Air Transport Services Group Inc (ATSG) 2005 Q3 法說會逐字稿

Good morning, and welcome to the Third Quarter Conference Call for ABX Air. My name is Maria, and I will serve as your moderator for today's call. Now, I will like to introduce Joe Hete who is President and Chief Executive Officer of ABX Air. Mr. Hete, go ahead please.

Good morning to all of you joining us for our third quarter conference call. With me today is Quint Turner, our Chief Financial Officer. The purpose of today's call is to discuss our financial results for the third quarter which ended September 30, 2005. After the close of the market yesterday, we issued our third quarter earnings release and filed the corresponding 10-Q with the SEC. If you haven't seen those documents yet, they are available on our website at abxair.com.

Quint will now go over our financial results for the third quarter and nine months. Following Quint's presentation, I'll discuss our operations during the quarter and some other matters. 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, 2004 and our Form 10-Qs for the first, second, and third quarters of 2005. 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 third quarter and first nine months results showed improvement in our business compared with the same periods of 2004. Our total revenues for the third quarter increased 28% to 369.9 million. Net earnings of 7.4 million were up 4%, which equaled $0.13 per diluted share. For the first nine months of the year, revenues increased by 27% to 1.07 billion, and our net earnings increased 12% to 21.2 million, or $0.36 per diluted share.

Revenues generated from DHL were 361 million in the third quarter, up 27.5%. They represented 98% of our total revenues for the quarter. The increase in DHL revenues was driven by increased costs under the Hub Services Agreement, due primarily to the expansion of DHL's ground network since the 2004 third quarter. This includes $86 million in reimbursed cost, primarily jet fuel, which are not eligible for markup. During the first nine months of 2005, the average cost of aviation fuel increased by 45.5%.

Our third quarter DHL revenue growth, excluding fuel, was driven largely by a 47.1% increase in costs eligible for markup under the Hub Services Agreement. 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, leaving us a total of 18 regional hubs now, compared with 11 one year ago.

At the same time, our DHL costs, subject to markup under the ACMI agreement during the third quarter, increased by only 1%. 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 1.2 million of incremental markup under the two agreements during the third quarter of 2005, greater than what we earned in the second quarter this year and in the third quarter of 2004. That 1.2 million represented 59% of the maximum incremental quarterly markup for both agreements.

We earned 682,000, or 100% of the maximum markup, under the ACMI agreement, and 557,000, or 38% of the maximum, under the Hub Services Agreement during the quarter. The equivalent percentages of maximum in the third quarter of 2004 were 98% for ACMI and 48% for hub services.

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.

As we explained in previous quarters, the two commercial agreements with DHL allow ABX Air to earn additional cost-related and service-related markups in the fourth quarter, based on our performance throughout the year.

While our nine-month results are not necessarily indicative of our full-year performance, at the end of the third quarter we were on pace to achieve 76% of the ACMI agreement maximum and 0% of our Hub Services Agreement maximum in annual cost-related markups. On the same projected basis, ABX Air was on pace to achieve annual markup from service quality performance equal to 60% of the maximum available under the ACMI agreement and 37% of the maximum available under the Hub Services Agreement.

In the fourth quarter of 2004, ABX Air attained annual cost-related markup equal to 100% of the maximum for the ACMI agreement and 76% of the maximum for hub services, an annual markup for service quality equal to 80% of the maximum for ACMI and 100% of the maximum for hub services. ABX Air's results during the last three months of 2005 may differ sharply from its nine-month results and affect its attainment of these goals.

Our non-DHL business continued to grow during the quarter. Non-DHL revenues grew to $9 million, up 32% over the third quarter of 2004. The increase is primarily the result of an increase in the level of aircraft charter services, airport-to-airport space, available cargo volumes, as well as revenues from operating US Postal Service hub since last September.

Excluding interest income, earnings from non-DHL sources totaled 1.5 million, down by 874,000 or 37% for the quarter. The decrease in earnings is due primarily to a $400,000 decease in net earnings from part sales as well as establishing 600,000 in reserves. The reserves are against third quarter revenue reported for maintenance services for Northwest and Delta Airlines prior to their bankruptcy filings in September. Now, Joe Hete will review our operations for the quarter. Joe?

Thanks, Quint. On our first conference call in August, we devoted a lot of time to the challenges immediately ahead of us and how we were preparing to meet them. I'm going to discuss our recent performance for DHL a bit this morning, review our non-DHL operations, and mention another matter referenced in our new release and filings.

Before I do that, I need to remind you of what I said on our last call that our DHL business is both very predictable and that most of our earnings comes from contract formulas in very unpredictable and at low package volumes, and how we handle them are not completely under our control.

That said, the latter part of the third quarter was very unpredictable. Just to mention a few of the changes we had to deal with, we’ve had the consolidation of DHL Cincinnati operations into Wilmington, including the transfer of over 150 truckloads of equipment from Cincinnati to Wilmington in one weekend, the opening of a brand new million square sort facility in Wilmington, 13 additional flights added to the operation, the opening of two new regional hubs, recruiting, repositioning and training more than 1,000 employees for new or relocated jobs during the quarter.

Turning over to DHL, the management of 24 carriers and their 62 aircrafts to provide contract in airline services in the tertiary markets. And finally, completing all these changes within a new financial structure, it shifted onto us more of the revenue risk in our Hub services agreement.

Despite all of that, we were still able to earn 1.2 million in incremental markup in the third quarter, which was 41% more than we earned in the third quarter last year. At the same time, our net earnings under those DHL contracts increased 10% from the third quarter of last year. Those results including 100% of the available quarterly cost related markup under ACMI agreement at a time when DHL was reassigning our routes and as we began operating at two new Hub locations.

Our 38% of maximum in Hub services was an improvement in dollar terms from a year ago under our amended contract. And only 10 points below the percentage of maximum we earned last year. In my book, it's pretty good performance under tough circumstances. Naturally, our more than 10,000 employees deserve the credit for that because of their performance during all of these changes.

Now, that's not to say there weren't any problems, you can’t implement as many changes as we have in a short period of time without some things not going as planned. For example, the expansion of our sort facilities here in Wilmington added 176 motors and related drive units and 6.7 miles of belts. Also 40% of the codes were used for sorting trades throughout our network were changed. And as graphic was reassigned among our new expanded network of hubs, the changes in volumes for some of the regional hubs were significant. Lastly, with so many new employees coming on in new roles, we didn't achieve the employee efficiency levels necessary to make everything work as smoothly as we would have liked in September.

For the most part, however, these problems were temporary and are largely behind us. We absorbed the 17% increase in packages handled for the quarter, and are now delivering substantially better service at more reasonable cost than we did before. Although the fourth quarter has its own set of complicating factors, including bad weather and heavy Christmas volume, we hope to continue along the same path for the end of the year and into 2006. We knew going into the third quarter that it would be a challenge to continue to clear the ever higher performance standard that DHL set for us on an incremental markup, especially on the hub services side.

And we also knew that missing some of those cost reduction service opportunities now would affect the markups we could earn for annual performance at the end of the year. Accordingly, we have disclosed where we stood at September 30th against those annual markup targets. And while we cannot promise you that we will succeed, I can promise you that our management team is doing everything it can to improve against those measures by year-end.

Our principal obligation every day is to deliver the best possible service at the most reasonable cost to DHL and our other customers. We know that in the long run, we prosper only if they prosper. We talk with them daily about how to make our partnerships better and stronger. We especially recognize the importance of what we can do to make DHL the number one provider of high quality package delivery services in the world, and we stand by them in that objective.

As Quint mentioned, our non-DHL business continues to grow rapidly. Two 767s in our non-DHL fleet throughout the quarter gave us a significant boost in fuel efficient cargo capacity, and our space available on aircraft maintenance products were also very popular during the quarter. Unfortunately, we were unable to bring all of that growth to the bottom line. We have established the bad debt reserve against $600,000 in revenue for maintenance services we provide to Delta and Northwest in the third quarter, while we await the outcome of their bankruptcy proceedings.

At the same time, we were successful in tracking more of the ACMI business with two 767s in our fleet. We have also said in the last quarter that we'll be challenged to gain enough utilization for both jets to offset their increased depreciation expense. We expect the utilization rates to improve in the fourth quarter and into 2006. A number of you have asked about the 767s we plan to purchase from Delta Air Lines over the next three years. You may have heard that the Judge overseeing Delta's Chapter 11 filing has ordered an auction for those planes. We are optimistic that when the auction process is completed later this month that our original contract terms will be reaffirmed.

As you also know, DHL has said it will reduce their fleet by 26 aircrafts by the end of this year. Seven of those 26 planes have been removed so far and several routes that we had been serving were reassigned to other carriers in September. DHL has told us all along that the plan is subject to change, so we still don't know if or when the remaining planes will be removed this year.

One final item about our aircraft operations relates to our management of air charter operators that service small tertiary DHL markets. As scheduled, we turned that job back over to DHL during the third quarter. Our reimbursable expenses associated with that service are about $22 million per year or about 400,000 in annual earnings. We do not have significant assets devoted to the management of that operation.

That's the summary of the operational issues we have been dealing with over the last several months. You probably also read in our press release and 10-Q that we have been notified by the Department of Justice that the company and several employees in our Human Resource department are targets of an investigation concerning Garcia Labor Company, a temporary employment agency, and our use and subsequent hiring of contract employees that were being supplied to us by Garcia Labor.

The investigation centers on the immigration status of the Garcia employees. We have continued to cooperate fully with the Department of Justice since first reporting this matter back in January of this year. We plan on meeting with the Department of Justice in the next few weeks to discuss the investigation and to communicate the company's position that neither we nor our employees engaged in any wrongdoing.

