Air Transport Services Group Inc (ATSG) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Fourth Quarter 2006 ABX Air, Inc. Earnings Conference Call. [Operator Instructions]

I would now like to turn the call over to Mr. Joe Hete, Chief Executive Officer. You may proceed, sir.

Thanks, Cherelle.

I want to welcome our shareholders and other investors to our Fourth Quarter 2006 Conference Call. Today's call is to discuss our results for the fourth quarter and discuss events since our last call in November. Hope you've had a chance to read our fourth quarter news release, which was issued yesterday and is on our website, at abxair.com.

Quint Turner, our CFO, will summarize our financial results for the quarter and the year. I'll cover our operations and then 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 to ABX Air's periodic reports that we file from time to time with the Securities and Exchange Commission, including our Form 10-Qs for the first, second and third quarters of 2006; our Form 10-K for 2005, and the 10-K for 2006 that we expect to file in the next few weeks. 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 will refer to pretax earnings per diluted share and the impact on a per-share basis of the income tax benefit recorded by the Company during the fourth quarter 2006, both of which are non-GAAP financial measures. A reconciliation of these non-GAAP measures is contained in our fourth quarter 2006 earnings press release and can be accessed on our website, at www.abxair.com.

We finished strong in 2006, with healthy earnings gains and positive operating cash flow, as we were able to sustain excellent service levels for our largest customer, while continuing strong growth in our air freight charter business.

We knew our revenues would be off in the second half, after DHL took management of its line-haul trucking business last May. But we believe that our strategy of maximizing our performance against DHL's requirements, while continuing to grow our non-DHL business, will provide us with continued strong performance going forward.

We reported net earnings of $68.9 million for the fourth quarter and $90.1 million for the year ended December 31st, 2006. Net earnings for the quarter and the year include a noncash income tax benefit of $54 million associated with the recognition of our previously reserved deferred-tax assets.

Earnings per share on a fully diluted basis were $1.18 for the fourth quarter and $1.54 for the year, including the $54 million tax benefit. The tax benefit added $0.93 to our fourth quarter earnings per diluted share and $0.92 to our full-year result. I will explain how we arrived at the noncash income tax benefit in just a moment.

On a pretax basis, which is more representative of our historical recording, ABX's earnings for the fourth quarter were $14.9 million, or $0.25 per diluted share; versus $9.1 million, or $0.16 per share for the fourth quarter of 2005. For the year, pretax earnings were $36 million, or $0.62 per diluted share. That compares with pretax earnings of $30.3 million, or $0.52 per diluted share for 2005.

Revenues for the fourth quarter were down 23%, to $306.3 million. For the year, revenues were off 14%, to $1.26 billion. As I said earlier, the revenue decline for the quarter and year are almost entirely attributable to the line-haul trucking revenue since last May. Fourth quarter 2006 revenues from the line-haul trucking operations were approximately $300,000, compared to $81.5 million in the fourth quarter of 2005.

For the full year, revenues from DHL's line-haul trucking operations generated just $83.1 million, $214.5 million less than in 2005. Loss of the line-haul trucking business also impacted the bottom line. Line-haul pretax earnings were $1.6 million in 2006, down $2.7 million from the $4.3 million we earned in 2005.

Even with the loss of the line-haul trucking business, DHL-related pretax earnings were up for the fourth quarter and full year, helped by an improved performance against service-related goals under our ACMI and Hub Services contracts.

Pretax earnings from the two DHL contracts were up 62%, to $10 million, including $2.5 million from the base markup and $7.5 million from our performance against incremental markup goals. Annual pretax earnings from the two DHL contracts were up 5%, to $22.5 million.

For 2006, we earned 100% of the available annual cost and service incentives under the ACMI agreement. That compares to 100% of the available annual cost and only 60% of the maximum service incentives earned under the ACMI agreement in 2005.

For 2006, we earned 70% of our annual service incentive opportunity under the Hub Services Agreement, versus none in 2005. No annual cost incentives were earned under the Hub Services Agreement in 2006 or 2005. As you may recall, our Hub Services operations were impacted by the Wilmington hub consolidation back in September of 2005.

Base markup earnings from the two DHL contracts in 2006 were $12 million, with the incremental costs and service markups totaling $10.5 million. In 2005, the base markup earnings were $13.5 million. Incremental costs and service markup added $7,8 million.

Non-DHL results were exceptionally strong, boosted by our Air Charter segment, where revenues increased 93% in the fourth quarter to $8.6 million. