- what we can tell you is that in that process, the -- we're okay, number one, obviously, in terms of all of the covenants. Number two, the liquidity covenants was reduced even though we were now well in compliance and would have been well in compliance with it. And some of the others were tinkered with. But Doug, if you want to go through --

Sure. These are -- (indiscernible). The liquidity one, is Atlas must keep in excess of $140 million until the end of November that increases to $160 million for the December. Then we ratchet back to $200 million, just like we said we were always going to have to go back, and ratchet back the original ratios or otherwise seek new ratios in 2003. We have been on record of saying a number of quarters now 2002 strategy was fine cover [INAUDIBLE] release through 2002 as we went through quite a difficult year. There are a minimum liquidity and -- there are minimum interest coverage tax and leverage ratio. Those were tinkered with. 1.57 times. And the leverage is 6.75 times I'm not going to get into calculation of how you get to all those things. There is also minimum equity test as well of 400 million of Atlas and we are in compliance are all -- with all those terms.

I'm sorry, when you say Atlas you mean Inc?

Inc.

Okay. Thank you.

You're welcome.

Thank you. That does conclude today's question-and-answer session. I'd like to turn the call back over to Mr. Shuyler for any additional or closing remarks.

I think that's it for today. Thank you for being on the line. We apologize for doing it late in the day. But that's, uhm, just the way the timing worked out. But we appreciate your being on the line. And look forward to talking to you next quarter. Thanks.

Thank you for your participation in today's conference. You may disconnect at this time.