To recap, we had a good third quarter under very trying circumstances. Now we are in our very critical fourth quarter, when seasonal volume provides us with greater risks and opportunities. We know that we need to substantially improve our performance in the final quarters both to support DHL's business goals and to have a reasonable chance of earning additional incremental mark-up revenues. At the same time, we are looking forward to even more growth and earnings for our non-DHL business during this very busy time of the year. Now we are ready to take questions. Moderator?

(Operator Instructions)

Your first question comes from the line of David Campbell with Thompson, Davis & Company. Please proceed.

Yes, thank you. Hi, Joe and Quint. I just wanted to ask you, Quint, what happened to the cash in the third quarter? I realize you haven’t published your 10-Q, but it went down from 82 million in June to 44 million at the end of September. You obviously had some CapEx for aircraft. I guess that was the main reason.

Yes, we also -- Dave, we also had some pension funding scheduled quarterly. And we invested approximately $20 million in marketable securities, which are classified in a separate line item on the balance sheet. So that was probably the single biggest impact, along with the pension funding and the purchases of the aircraft in July.

Right. So the aircraft purchase was explained, this 20 million marketable securities that you bought -- that will be used, I guess, for future funding of some sort?

Yes. It's a slightly longer duration, a little longer than the typical three month or less duration and government treasuries and high grade investments, maybe go out a year in duration.

Right. And Joe, could you disclose any more about your charter revenues in the quarter, or the revenues from your -- I guess you're still turning out DCA capacity?

Yes, David. Just going back to our conference call last quarter, we talked about the fact that we’re bringing those 767s online. And during the course of the quarter we did continue to ramp-up the utilization of those aircraft, just as a benchmark for you in July for those two 767s, we flew about 199 total block hours for the aircraft. By the month of September, we had increased that up to 321.

And as I mentioned in my opening remarks, we expect to continue to build on that going through the fourth quarter. From a revenue standpoint, we were up a bit on the revenue side over where we were last year, about 20% on the charter segment. And then on the net side, because we weren't getting the full utilization of those aircraft -- and as you recall those are aircraft that essentially have a book value about $30 million apiece, there is a heavy depreciation expense associated with that. So it did have a negative impact on the net margins.

Due largely because of the low utilization at the beginning of the quarter. I am sorry.

Yes. We would anticipate with an aircraft with that kind of fuel efficiency, and of course, asset value, that the utilization has got to be somewhere between 175 to 200 block hours per aircraft per month; and as I mentioned earlier, by September, we were closing in on that quite quickly.

Okay. One last one, why -- two license (ph) -- they did $22 million of reimbursable expenses, you mentioned that was fully effective in the third quarter, you passed it on to DHL?

That was a gradual phase out, but by the end of the quarter that 22 million was gone, David. But I think out of the quarter, we had roughly two out of three months where we still continue to manage the bulk of that operation.

Okay. And last question is why -- and do you have any feeling as to why they -- DHL has not reduced the number of aircraft on your fleets since seven they took out in first quarter. I mean, that we – the overall object was to reduce the duplication, duplicate flights in the same cities once they merged the operations; and sounds like they haven't done that?

A couple of factors, David. Firstly, the actual carrying cost of the aircraft that aren't flying today are the DC-9 and DC-8 aircraft. The carrying cost for those from a depreciation standpoint is pretty low. From a maintenance standpoint, unless we would have to induct one into a heavy check, the maintenance costs are going to be negligible as well, while you have those on standby.

So in the sense of function as a very inexpensive insurance policy for DHL until the network stabilizes to where they know exactly how they want to craft the overall network in terms of what aircraft in which markets. But you also have to remember we're coming into the peak holiday season, to where you -- depending upon what kind of growth they may see from their customers, especially in the air segment, you can have wild swings in lift route capacity, be it truck or aircraft to service a particular marketplace. So that's essentially through the end of the year, it's just good cheap insurance.

And does that mean they're flying those extra flights, it just means they were still paying you for them?

Correct. I mean, if you look at it from the standpoint of those 20 aircrafts, they are not flying routes today. And of course, the jet fuel is almost $2 a gallon in September, you're not flying. I mean you're saving a bunch of the money versus where you would have been prior to the integration by having two fleets operating into the same marketplace.

Right. Okay. Thank you very much.

Thank you, David.

Your next question comes from the line of Helane Becker with Benchmark. Please proceed.

Thank you very much, operator. Hi, gentlemen.

Hi, Helane.

Just on the 767s, assuming that you do get the aircraft at auction, well, I have two questions. One, do you have to resubmit your bid and change the terms of the contract that you have with Delta on those aircrafts?

And two, as you induct those aircrafts into the fleet, can you just discuss how the pricing on that is going to work? Is that going to go into charter service or is that going to go into the service on a scheduled basis? I heard you answer David's question with 175 to 200 hours a month, but will it be priced on per hour basis or how does that work?

To answer the first question, Helane, things do go out for a bid. The terms of the bid requires that there be a minimum bid of $4 million for the aircrafts. If someone does come up with a bid that's better than the one we currently have on the table we have an opportunity to match that. And certainly, another point in our favor is that you could have somebody that may on a one-off basis want to offer more money for a particular airplane, but the preference that has been expressed to us is that it sells with an entire fleet. So as it stands right now, we don't have to change anything with our current bid. It's – it’s there, it is on the table. It only has to change if someone comes up with a better offer.

As far as the deployment of the aircraft, first, you know, there is 11 aircrafts in the last announcement we've made that we committed to purchase, and they are spread out between now and 2008. So you're talking about a three-year timeframe over which we can plan for the deployment of those aircraft. As far as how we would market them, we do them on an ACMI basis where it’s on a per hour -- per block hour basis. And there's got to be some minimums associated with that so that we can ensure that we cover the fixed cost associated with the deployment of the aircraft.

From a pricing standpoint, it's really going to depend -- it's a combination of -- cost per hour and utilization are the two drivers. In other words, if somebody is willing to only guarantee 100 block hours a month, but is willing to pay 50% more than what the rate would be for somebody who is willing to do 200 hours, you'd run the math and say whether that made sense to deploy them. We would anticipate that from a margin standpoint that we've got to net something on the order of 12 to 15% minimum margins for any one of these aircraft that we would deploy.

Okay. Just one point of clarification. When you say the minimum bid is 4 million, is that per aircraft?

Yes, Helane, per aircraft.

Okay. And then during the month of September when you were doing the hub consolidation, I don't know that you can answer this question, but are you aware of any customers of DHL being frustrated with their performance on P&D (ph) that maybe they lost the most customers that would have affected the volumes?

Helane, it's really a question you’d have to ask DHL. I know they had an earnings call this morning, but unfortunately I wasn't able to get on that call. But I believe that there was some discussion about that.

Yes. There was. They did –- they did actually mention that, I just kind of wondered if you were able to tell in your volume how much of the business was affected by that. But that's fine. And then my last question was on -- just on the income statement, the salary line was a little more than I thought it was going to be. Is that where the pension contribution was?

No. And that pension contribution is -- would go against the balance sheet. The -- of course, the pension expense lines up in salaries, wages and benefits, but that wasn't, you know, out of the ordinary for the quarter. It was more a function of the additional employees that we added to the payroll as we ramped up for the hub consolidation.

Okay.

And the volumes that we handled.

Do you have the FTE's like this year versus last year by any chance?

Not at our fingertips, but (indiscernible) -- currently our total employment rolls was well in excess of 10,000 and that -- then just going from memory last year about this same point in time it was probably between 8,000 to 9,000 people.

Okay. All right. Thank you.

Your next question comes from the line of Dwayne Kennemore with First Capital Alliance. Please proceed.

Hi, this is actually Henry Chu. I had a, sort of, further extension question of Helane’s with regards to the planes that we acquired from Delta, hopefully. Can you elaborate a little bit more exactly what kind of type of business you're expecting to place once those planes become online, and when do you except actually the first aircraft to be acquired and actually refitted?

To answer the first question, Henry, the aircraft would be deployed to deal in the same kind of marketplace that we do today. You know there are forwarders and consolidators down in the Central South Americas, Caribbean market. So we fly on behalf of -- and they can either take the aircraft in it's entirely or they can, you know, get together with a group of folks, but what we want to come out of it with is to make sure that we have a guarantee of minimum utilization and revenue stream that would offset the carrying costs of an asset of that type.

Keep in mind it is in ever increasing demand these days because of the high fuel prices. We mentioned our September fuel price on average just for the operations that we run was just shy of $2 a gallon. But in that marketplace down there, it's significantly higher, somewhere between $2 to $2.50, if not more. And when you look at a 767 compared to a DC-8 with the reduced fuel consumption of 400 to 600 gallon an hour, that saves them a significant amount of money in order to get their products delivered.

From a delivery standpoint, we have two aircraft to be delivered this year. One was in July, that was the single aircraft that we made an announcement about earlier this year. And then we will take -- assuming the option, so to speak, for the aircraft is afforded by the bankruptcy judge doesn't change anything, we'll take the second aircraft in December of this year. And then there will be three in 2006, four in '07, and three in '08

The first two aircraft, keep in mind, there will basically be a swap out for the two aircraft that we currently have in service. Now that's scheduled to occur about March and May of 2006, because those were the aircraft that were deferred from being deployed in the DHL network. So you'll see no net increase in the aircraft. What you would see is an aircraft that is now going into service at a reduced acquisition and service cost of 17 million to 18 million, versus the ones that are out there today, which are 28 to 30 million.

And, then I want to expand a little bit more on -- I know you've made some international air carrier applications, I assume that ties in with some of these acquisition of planes from Delta going forward. Can you elaborate a little bit on that from an international standpoint? And also what kind of goods are you actually looking to fly from that area?

Well, again we are not -- in terms of good that's up to whoever is buying the aircraft utilization itself in terms of what commodities, but I know it runs the gamut of everything from flowers to machinery and machinery parts in terms of what we've seen onboard the aircraft over the time that we've been operating in that marketplace.

Okay. One last question. According to my calculation the company generated -- generated about maybe $1.21 in trailing 12-month capital per share. And I remember there are some restrictions with DHL on using cash to purchase stock hover. This number is getting pretty substantial, and we are obviously building up cash on our balance sheet.

I'm wondering whether we can request some relaxation on the restrictions, or are we close to some point where we wouldn't be violating restrictions any more, if you can elaborate a little bit on what we're doing here?

Well, at this point, Henry, nothing has really changed in that respect, although it's not to say that at some point it could. And that would have to be subject to DHL and ABX sitting down and agreeing to relax those restrictions. Currently, as you've mentioned, our note with DHL precludes us from repurchasing stock or significant dividend.

So I take it that -- I mean we're building up a fair amount of cash on the books, I mean that’s just going to continue? It seems like there should be -- at some point, we should be able to either redeploy it prudently or repurchase stock, or issue a dividend. I still don't see what kind of timeframe we're looking at, can you elaborate at all?

Again, Henry, there is no specific timeframe as it relates to the dividend and the repurchase. Until such time that we would get a restructuring agreement that would allow us to either pay a larger dividend than $1 million a year, or repurchase stock without having to pay off the $92 million note. That -- those two things just aren't going to happen.

As far as redeploying their cash by making other investments, well, certainly the announced acquisition or the contract to purchase, you know, 12 aircrafts from Delta Airlines, is one avenue we expect to be able to deploy some of that cash and bring back a return that offsets our weighted average cost of capital for the corporation. We're not in a position where we need to be desperately out there seeking business without ensuring that we would go after something. It would ensure that we had a decent return on it.

All right. Thanks for a great quarter.

Your next question comes from the line of David Horn (ph) with Perennial Investors. Please proceed.

Good morning. You just mentioned that, you know, when you look at this acquisition you needed a decent return on your investment. How do you go about defining a decent return?

Well, we look at what the other uses of our capital are, what are average cost of capital is, which we believe is a little north of 10%. And on that basis we look for investment opportunities, certainly, that yield a better return than that cost of capital.

And how did this acquisition fall into that? Is it a boon, or is it just north of 10%? I mean I imagine that we had a great opportunity. It seems that -- Delta seems like a distressed seller, you seemed to get a good price for the planes. Is that an accurate assessment or no?

As we discussed there‘s going to be an option. I guess it's certainly determined. I think we always end up having to pay market. I don't know that you'll get a sweetheart deal, but certainly we believe the aircraft themselves, as Joe talked about, the future is bright in terms of what their earnings potential are. And we expect to get a long-term return of somewhere 12%, 15% in the contracts that we deploy those non-DHL aircraft on. Aircraft utilization plays a big part in that, and obviously the more hours you can fly for a customer in the ACMI business the better yoar return. And so, you know that that will, of course, vary depending upon this specific contract. But to answer your question, David, we do expect to exceed the weighted average cost of capital and to be able to get on average 12% to 15% return on those aircraft.

Keep in mind, the aircraft themselves are again, you know, that ones that are currently flying the ACMI work for the non-DHL segment were on the books as between 28 million and 30 million, and we expect to get the Delta aircraft to go in service at somewhere between $17 million and $18 million copy. So that reflects the reduction in market price of the aircraft versus from ones that we originally agreed to aquire from ANA back in 1995.

And that the planes that you have now that you are flying for third party. Generally what type of revenue can they -- did they produce a month?

Again, our target is to get between 175 and 200 block hours per airframe at a minimum. Again it's the market -- it's going to depend a lot in terms of, you know, what the actual utilization is at the guaranteed minimum from a block hour standpoint, it could be more, it could be less. If you're talking a block hour rate anywhere between $3000 to $3600 a block hour probably depending upon what type of utilization we would ultimately net out of it.

Great. Thank you very much.

And next question comes from the line of George Kim (ph) with Cadmus Capital. Please proceed.

Oh, Hey guys, its Jed Bonnem from Cadmus Capital. How are you?

Good. How about you?

Good. Well, first of all congratulations on the quarter. There were lot of balls in the air and I think you guys did a very good job. Looking specifically at the cost -- the annual cost target on the Hub Services Agreement, the -- I'm just trying to reconcile the year-to-date 0% attainment versus the fact that on a quarterly basis, you have -- you've made some of the goal on a quarterly basis. So that's the first question.

Second question related to that is, specifically in the fourth quarter, I don't know exactly how that target works, but if you were to do everything right in the fourth quarter, how much of that can you make up? I'm just trying get a sense for how much is weighted towards the fourth quarter, how much can be made up in the fourth quarter?

