Air Transport Services Group Inc (ATSG) 2005 Q2 法說會逐字稿

Good morning and welcome to the second quarter conference call for ABX Air. My name is Tameko (ph) and I will serve as the moderator for today's call.

Now I would like to introduce Joe Hete, who is President and Chief Executive Officer of ABX Air.

Mr. Hete, go ahead, please.

Thank you, Tameko, and good morning to all of you joining us for what we anticipate will be regular ABX Air quarterly conference calls. With me today is Quint Turner, our Chief Financial Officer.

The purpose of today's call is to discuss our financial results for the second quarter, which ended June 30th, 2005. After the close of the market yesterday, we issued our second quarter and first half 2005 earnings release and filed the corresponding 10-Q with the SEC. We also put out a release and an 8-K announcing a one-year extension of our hub services agreement with DHL, along with some changes in terms of that agreement. If you haven't seen those releases or filings yet, they're available on our Web site at ABXAir.com.

Quint Turner will now go over our financial results for the second quarter and first half. Following Quint's presentation, I'll discuss our operations and the challenges ahead of us. Then I'll review the amendment to our hub services agreement. Finally, we will open the call to your questions.

Quint?

Thanks, Joe. I need to begin by advising everyone that we may make projections or other forward-looking statements during the course of this call. Such statements involve risks and uncertainties, and our actual results and other future events may differ materially from those we may describe here.

I'd like to refer you to ABX Air's periodic reports that are filed from time to time with the Securities and Exchange Commission, including the Form 10-K for the year ended December 31st, 2005, and other Form 10-Qs for the first and second quarters. These documents contain and identify important factors that could cause the actual results to differ materially from our projections. In addition, during the course of the conference call, we may describe certain non-GAAP financial measures, which should be considered in addition to, and not in place of, the GAAP financial measures we include in our financial statements.

Now for the financials. As we've said in our news release, our second quarter and first half results showed improvement in our business compared with the same periods of 2004. Our total revenues for the second quarter increased 28% to 351.2 million. Net earnings of 6.8 million were up 16%, which equaled $0.12 per diluted share. For the first half of the year, revenues increased by 27% to 697.8 million, and our net earnings increased 17% to 13.8 million.

Revenues generated from DHL were 344.2 million in the second quarter, up 27%. They represented 98% of our total revenues for the quarter. That includes $80 million in reimbursed costs, primarily jet fuel, which are not eligible for markup. During the first half of 2005, the average cost of aviation fuel increased by 42%.

Our second quarter DHL revenue growth, excluding fuel, was driven largely by a 44% increase in costs eligible for markup under the hub services agreements. DHL's ground network has expanded significantly since a year ago. We were selected to operate seven new regional sort centers for DHL last fall, giving us a total of 18 regional hubs now, compared with 11 one year ago.

At the same time, our DHL costs subject to markup increased during the second quarter by only 3%. That's because the increase in package volumes and expansion of the DHL network was driven by growth in DHL's deferred ground products as opposed to its air products. As you know, we can earn additional revenues and earnings from incremental markups under our DHL agreement.

Some of those markups are based on achieving certain cost-related goals each quarter. We earned $500,000 of incremental markup under the two agreements during the second quarter of 2005, half of what we earned in the second quarter last year. That 500,000 represented 39% of the maximum incremental quarterly markup for both agreements.

We earned 68% of the maximum markup under the ACMI agreement, and 15% of the maximum under the hub services agreement during the quarter. The equivalent percentages of maximum in the second quarter last year were 86% for ACMI and 90% for hub services. The incremental markup and percentage of maximum for hub services were down, primarily because of higher labor cost.

We had higher than budget piece volumes and a higher percentage of larger box traffic this year, which requires more labor to process than letter traffic. DHL also asked us to implement additional sort processes in all hubs, resulting in more labor hours than we had projected.

Our non-DHL business continued to grow strongly during the quarter. Non-DHL revenues grew to $7 million, up 84%, over the second quarter of 2004. That increase stems from higher sales of aircraft maintenance, services and parts, revenues from operating a U.S. Postal Service hub since last September, and more non-DHL air cargo revenues.

Excluding interest income, earnings from non-DHL sources were $1.1 million, up 6% for the quarter. Although revenues for non-DHL air cargo services increased, earnings from that line of business were down. We had significant depreciation experience from two Boeing 767s that were being transitioned into scheduled service during the quarter.

DHL agreed to let us use these two 767s in our non-DHL cargo operations for 12 months. During that time, we will bear their depreciation, maintenance and other operating costs. We believe we can be more competitive for business with new customers using the 767 instead of our DC-8s or DC-9s. We expect these two 767s to go back into service for DHL and be reimbursed for them under the ACMI agreement during the second quarter of next year. Now, Joe Hete will review our operations.

Joe?

Thanks, Quint. This morning, I want to cover a few key points that are important for you to understand in order to assess where ABX Air is headed and the challenges and opportunities we face in the second half. As we have been telling investors since we became public two years ago, our business is very predictable in one sense, since the vast majority of our costs - our results come from contract formulas. But it's also very unpredictable in another sense. Much of what we can earn in any given period is based on business volumes that are very difficult to project and on changes in the way that DHL chooses to use our services.

The key challenges before us will have a major impact on our results for the rest of this year, as well as the next few years. First, we are intensely focused on helping DHL plan and implement the consolidation of its main sorting operations into the expanded sort facilities here in Wilmington. That expansion stems from DHL's decision last year to consolidate it's main U.S. hub operations.

This will be, when completed, the second-largest international gateway in the United States. We expect it to go into operation in September.

The process of integrating these facilities while maintaining the superior service DHL expects every day is our challenge in the second half, and it is a major one. We have invested substantial time and effort to make sure that our part of that project is carried out on time and on budget. The best possible outcome would be to dedicate this new facility with our best-ever service quality and cost control performance throughout the second half. We will work hard toward achieving that objective.

As we are in the middle of DHL's integration of its contracted air fleet. Their plan, announced last November, calls for the reduction of 26 aircraft from our fleet by the end of 2005. Five aircraft have been removed so far. DHL has said its plan is subject to change, so we have no firm plan as to when the remaining planes might be removed.

As you know, we have some flexibility about how to respond to those cuts. We can, for instance, sell removed aircraft back to DHL. So far, we have opted to retain all but one of those five planes. We will use them for spare parts and to serve our other customers. We have learned a lot about maintaining DC-8 and DC-9 aircraft, which has led to significant demand from other airlines for our parts and our maintenance services.

At the same time, DHL is taking over management of the contract to charter aircraft operations that serve markets too small to justify large, transport-size aircraft. The expenses associated with this run about 22 million per year, so the income on net earnings in the second half of 2005 would be about $200,000. Third, we have purchased two Boeing 767 200s that will be available for cargo services next year, one from All Nippon Airlines, and one from Delta. That would bring our total of 767 aircraft to 30.

The Delta plane, when ready for service next March, will replace one of the 767s we deferred placing into DHL service. The DC-8s and DC-9s in our fleet continue to provide reliable, cost-effective service, but we are opining (ph) that third-party customers prefer the fuel efficiency that the 767 offers, particularly on longer routes. We also signed a new 10-year maintenance agreement with Delta TechOps for the GE engines that are installed in our 767s. That agreement will bring us incremental cost savings and a long-term commitment for more excellent service we have received from Delta over the years.

Finally, we announced yesterday that we have reached agreement with DHL on an amendment of our hub services contract. The amendment extends the agreement for one year in exchange for temporary changes in both the base and quarterly incremental markups we can earn. We will be able to earn a higher markup percentage for achieving quarterly cost-related goals, but we also absorb a half-point reduction in our hub services base markup to 1.25% for the second half of the year.

The regular contract terms for hub services will be restored on January 1st, 2006, and the overall agreement now runs through August 15th, 2007. The annual hub services cost and service markups are not affected by modifications to this agreement.

We appreciate DHL's desire to motivate us to push forward aggressively on our cost-related targets, while continuing to improve service levels during this period of major consolidation and transition. We will do our utmost to achieve both objectives, and we will continue to seek new customers.

That's the summary of what we have been working on over the last several months. Now we have the tremendous job of combining two primary hub operations into one, something no one has done before. This provides us with tremendous opportunity, but it makes the second half very hard to predict.

We have been substantially increasing our sort staffing and working to bring the operation in line with the high efficiencies of our other operations. Given all that we are likely face in the second half, we are not prepared under the circumstances to provide a specific financial forecast for the second half, or for the year as a whole.

We had a good second quarter, but we know we need to substantially improve our performance in the second half to have a reasonable chance of earning significant incremental markup revenues. I can promise you that the management team at ABX Air is well aware of what needs to be done and will be working extremely hard to get us there.

Now, we are ready to take questions. Moderator?

Thank you.

[OPERATOR INSTRUCTIONS].

Question comes from the line of Ian Zaffino of Oppenheimer. Go ahead, sir.

Good morning, gentlemen. Good quarter, here. On the new agreement that you just struck with DHL for hub services, the incentive fees, are the terms and the bogeys included in those identical to what they were before you negotiated this space reduction.

Good morning. This is Joe Hete. Yes, the terms of the agreement in terms of how we earn the incremental markups would remain unchanged. It's just a percentage of them changed.

And when those bogeys were first established, was the mix shift and higher labor cost known in that you see this big reduction in the incentive fee that you achieved at hub services. Can we see that 15% return to the 90% level, or how should we think about that? Or is it just that the existing bogeys are just unachievable, or just too difficult to reach at that level given the new shift of mix and higher labor costs.

Ian, from the standpoint of the challenges that we face in terms of the integration of the hub, certainly it's not going to be without significant challenges, as I already mentioned. There are a lot of things taking place with the construction going on here at Wilmington. Prior to the new building coming online, they have to integrate that facility, for example, into the four other primary sort facilities here in Wilmington.

So there are a lot of unknowns in regards to how that is actually going to take place. The characteristics of the freight are going to be markedly different. The majority of the freight that is handled through the CVG hub operation today is international freight, as opposed to domestic. So what would be considered to be the legacy Airborne business is more the small traffic.

So all of those factors are taken into consideration, but certainly you can't always anticipate every potential problem you may have that may hinder your productivity.

And when will you have the opportunity to renegotiate some of the bogeys in those contracts, or are they going to be the same until August of '07?

The bogeys, as far as the formulas that are utilized are based on the budget, and keep in mind that the budgets, we do it on two bases. One is the annual component and the other is the quarterly. Quarterlies are dovetailed off of the annual budget, but updated on those quarterly bases. So each quarterly markup is going to be different from what was originally anticipated, so that gives you an opportunity to make adjustments to reflect the most current conditions you can anticipate.

And then again, going into 2006 and 2007, we will recap the annual plans for those years as well.

So it seems to me that the reduction in the amount of incentive fee that you actually captured this quarter is more temporary until the infrastructure's in place, and then we could start seeing it somewhat climb back up.

Certainly that's one way to look at it, but obviously it's going to be dependent on how well we're able to perform against those metrics.

Okay, and then just on one other subject, the plane you're buying from Delta - when will you actually take delivery of that plane? I know you're putting it into service in the first quarter or second quarter of next year, but when are you actually taking delivery of that, and what can we look at as far as the reimbursement - or what will be the cash that you receive for reimbursement for the plane that you're giving back to DHL.

Well, if you look at the aircraft, we referenced two aircraft that we acquired. Both of them were acquired in the month of July. The first was the last of the 24-aircraft purchase that we had contracted with All Nippon Airways and a couple of its partners for back in 1997. So we close out that 24-aircraft purchase. The second aircraft was the one that we purchased from Delta. We also acquired that in July as well.

The All Nippon aircraft is anticipated to go into service probably at the end of December, 1st of January, while the one acquired from Delta will go into service, according to the current schedule, in the month of March 2006.

The Delta aircraft was purchased in anticipation of returning to the aircraft that was deferred from being placed into DHL service. It will take its place in our third party business segment. The aircraft that was deferred would go back into the DHL network. The depreciation on that aircraft would be reimbursed as part of the ACMI agreement, and the value of that aircraft when it was placed in service was somewhere approximately $28 million.

So the way I look at it is probably you didn't purchase the Delta plane for anywhere near that number, so once you gave back the original plane, your cash you're receiving from reimbursement is going up significantly more than your depreciation expense you're going to incur from the Delta plane.

Yes, sir, that is correct.

All right, no more questions. Thanks.

Your next question comes from Helane Becker with Benchmark.

Thanks, Operator. Hi, gentlemen.

Good morning, Helane.

A couple things. The balance sheet looks really terrific. It looks you managed the receivables down a little bit in the quarter, as well as adding to cash and improving the equity line. But maybe you could just address your thoughts on the receivables a little bit and if there's any more room to go, to manage that down a little more.

And then the second thing I have is if you look at the 767s, isn't the right way to look at it to say you've got $2 million of annual depreciation on those plans and you're going to earn a greater return than $2 million, so it makes sense to do that in third-party service?

Helane, it's Quint. With respect to your first question on the receivables, yes, as you say, there was a decrease since the prior quarter, and certainly a lot of that was primarily due to the DHL receivables, which is down to about $22 million as of the end of June. And as we discussed in our prior filing, it got as large as it did somewhat due to the growth that we had in the expenses and the business volumes with DHL. And so there's a lag in paying that down.

As far as having that come down further somewhat, potentially, we have of course received payment on a majority of that since the end of June. So the number is down farther, and now that the business volumes are more stable, I think it will match the funding through the budgeting throughout the quarter, so that the receivables should be lower. As far as the aircraft, Joe, I don't know if you want to. On the 767 aircraft, Helane, just repeat your question on it. You're saying that the right way to look at it, again, is the $2 million of depreciation?

Well, you've got $2 million of annual depreciation on the plane, but the margins in the non-DHL business are significantly higher than the margins in the DHL business. So you're going to earn $2 million plus a margin.

The idea when we went to DHL and asked for the 12-month deferral of course was that we would cover the deprecation ad achieve a better margin than we would get through the DHL contract. And we'd also have an opportunity to grow our customer base for that non-DHL portion of our business.

Right.

The other thing we will be facing, Helane, as part of the consolidation here in Wilmington is up until now we have focused on our non-DHL ACMI biz in the DC-8 line of our aircraft fleet. Come the consolidation in September, the freighter aircraft, the ones that don't have the ABX particular C Container configuration, the traditional large-cargo door equipped aircraft will be pulled back in as part of the DHL network. So we really wouldn't have accessibility to those aircraft once this consolidation occurs. So our mission is to be able to replace those with a newer generation aircraft, and that is the 767.

DC-8s, they are getting long in the tooth. They're between 35 and 40 years old for the majority of the fleet, so it's time to do a little bit of modernizing if you're going to have to go out and find a replacement asset to fund your third-party business.

Right, so isn't this a non-risky way to do it. I would think that this is a complete riskless way to do it. You take a plane that you know DHL will eventually need, you use it in your own service and you kind of just work through the replacement of the fleet that way, and it makes for a more stable replacement cycle.

Certainly gives us another option, obviously, to integrate it, if we're not successful in being able to find customers other than DHL to use the aircraft, but we don't believe that will be the case, especially when you look at the aircraft that it replaces, which is the DC-8. There are still approximately 130 of those aircraft in service today. Fuel consumption differential between a DC-80 60 series and a 767 for example can be, depending upon the stage length, can be anywhere from 400 to 600 gallons an hour of fuel. And so if you're an ACMI customer, obviously when fuel is at around $1.70, $1.75 a gallon, it's a significant savings for you to be able to replace a DC-8 with a 767, and then certainly obviously DHL does provide a bit of a safety net, if the need arises, and their continued growth, to be able to fund that airplane. Certainly, we want to always be there to be able to fulfill their needs when they have them.

Right. That makes perfect sense. And then just one Delta-related question. If Delta files chapter 11, you're not exposed at all in any areas, are you?

The only question would be as to whether they would for some reason want to cancel the engine maintenance agreement that we just re-executed, but when you look at the breadth of the DHL customer base, they have, from my understanding, approximately 100 customers that utilize their TechOps services, and we would only be a portion of that.

And I can't imagine they'd want to do that. Okay. Well, thank you very much. Great quarter.

Thank you.

Your next question comes from Matt Zott (ph) with First Capital Alliance.

Well, gentlemen, congratulations on your quarter. This is actually Dwayne Kennimore (ph). As a long-term holder, we're pleased that ABX and DHL are strengthening their partnership and that it looks like you're obviously working together to handle the growth that we're experiencing. And I know we know that ramping up the consolidation of the hubs is a big challenge, and it's occurring around December. Having said that, how are you going to handle the personnel needs and productivity issues going forward, and what did you learn in this regard last year?

In terms of being the first mail needs, obviously they said we're going to be on a big recruiting campaign. Based on what we know today and discussing with the engineering folks is we anticipate that we'll have to add somewhere between 500 and 600 people to our payroll here in Wilmington to handle the implementation of the new facility when it comes online in September.

So we have had a very, very aggressive hiring campaign going on for the last couple of months, and as we stand today, we're progressing against our targets very well. Obviously, once the facility comes online, you'll look for opportunities to be able to tweak the productivity side, so that the numbers we throw out in terms of what we anticipate the staffing requirements will be are obviously going to be on the conservative side.

The mission that we have at hand, ourselves and DHL, is to make this transition as seamless as possible to the customer, and that's going to be critical. And so one of the things you don't want to do, obviously, is to fall short of that goal, and to that end we plan on coming out with a strong showing, and then be able to tweak it to get better productivity and efficiencies as time goes forward.

Okay, and I had one more question. As Helane mentioned, you're obviously accumulating a substantial amount of cash relative to your market cap, and it seems to us that a stock buyback might be something you could do in the future, given your steady cash flow, and obviously the financial metrics of the stock. But I know that you also have some restrictions in your DHL agreement, such as you can't do this right now in your (inaudible), of course. But do you think there might be some room for that in the future, potentially? Is it something that you've considered?

Dwayne, it's Quint. Certainly, we recognize that that is flexibility that we would like to have. Of course, as you stated, under the current note with DHL, it's flexibility we do not have.

Right.

I certainly - it is possible, but it will require DHL to agree to any changes to the current arrangement. We recognize that that would be beneficial to us to have that flexibility.

Okay.

And, really, that's all we could say at this point.

having said that, Quint, what is your expectation currently of what you're going to do with the excess capital?

Well, again, we would evaluate opportunities as they present themselves to use that capital to grow our cash flow and net earnings. And one thing we would not want to do, obviously, is in any way make a misstep or take an unwarranted risk that wasn't supported by what we believe was a sound analysis and a good payback. So other than that, I'm not sure what I could add to that.

Okay, thanks. Good quarter.

Thank you.

Your next question comes from David Campbell of Thompson, Davis Companies.

You're saints, Joe and Quint. I just wanted to make sure I got everything straight. The All Nippon plane is one that Airborne had purchased or agreed to purchase in '97, and just been delayed. And when it comes in delivery in December, it will go into the DHL fleet in January. Is that correct?

That is correct, David.

So the only additional - and the Delta plane will come in service in March. That will go into your service to replace, I guess, one of the two - the 767s that are currently out of the DHL fleet. Is that correct?

That's correct.

So you will have one less 767 next year in the charter fleet, and that should do something than you have right now.

Yes, sir.

I'm surprised that it's taken - I'm surprised that you haven't had more 767 charter revenues in the second quarter, given your apparent enthusiasm for the aircraft and willingness to add one permanently to the charter fleet next year. It sounds like you have a pipeline of business that you just haven't been able to implement yet, or something like that?

Well, essentially, David, we had been limited in terms of the available assets up until now. Obviously, the majority of our fleet is contracted to DHL. We were able, through discussions and negotiation with them, to make two of the DC-8s with the traditional large cargo door available for our non-DHL ACMI biz, essentially since the time of our separation from Airborne. So we've been doing that for almost two years now.

As I mentioned earlier, those two DC-8s are on the schedule to be placed back into DHL service come the consolidation in September, and so with that in mind we obviously had to look for replacements or abandon the non-DHL segment of our ACMI biz. If you look at the 767 market, it is a very tight market in terms of available aircraft. The aircraft with the GE engines are the preferred aircraft type, and we were fortunate enough to have Delta take one out of service and make it available for acquisition in a timeframe that would dovetail nicely with the deferral - the return of the two deferred 767s into the DHL network.

So, but in looking at 2006, it would appear that your charter revenues - capacity to do charter revenues would be less than this year, given the fact that you're getting only one 767 to replace the two DC-8s. Is that the way to look at it?

That assumes that we don't look for additional 767s. Obviously, if the business pans out the way we expect, we will make an assessment as to whether to launch additional acquisitions to continue that non-DHL segment.

Right, right. And you'd talk about the DC-8 coming back into the DHL service, but DHL has said that they're going to use fewer aircraft by October. How does that add up?

Well, when you talk about DHL using fewer aircraft, obviously, as we have disclosed previously, they had advised us previously that they were going to reduce our fleet by 26 aircraft, and again, that would net out at 22, because during that same timeframe we would be putting four more 767s into service.

So the aircraft that are coming out in terms of a reduction are essentially focused in the ABX Air fleet. The predominance of those aircraft would be the DC-9, which is the smallest aircraft between its combined fleets of ABX and ASTAR. And if you look at it from the standpoint of why would the ABX fleet get hit harder than the ASTAR fleet in terms of reduction, the 767 being the smallest aircraft out there, if you look at a marketplace today that ABX has a DC-9. If the aircraft is full, the next logical step up is a 727, which is what ASTAR operates. So, essentially, when you're combining volumes between two networks, you're going to essentially get the efficiencies of larger aircraft to be able to handle the combined volumes.

What does the Delta aircraft acquisition do to your capital expenditures in 2006? Do you have any estimate for cap ex in 2006?

We're not providing guidance on the 2006 cap ex as of yet, David, other than the disclosure in the Q with respect to the two aircraft that we added in July. Now, maintenance cap ex, and it's a question that I hear from time to time from investors is what's the base level or the maintenance cap ex that ABX requires. Essentially, it's approximately 10 to $15 million. So, assuming you didn't have aircraft commitments for large single slugs of cap ex, just the maintenance cap ex would probably be 10, 15 a year.

Okay, okay. I'm really pleased that you're getting some revenue. You mentioned revenues from forwarders, I guess, on your scheduled system. Is that the first real success you've had in getting revenues on the scheduled system in the second quarter?

We've had some of those revenues all along, David. It's just not significant enough in and of itself to say that it should be a segment all its own in terms of the reporting, but we're pleased with the progress that we've made in that arena.

And will the enlarged aircraft capacity help that in the fourth quarter because using the larger DC-8s - well, not larger, but the cargo door DC-8s and the 767s - will that help generate more revenues in that sector of your business.

Well, keep in mind, David, that since DHL is paying the tab for those aircraft in the network itself, obviously they have the first opportunity to be able to fill those aircraft up. Our use of that space is totally contingent on them not having any use for the available space. So, with a lot of the aircraft that are currently operated by ABX being taken out of the network and replaced by aircraft operated by ASTAR, certainly that will change the coverage that ABX would have available to it to use that space available business.

And, Quint, this is my last question. Quint, you mentioned the receivables down again in the third quarter, and that they should be relatively stable from here on out. But last year, there was a big increase in the fourth quarter in receivables, the timing issue. You don't expect that again this year?

Again, in the fourth quarter, because of the annual component of the incremental markup, you've always got that at play as far as the fourth quarter numbers go. To the extent that we earn that, that's settled in the first quarter of the following year. So that could affect our fourth quarter receivables.

I think the other contributing to the receivable run-up, other than just the business volumes, was the jet fuel price. As you are aware, we are funded throughout the quarter based on a budget, and as we all are painfully aware of, the fuel price has increased during the earlier part of this year more dramatically than anticipated.

And so as a result, even though that's a reimbursed only, no markup item, we are paying the tab for the actual fuel during the quarter, and because of that price increase, we built up some receivable associated with that. Now that the fuel prices have stabilized, at least we hope, knock wood, they've stabilized, that will be factored into the budget and the funding we get throughout the quarter.