Well, Jed, to answer your question, one of the distinctions you need to draw is the quarterly cost targets that, you know, as you mentioned on the Hub Services Agreement, we have been successful in earning some incremental mark up on the annual cost -- excuse me -- the quarterly cost related goals. The -- only the first quarter is part of the annual target. In other words, we do an annual budget, and effectively the first quarter budget is part of that annual budget. But then the goals are reset in the subsequent two quarters, second third -- well, subsequent three quarters, second, third and fourth, for the quarterly targets. However, the annual target remains the same. In other words it's the target you set at the beginning of the year.

And so the disclosure in this press release, of course, is meant to point out that, certainly, in the fourth quarter of 2004, we were quite successful in earning annual mark up, in particular on the Hub Services Agreement. And that based on that annual target that was set in '05, you know, beginning of the year, to date we are not -- in terms of our costs per piece, against that cost per piece target -- in a position where, if that were to not change in the fourth quarter, we would not earn any cost related mark-up on that goal.

Just to give you an idea in the fourth quarter of last year, we earned $2.7 million on the annual cost related goal in the Hub Services Agreement. On the service goal and Hub Services Agreement, we got 3.2 million, which was 100% of what we could have achieved in that agreement. And so, certainly, as the year goes on and you get now at the end of September, three fourths of the year gone, that goal becomes -- or where you stand becomes little more meaningful in that it takes -- you only get a quarter left to move. And so I guess, the second part of your question is how much could the fourth quarter impact that? We really can't say right now. Certainly, it can impact it. But I think it's also fair to say that with three fourths of the year gone, it become less of a factor. In other words that -- where we stood in the middle of the year, there was more opportunity to move it than there is three fourths of the year.

Right. And just very quickly, if the target is really a collar -- sounds like there is a lower-end and then you can earn up to a maximum. How far under that collar are you, are you hopelessly below the collar on a cost per piece basis, or are you relatively near the low end of the collar where if you shoot the lights out in the fourth quarter, that you can get into the -- get into a -- beyond the zero range.

I really -- as we've said in the past we really don't give a lot in the way of forward guidance. And I wouldn't really want to set -- peg that for you right now, other than to say that currently we're not in that range where we would qualify for anything on that goal. As Joe mentioned, we are always looking to be as cost effective as possible and improve productivity, so likewise I am not ready to write off any possibility that we can improve on that goal.

Thank you.

Your next question comes from the line Alex Ducharme (ph) with Dale (ph). Please proceed.

I think you may have already answered this question, but I was looking at the annual, I guess, where you stand for the annual goals on the ACMI costs bonus.

And I think in second quarter, you said you're -- I guess based on what you knew then you’re 81% of the way to the full goal. And now in the third quarter it went down to 76%, yet meanwhile, in the third quarter itself you got 100% of the ACMI cost incentive for the quarter. And I was thinking if it was 100% you’d expect to see the 81% go up for the third quarter. Now does this relate to what you were just answering, or --

That's correct Alex. The third quarter goal is not the same as the third quarter portion of the annual goal.

Okay. Very good. And I have a couple of other questions. Now, how are you planning to fund the Delta aircraft, is that mainly out of the cash you have on the balance sheet?

We would look at financing certainly the majority of that purchase. And as far as the structure, it could be in the form of the lease, there could be potentially some of that as the term loan. But there would likely be a combination.

Okay, do you have an idea of the mix of existing funds versus new debt funding for, I guess, the average aircraft (indiscernible) on the $200 million. Can you give me an idea of the debt equity on that?

Other than to say the majority of it certainly would be financed.

Okay.

And I would say more than 75% of it could be financed.

Okay. My last question was on your $600,000 reserve you've set for Northwest and Delta, does that represent 100% of the collectable amount or is that just an estimation on what they owe you?

That is an estimation, hopefully a conservative one. And it is not 100% of what is on the balance sheet in receivables at the end of September. Certainly on the upper side.

Is that above 50% or -- ?

It's above 50%.

Okay. Well, thanks a lot.

Your next question comes from the line of John Curti (ph) with Principal Global Investment. Please proceed.

Good morning. I wanted to ask a couple of questions on the Delta acquisition. The difference between, say, 4 million a plane and the cost out of 17 million, 18 million -- is it the cost to modify the planes for your use and airframe checks etc.?

That's correct.

And you mentioned that the two planes that are -- you are flying now on a charter service basis, you need 175 to 200 block hours per month to, I guess, cover your costs. Would it then be fair to say that with these Delta aircraft as they come into fleet at a cost of 17 to 18 million versus the 28 to 30 that you would need roughly 60 to 65% of that -- those hours to cover your cost?

Not really. Because part of the -- in terms of pricing the aircraft, a lot of that is driven by market conditions, it's just not a matter of saying right, this is what I want and this is what I need. So, you are -- you've got some competitive pressures in there as well. But keep in mind that we knew that the two aircraft that are out there today were on a short term deployment, you know, because we've got only a one year extension out of DHL, and our mission was to go out and find replacement lift for those aircrafts, if in fact we are able to market those effectively at the utilization rates that we thought made sense. So, the pricing -- the actual pricing per block hour that we're receiving for the aircraft today is market driven pricing. So, what that will do is with a lower priced aircraft -- the lower cost aircraft going into service next year will -- that all will go to the bottom line, in terms of the margin.