Okay, thank you.

Okay, David.

Your next question comes from Brian Bender (ph) with Caxton Associates.

Good morning.

Hi, Brian.

Just want to make sure I understand the third-party business in the 767. The way that we have I think talked about this a little in the past is the new plane that comes in - basically, when you decide to take the 767 away from DHL, just taking them one at a time, basically there's about $2 million of depreciation there that you're foregoing in cash flow. And so your view long term, the opportunity was to get higher than 2 million, plus markup, on new third-party business. Is that correct?

Well, we certainly expect to cover depreciation. Joe mentioned earlier the Delta aircraft that we recently purchased, we anticipate replacing one of these two. And as market values now are of course lower than they were back in the '90s, when we committed to the ANA 767s, the other thing that will occur is that depreciation on the Delta plane should be lower, will be lower.

I mean, I see that, but as I look at your cash flow, what I'm looking at is basically the 767, once you put that back to DHL, you'll recoup that 2 million plus the 767 that you've just purchased from Delta should still make a $2 million in cash flow, and so you'll be making $4 million, minimum, on whatever cash you invested in that Delta plane. And based on current market rates, I think it's probably around $15 million. So I'm just trying to get ...

Brian, basically you're correct in the aircraft that's returned to DHL, will, under the ACMI agreement, have its depreciation reimbursed and be subject to the markups that are a part of the agreement. The Delta plane that will then replace it, we will anticipate to cover the deprecation, as well as earn a margin, which based on past results has been certainly better than we have achieved on the ACMI agreement.

Right. So is there any reason to believe that you won't earn at least the $2 million that you intended to earn originally on a 767, even though your actual deprecation cost is going to be lower for the new 767, but obviously the 767 that you took out of service from DHL, you were expecting to make at least $2 million on that, so you wouldn't you make at least $2 million on the new one that you bought from Delta, even though the cost to that plane is much lower?

Well, other than to say that we would cover the deprecation with a better margin, we're not giving any guidance on specific amounts, Brian.

Okay, it seems like that's a pretty good investment. That's kind of what I'm getting to. I just want to make sure that our assumptions are correct. And then, secondly, just looking at your net cash and obviously you have some cap ex on the new planes going forward, but kind of your free cash flow before maintenance cap ex is probably $1.15, $1.20 next year on an $8.00 stock. So the previous caller who suggested exploring a buyback, we certainly agree that that would be a great way to return some value to the shareholders. So as you kind of progress, it is something that we certainly would be in favor of.

And my last question is, I think doing the call is a great way to get the story a little bit. You haven't really done a road show and I obviously realize that you're busy with the integration, but is there a timing when you expect to be able to kind of come to New York and meet with investors?

We appreciate the fact that everyone is interested in seeing us on a face-to-face basis, and up until now, anybody that's had an interest, we've certainly invited them to come out and see our facility here, to DHL's facility and our operations, because it is quite impressive, especially when you think about the investment that our partner, DHL, is making here in the Wilmington facility. It's quite significant.

Our IR program is in the development stages, and as you mentioned, Brian, certainly right now the number one focus for us has got to be on the integration, because that is critical to DHL's success, and we are only as successful as DHL is in this marketplace.

Yes, and I think that was kind of modifying the last six months, shows a good team player on your part, and I think over the long-term relationship, it can only be positive. So, congratulations.

Thanks, Brian.

Your next question comes from Patrick Anderson (ph) with Luxor Capital Group.

Hey, guys, great quarter. Just wanted to talk to on the volume in the package growth, I guess that really seeing that is sort of surprising in terms of the amount of volume growth. And the question to that is, how much more efficiently can you manage once things stabilize and sort of have a better sense for this is the volume coming through the system and this is the headcount we need. And I guess that's difficult to answer that directly, but if you can just say, hey, we were paying people overtime. Overtime is very expensive. If we can have full-time employees, maybe that's going to improve some of the markup under the cost incentive of the hub services.

And then can you talk to the mix shift and how that's being realigned, and in your quarterly discussions for cost and budget with DHL?

Patrick, this is Joe. Certainly, as far as the mix goes, what we referenced in our filing was that there's a significant increase in the box traffic, and anybody that follows the industry that DHL is in, with their competitors FedEx and UPS, knows that a lot of the growth in that segment is not in the air segment, which has tended to be the smaller packages, it's more in the ground business. And, of course, ground business generally brings with it more of what we refer to as the box traffic, as opposed to letters and envelopes.

If you look at what we have handled in the past, the letter and envelope traffic was, at least in the Wilmington operation, during our overnight ops, was about 55% of the total. But as the ground business grew, and with the expansion of the seven regional hubs put into the network last year, one of the things that occurs with the ground business is that you will handle a package more than one time through that hub network, potentially, when you're passing it from an origin hub facility, for example, to a destination hub facility.

That in turn drives the actual number of units that we handle at a greater rate than what the actual shipment growth that DHL would experience would be. So that presents some challenges in that the facilities that DHL inherited with the acquisition of Airborne were designed around the smaller package business.

So it does prevent some problems in terms of taxing the infrastructure within those facilities. As you have no doubt seen, DHL is talking about investing over $1 billion in the infrastructure in the U.S., not the least of which is being invested here to the tune of over $300 million in the Wilmington facility.

Going forward, the growth has slowed somewhat. DHL had a very good and aggressive advertising campaign at the latter part of last year, which drove shipment volumes up significantly. And then we had some issues as to what we referenced in a prior 8-K filing in regard to a loss of some contracted workers here in Wilmington. Since that time, we have obviously increased our staffing levels significantly and will continue to do so in anticipation of the opening of the consolidated hub here in September. And then once you have that in place, we'll be coming right out of that consolidation into the heavy peak season of the fourth quarter.

So I would not anticipate that we will be able to make significant gains in terms of fine-tuning the operation, so to speak, until we get passed the holiday peak season. That, as I mentioned, does tax all of the resources of these facilities and/or the resources to move the packages in terms of the people staffing them.

Okay, that's great. That's great. I know you guys are very focused on costs and maintaining productivity, so I'm sure that's where everyone's focus lies at the moment. Thank you, guys.