Okay. So, you are going to get roughly the same amount per block hour, but you’ve got a -- just got lower costs on the plane.

That's correct. So, the margins are going to be a little bit tighter right now because we are having -- we do have more expensive aircraft covering the routes. But we did it knowing that if we were able to -- successful to -- in being able to deploy the aircraft with those higher asset values today, then certainly we'd be able to see significant gain on the margin when we went out and bought aircraft at current market prices.

And then, is this -- new little wrinkle having to go through the auction process. Does that in any way slow you down in terms of being able to go out and forward market the aircraft to people, because you are not absolutely sure you are going to get them?

Certainly, it slows down our ability to make a commitment. But, again, the first two, which wouldn't go into service until March and May of next year, but since we are only replacing aircraft that we have in service today. So, as far as looking for new bids, we are talking about aircraft availability in the latter part of 2006 that we would have to be looking for today.

So, while there is a temporary pickup that we've experienced with the acquisition of the aircraft, it shouldn't have a marked impact on our ability to secure customers for them since they are not coming into service anyway until late 2006.

And then is -- is there much of a lengthy sales cycle in going out and acquiring additional customers -- on a charter basis under the -- ACMI contract type contracts?

There is plenty of demand out there today for the aircraft. Really, the pacing item in terms of where you would place the aircraft and how would you utilize them tends in many cases to be what the customer preference is as far as the route you would fly.

Domestically, you know, you could turn on an aircraft almost overnight. But if you go into the international sector, it requires some additional training from a flight crew standpoint so they become internationally qualified, and that could be a pacing item in terms of how quickly we can deploy. And so ideally you would like to have noted this exactly what routes they are going to fly 90 to 120 days prior to the deployment of the aircraft.

And do you anticipate that most of these aircrafts would be deployed in Latin America and South America, but would some be --

That seems to be the hottest marketplace for us today, but the combination of that and domestically -- the aircraft in question aren’t ones that you’d -- that are well suited for going across the Pacific, for example. But they do have the capability to go to Europe with the type of aircraft we have. So they are not extended range versions, they are more domestic type aircrafts.

And then, just a question on the non-DHL business, you mentioned that I guess the parts business was down a little bit. Any particular reason?

The nature of parts we sell are parts that are surplused to our current operations, DC-8s and DC-9s. You know, as we talked earlier with the -- one of the pluses of having a lot of market demand for the 767 is because the DC-8 is falling out of favor because of the high fuel consumption associated with it. So if you look at the number of people operating the aircraft, even though there are -- today worldwide there’s probably 120 to 130 DC-8s operating, the utilization is falling because of exorbitantly high fuel prices that we've experienced as of late. That in turn says there is less demand for the parts that we have that have become surplused to our operations.

And then finally, would you anticipate that by the end of the year or shortly thereafter DHL would give you some sort of notification on the remaining 19 planes that were supposed to come out of service? Or is it -- is there a specified timeframe where they have to give you an answer, or can it be just kind of indefinite?

It can be indefinite. I mean, it’s their call in terms of how long they want to do it. From their standpoint, again, any carrying cost associated with the aircraft, be it depreciation or if they want to make sure that they stay with a valid certificate of airworthiness, any heavy maintenance check that would have to be incurred they’d have to be willing to bear that expense.

As I said earlier in the call, right now they're relatively inexpensive insurance, and so there is no specific driver right now that says we need to get these out of there very quickly.

Okay. So none of the parked aircraft are coming up for the major airframe checks that would require a pretty significant out of pocket to keep them flying?

I don't have the schedule in front of me, but I'm sure there is more -- there's a couple of that may be coming near the end of their heavy check cycle.

So those might be candidates for being put back.

Potentially.

Okay. Thank you very much.

Yes.

Your next question comes from the line of Dwayne Kennemore, a follow-up, he is with First Capital Alliance. Please proceed.

Yes, I’d just like to clarify a little bit more regarding the service performance markups and the cost related markups. First of all, is there a quarterly service performance markup?

No, those are all annual.

Okay. So I understand the fourth quarter – let’s call it cost related markups has been adjusted to allow you to recover the decrease in the base fee, but would you say that the cost related markups have some adjustments knowing that the annual performance markups and cost related markup fees would be lower than last year?

No the -- if you are talking about the amendment, I think you are to the hub services. You are saying that we put more markup at risk on the quarterly cost-related goal in the Hub Services Agreement for the final two quarters of this year. And we took a lower base markup on the Hub Services Agreement. That's correct, but that amendment had no impact on the annual components of our markup potential, either the service or the annual cost goals.