Thanks, Patrick.

Your next question comes from George Kim (ph) with Cadmus (ph) Capital.

Hi, guys. It's Jed Bonham (ph). How are you?

Hey, Jed.

Hi, Jed.

I jumped on the call late, so I apologize if this has been asked, but have you already described the business in more detail that you're doing with the 767 fleet that you're developing?

Are you talking about the non-DHL segment?

Yes, the non-DHL segment.

As we mentioned earlier, Jed, and I don't know when you came into the call, but essentially the 767 we acquired from Delta was anticipated to take the place of one of the 767s that we deferred placing into the DHL network. The aircraft is slated to come out of modification in March, which is the same timeframe with which the first of the deferred aircraft go back to DHL.

One of the primary drivers to going after the 767 was the fact that the DC-8s that we have utilized in our non-DHL business for the last few years, those DC-8s will be pulled back into the DHL network come the consolidation in September. The aircraft are equipped with a large cargo door. The freight characteristics of the DHL freight that currently run through their CVG hub operation require in many marketplaces the ability to load something larger than what will fit in one of our C Container aircraft containers. And, as such, they want to make full use of all of the aircraft that are within the two combined fleets that have a large cargo door.

So one of the primary drivers is not just whether there's new business out there for the 767 in the non-DHL segment, but also to maintain the existing level of business that we have.

No, I understand that, but are you running specific scheduled service routes, or maybe you could provide some more details on what type of routes, what geographies, whether it's scheduled service or other types of service this aircraft is running.

The aircraft will be running ACMI service, so essentially someone else is guaranteeing the use of the aircraft. We did not run it scheduled airport to airport service. The contracts contain minimum utilizations out so we're ensured that we have some return on the investment, because it is a significant investment to acquire a 767 and place it into service. Right now, what we have focused the lift capability has been out of a domicile in Miami in service of Central, South America and the Caribbean.

Okay, and you mentioned that this aircraft was not fully utilized in the second quarter, and you also then go on to mention that you expect it to be better utilized in the second half. The types of routes that it's flying, what's a typical block hour utilization of an aircraft like that in a typical day, and what was your utilization in the second quarter? You sort of described it as being relatively low, but what utilization were you seeing, and then what type of load factors do you think are possible on these routes?

Well, from a load factor standpoint, take the easy one first, whoever contracts for the lift under an ACMI agreement puts one pound or 90,000 pounds on the aircraft, we get paid the same. We charge it on a block hour basis, and those contracts do contain minimums.

As we put the aircraft into service in the second quarter, obviously, we're going through a transition in terms of being able to pick and choose some additional business on a short-term basis, because, as I mentioned earlier, the aircraft eventually will be designed to replace the DC-8s, so we have to protect that segment of the business as well. Any time you're putting a new aircraft type into a new market, you can't just flip a switch and automatically start flying it. There's things you have to do with regard to crew scheduling in advance of that, you have to get your maintenance technicians up to speed in terms of maintaining the aircraft.

So, if you have significant notice to be able to put that plan in place, obviously, from the minute you put that aircraft into the market, you're going to be able to derive revenue, but, unfortunately because the agreement with DHL was not negotiated until the first quarter, we're a little bit behind the power curve in that respect. We do anticipate that through the third quarter and the balance of the year that you will see significant contributions to the revenue stream from those aircraft, much more so than what we saw in the second quarter.

And if I look at a cargo airline like Atlas, they tend to, on average, each of their 747s flies about 10 block hours per day. I'm just trying to think of the routes that you've been playing here with your DC-8s. Is that the type of utilization that is possible with these aircraft, or are they shorter routes. And then what type of compensation do your receive, generally speaking, on a block hour basis under these contracts.

We're not going to disclose what kind of revenue we receive on a block hour basis for the aircraft. Ideally, we'd like to get 20 hours a day utilization out of the aircraft, and that's for the heavy fixed investment costs of it compared to a DC-8. But, generally, you're looking at something that's going to be in the vicinity of let's call it five to seven hours a day of utilization for an aircraft that's operating in the theater in which we operate.

Obviously, Atlas is flying 747s, flies back and forth across the Pacific a lot, which is, in and of itself, just one trip is going to generate more hours than what we would fly on a daily basis with the 767s.

That's great. Thank you.

Your next questions are from Jason Young (ph) with Sofilet (ph) and Company.

Hi, good morning. Most of my questions have been answered, but just wondering if you could quantify, or at least give an estimate, of how you expect the incremental costs to look in the anticipated hub consolidation process?

In terms of specific guidance, we don't have that to offer. However, as Joe mentioned, we are adding employees to the payroll, 500 to 600 employees, and certainly there will be some additional costs as the volume that had been handled at DHL's other main hub in Cincinnati is consolidated at the single Wilmington location. We will of course work towards putting those estimates into our budgets and the incremental markup, as you know, results from how we compare to those budgets.

Okay, great. And just lastly, you've kind of addressed this, but could you just summarize your outlook for the third-party business, just where you see that going, going forward?

Well, obviously, one of the things we've tried to focus on is leveraging those areas in which we have a significant amount of expertise. And certainly one where we have the ability to make decent margins on it, and I think we've been pretty successful with that to date.

When you look at the third-party business for us, you kind of have to look at it almost as a new business, and I know a lot of people say, well, jeez, you're a $1 billion company and that segment of your business is only $20 million. Well, it is a business in its infancy. The areas that we focus on, primarily, as we discussed earlier, were the available space component, space not used by DHL that we can sell to other people. Obviously, that's going to be negatively impacted by the consolidation of the two fleets here in Wilmington, because our total fleet gets reduced.

Aircraft maintenance services, technical services to other folks. We've developed a significant amount of expertise over the years on particularly the DC-8 and DC-9 aircraft, as well as we have a very skilled and qualified engineering staff here at ABX. And so we've managed to leverage that, and we're doing heavy checks in mixed markets. We're not going to be an MRO in the traditional sense in that we are structured around an airline cost structure which is a little bit higher than what you'd see from a typical MRO provider. But we're going to focus on something that's a lot more efficient in terms of us being able to reduce the number of hours required to do heavy check work, and we've done a significant amount of that for other DC-9 operators.