Okay. What I'm trying to drive at is that both sides know that as far as the annual performance markup, that it was going to be difficult to achieve any significant percentage this year, given what has already happened through six months. So when you renegotiated, or let's say, with regard to these amendments, DHL’s goal here is to incentivize the company to improve its service performance. So what is the mechanism that’s allowing that to occur during the last two quarters here of the year so that the company is properly motivated to perform on a service basis and earn monies based on that performance?

Well, the goals remain attainable. There is nothing that says that we can't attain those goals, and they've been unchanged since August of '03, when we began the DHL agreement.

From a service perspective, I mean you’ve got to remember we did say that right now we are on pace to earn some service incentive, and we can certainly drive that up. But by the same token, if we don't provide decent service, that could continue to erode downwards. The changes that were done with the amendment only affected the cost side of the equation. And what you have to keep in mind as well is one of the best ways to control costs is to improve the service levels by turning the operations timely. Because if we don't turn timely, it only drives additional costs. So we are motivated both from a cost and service standpoint to continue to strive to make sure that we provide better than expected service levels to DHL.

So would it be fair to say that that the adjustment in the cost related markup encompasses -– let’s call it service performance, even though it's not direct?

That is correct.

Okay. All right, thank you.

Your next question comes from the line of Patrick Anderson (ph) with Luxor Capital. Please proceed.

Hi guys. Nice job in the quarter, and I guess there are a lot of moving pieces. From our perspective it's great to see you doing a nice job with the transitions that have occurred in the volume growth and (indiscernible) incentives maybe -- the cost markups may be a little bit weaker than historically, under understandable circumstances. So I just want to congratulate you on that, and ask you a little bit more on third parties, even though there’s been a lot of questions. For the planes, there was -- noted that you are paying about $4 million per plane, you are estimating the cost at 17 to 18 all in. Is that sort of implying a modification cost that differs from the prior 76s you’re having modified?

No, these modification costs are roughly the same.

Okay. And in terms of third party, last fourth quarter you had done work with the Postal Service, with the West Coast network, is there a reason to think you'll potentially be able to bid for that again?

Right now, Patrick, I think we've talked about it in the last call, we had not heard anything from the Postal Service in regard to a potential -- what they call -- refer to as the C-Net (ph) operation that we ran for them last year. And over the course of the last quarter they did confirm that they are planning on doing a similar network this year.

Now by the same token we did garner one additional piece of business from the Postal Service, which we are just in the process of starting up. And it's a terminal handling service agreement for military mail that we are operating in Newark, New Jersey, for the Postal Service. It's a 90 day contract, started the first of November and runs through the end of January. And essentially, we are just doing the sortation of the mail, we are not doing any trucking of the mail, or flying of that particular mail, we just sort it and then turn it over to another carrier who flies it to, I believe, they send to both Afghanistan and Iraq.

Okay. And 90 days for you staff this, it seems -- military deployments in those regions will go longer than 90 days. Should we think that you'll continue to staff it after the 90 days expires?

The only guidance we've been given from the Postal Service, again, it was a contract that was bid for a 90 day period, although they have advised that there is the potential that they may extend it beyond that. Certainly with the holiday season upon you, the volumes are going to be more significant than what they normally would be through the course of the normal year, even with the large military deployments that are out there. But as it stands right now, we are currently planning 90 days only; and if they are willing to extend it beyond that, then we'll certainly be interested in pursuing that as well.

But along those same lines from a Postal Business perspective, we operate the HASP operation for them over in Indianapolis today. There are additional HASP operations out there. I believe a bid was just led out for small operation that's headquartered in Tucson. We certainly will take a look at that and see whether it makes sense for us to bid on it. And I am told there is the bid for the Dallas-based operation that comes due sometime in the first quarter of '06.

Okay, great. And also there has been announcement of STC with Innovative Solutions, you will be the -- you'll be providing the service of modifying this for customers, can you talk a little bit more to that? Did you have expenses associated with -- can you able (ph) to modify future plans in that partnership, or just expectations for the amount of potential work in that?

The development of the STC was done on an arm’s length basis with IS&S, unlike some of these previous arrangements we have made with them. So we develop the STC and they compensated us – or will compensate it for us accordingly as part of our fourth quarter reporting.

A part of that is that we will employ that flat-panel technology in the Delta aircraft, assuming the whole thing is approved by the bankruptcy court. And then what we are certainly willing -- ready, willing and able to do is offer a turnkey service to anybody who would like the flat-panel installation, so where we could do that for them, to the third party operators.

Okay, great. And one -- and just finally on the 76s, when you talk to a 12 to 15% margin as the minimum -- that's the minimum you see you need to earn to cover your cost of capital, is what you're saying. And given, you can price it higher, or you essentially have to price it lower depending on market condition. Is that a fair summary?

That's pretty fair summary.

Okay. Great quarter. Thanks guys.

Thank you.

There are no more questions at this time.

Since there are no more questions, I would just like to thank everybody for being on this call and for your support throughout the year, so thank you. Talk to you next quarter.

Thank you for your participation in today's conference. Ladies and gentlemen, you may now all disconnect. Enjoy your day.