Of course, the last piece, or last two pieces, would be continuing to see what other opportunities the Postal Service has for us to increase our third-party revenue stream. We do operate a hub facility for them in Indianapolis, and we started that in September of last year. The current network of HAST, as they are referred to, is comprised of, I think, 13 facilities in total. We are currently only operating one of those facilities, so we see that as definitely an opportunity, as those facilities come up for bid in the future. And we would anticipate we would be out there bidding with everyone else.

Last year in the fourth quarter with the Postal Service, we ran a network for them to handle their increase in holiday volumes. As everyone knows, FedEx has the lion's share of the flying - scheduled flying that's done for the U.S. postal service, and then of course the Postal Service also avails themselves of available space in passenger carrier bellies, for example, and they have done some work with us in that regard as well, in terms of using the space that we don't.

So we'll continue to push with the Postal Service for what other opportunities may be out there, both for available space, hub operations and certainly key onto this would be to run scheduled flight service for them.

And then the last piece is, as we've spent a lot of time talking about today, is the ACMI work for people other than DHL, and we see that as a great opportunity. As I mentioned earlier, if you've got 130-some-odd DC-8s out there flying today and the 767s, most people in the business, it was the likely replacement for a 35-plus year old airplane. That certainly has a lot of potential for us to take advantage of on into the future.

Okay, great. Thanks a lot. Good quarter.

The next question is from John Curti with Principal Global Investor.

Good morning. I have two questions. I wanted a point of clarification. Earlier in the call, you talked about somewhere in the neighborhood of $22 million in revenue, and I guess a couple hundred thousand dollars in operating income from some reductions of the DHL network to smaller cities. Is that correct?

That was referring, John, to the feeder charters, which was smaller, contracted aircraft that serves markets that are small, such that they don't justify the larger transport aircraft we fly. We had managed those contracted feeder charters into those cities, and on an annual basis it was approximately $22 million of revenue associated with those. And DHL had notified, I think last quarter we had mentioned it in our press release for first quarter - that they wanted to assume the administration of those contracts, and that that was expected to occur, and still is expected to occur, during this coming quarter. The quarter we're in, third quarter, and the estimates that we gave stem from that.

And that's on an annualized basis?

Twenty-two million was an annualized basis, correct. And, of course, this year, given that the reduction will occur midway through the year, you see the smaller impact for this year. I believe we gave a full year estimate and a $200,000 estimate for the calendar '05.

And then the remaining aircraft that DHL will be taking out of service, those are all DC-8s and 9s?

The 26 aircraft that were announced to us in November of 2004, and that really hasn't substantially changed at all, in terms of the plan, was for 16 DC-9s and 10 DC-8s. And as Joe mentioned earlier, we've had thus far five aircraft removed. I believe that's one DC-9 and four 8s.

The remaining planes that will come out of service, you have the opportunity to maybe put some of those back to DHL, as well as I guess keep some for your own operations and for spare parts. What's the likelihood of you putting some of those planes back into service under your own third party operations? Or are a lot of these planes just likely to be sold or just kind of kept for spare parts?

This is Joe Hete. A lot of it will depend on when those aircraft are released and what type. As we mentioned earlier, we have no firm plan at this point in time, and certainly with coming into the fourth quarter, which is the peak season, we may find that a lot of those aircraft may not even be pulled out of service into some time in 2006.

The one limitation we do have with the aircraft that are being removed from the DHL network is they don't have the traditional large cargo door. They do have the ABX unique container system, which does limit their marketability to a certain degree. Certainly, one target customer that would not see any drawback, or shouldn't see any drawback to that type of container service would be the U.S. Postal Service, for example. They are all small package - they don't have the large crates and things like that that would require a traditional large cargo door and the large eight (ph) container system.

Coincidentally enough, if you look at some of the containers the U.S. Postal Service uses in their facilities, the footprint of them is almost identical to what we refer to as our C Container. So they would certainly be a potential customer, and then we're certainly on the lookout at any point in time for any opportunity to be able to redeploy those aircraft in revenue service, flying, as opposed to taking them and either putting them to DHL or parting them out.

And when they announced this to you, at the time, there was no firm schedule in terms of when the aircraft would come out service. Correct?

That's correct.

Have you been surprised that there's only been five so far. Had you thought there would have been more by this point?

We would have anticipated maybe there would, but obviously it's really going to be dependent upon how their volume grows overall. Of course, we're certainly pleased not to have to take (inaudible) at this point in time, and if it didn't happen for a couple of years, that would be good for both us and DHL because it would say that certainly their business is growing and we in turn would grow with that.

And would a factor be in that just the consolidation of the two hubs, as they would want to have a little more extra capacity, and coming into the seasonal busy season as well?

Yes, I think you're pretty much spot on with that comment in that obviously when you're putting two things together that have operated separately, there's going to be some unknowns when you've got, essentially, 100-plus cities that you're flying into, and how those respective combined volumes may materialize when you're actually trying to load the freight into the containers and ultimately into the aircraft themselves. So they will keep a safety net, so to speak, in place. The aircraft, while they may not be located here in Wilmington, some of them will be parked down at the CVG facility that we have been asked to keep those on a flight-ready status on an ongoing basis.

Thank you very much.

You next question comes from Matt Zott of First Capital Alliance.

Hi, Joe. First, thanks for a good quarter. I know this is your first conference call, but I don't want people to get the impression, when you're talking about challenges the company is facing. I think you mean challenges in the context that it's a good problem and a direct result of the strong growth you're experiencing from DHL and North America and the investment that DHL is truly making, to become the international player.

Maybe, perhaps for, like, new investors, can you give some background on maybe the magnitude of the volume increase we've had in the past, let's say, year, and how much product you've had to push through your hubs and how you monitor performance to minimize costs and maximize profit?

Certainly. In terms of metrics, keep in mind, as I mentioned earlier on the call, that the growth that we see in terms of the number of units that we handle for DHL is not necessarily indicative of their shipment growth, because with the advent of the growth in the ground product, as I've mentioned, many of the packages are handled more than one time, and we take credit based on pieces handled, as opposed to shipments. But if you look at the growth on a year-over-year basis throughout the network, the growth second quarter of '05 versus second quarter of '04, for example, was at 20-plus percent in terms of the number of units that we actually handled on behalf of DHL.

Again, some of this being organic growth within the actual shipment counts and others being the nature of the best in terms of how you moved that freight across the country. So the growth was very strong. A lot of it was generated in the third and fourth quarters of last year, with the aggressive advertising campaign that DHL put on, as well as, to mention it again, the double handling of some of these pieces.

In terms of how you look at the metrics in terms of performance, again, the mix in terms of certainly letters and envelope traffic is much more productive than moving a box, both in terms of your facility requirements, as well as your staffing requirements. But the metrics that we focus on, primarily, would be focused in the area of pieces per man hour versus whatever your pleasure would be, in terms of how many that you can push through for the hours that you're paying for. And, again, factoring in the change in mix is the biggest difficulty you have in any one hub environment, and every hub's going to be different, because it could be markedly influenced by DHL signing up a new customer, for example, in the type of freight that that customer presents to them for movement, be it air, ground, letter or box. So it is a challenge.

At this point in time, as mentioned, it's a good challenge to have, because it's growth related as opposed to retraction. And you're always more often than not going to welcome those kinds of challenges, but they certainly do keep you busy.

Okay, thanks, and the other thing I wanted to maybe just point out is it's a little counterintuitive. When the company adds labor, it's sometimes viewed negatively because of the higher costs associated, but here's the positive in that the contract with DHL is a cost-plus arrangement. Can you maybe elaborate a little bit on that, as well as what would be a typical average increase in terms of, I guess, benefits and compensation for an additional labor.

We haven't given any guidance at this point in time in terms of what the additional compensation and benefits would be from the labor. But to answer the first part of the question, a lot of the - the arrangement is one that's a cost-plus. You could really view it as a cost-minus arrangement, because realistically where we, as ABX, are able to be more successful, and ultimately that would make our customer, DHL, more successful, is by driving down unit costs.

Keep in mind that the metrics that we use in terms of a cost per piece in garnering the incremental revenue is based on a budgeted amount. So that's part of the negotiation that takes place with DHL, both annually and quarterly, to say, all right, these are the units that you anticipate that we will have to handle, and then of course we counter with, "Well, this is what we think our costs are going to be to move those units."

And then our ability to really enhance our bottom line is predicated on us being able to reduce the cost as compared to that budget as opposed to just saying, "Well, I can throw all the money I want at it, because every dollar of it is marked up.' We are benefited to a greater degree by actually reducing the costs than increasing them. So, certainly having growth in terms of the overall level of business that we handle on behalf of DHL is certainly a positive as well.

Thank you, Joe.

Your next question comes from David Horn with Perennial Investors.

Good morning. In the Q, you refer to the two 767s that you bought for 20.1 million. I'm assuming that these is the Nippon and the Delta plane.

that's correct.

What was the cost breakdown between the two?

We haven't disclosed that, but mentioned earlier, the All Nippon airplane was contracted for back in 1997, and it's market price at the time was significantly greater than what we were paying for the Delta airplane.

And regarding the 23.2 million that you're going to spend over the next two years upgrading the planes, or converting the planes? What is the BPs on how much you're going to spend on each plane?

Essentially, it's almost a 50-50 split. I mean, the only real cost driver differential between a Delta airplane or an All Nippon aircraft would be what do you have to spend in the way of maintenance as you integrate that aircraft into your fleet. Every aircraft has to go through an alignment process where you take it off the existing maintenance program and put it into your maintenance program, and depending upon what level of check it's at at that point in time, as well as what kind of utilization it's had and kind of where (inaudible) drives some of the maintenance costs.

And that's why when we talked about a range that the aircraft will ultimately be placed in service at from a pricing standpoint, you can accept a swing of up to $2 million, positive or negative, depending upon what level of maintenance condition the aircraft is in.

And the 20.1 million, that's for the entire cost of the plane, correct? There's no other payment in any other quarters for these planes?

The 20.1 million, that's referring to the 2006, David.

I think he's talking about the acquisition.

I'm talking about the acquisition.

The 20.1 million is the acquisition and what we would anticipate spending towards modification during '05.

But there are no further payments in regard to the acquisition.

Right. The acquisition is of course the first payment you make.

Okay, thanks.

Your next question comes from Zobonel Aronoski (ph) with Docavel (ph) Asset Management.

Good morning. I had one question about the actual cost of the two planes that you bought in July. According to the 10-K, the cost was 20.1 million, that's correct?

Correct.

And there are also conversion costs of 16.3 million this year and 6.9 next year, right?

Yes.

Is that correct?

That's correct.

So the total cost of the two planes is actually 43.3 million? Is that correct? Because you cannot use those planes without the conversion, right?

That is correct.

So the actual cost is 43.3?

Of the two aircraft.

Yes, okay, that was my question. Thank you so much.

Thank you.

Your next question comes from Tyler Burke with Trenton Capital.

My question is on the $92 million note you have payable to DHL. I understand that that causes some restrictions in your ability to buy back stock. And given that the interest expense on that note is reimbursed by DHL, it's sort of analogous to a zero coupon bond, such that the present value of it is, based on my calculation, less than $30 million, even thought he face value is 92 million. I'm just wondering, why not use some of the cash you're building up to make a discounted payoff for DHL? That seems like it would be a win-win for both of you.

The arrangement that exists today isn't set up that way. I understand where you're headed with that, but basically DHL has a right in that note to call it for face value, and so they would have to make a decision as to what they felt was in their best interest, and at the present time that's not the arrangement.

Okay, maybe its' something you guys could keep in mind if you have to do any more quid pro quo type of agreements.

Thanks, Tyler.

And, Tameko, we have time for one more call. May I have the last question, please.

Sir, at this time, we have no more questions in the queue.

Well, before I end this call, I want to thank you for your support as shareholders and for your patience in allowing us to address many of our integration and transition issues first. I expect these calls will become a regular quarterly event and that we will be able to meet more of you face to face as our IR program develops. Thanks again for joining us on our call today.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.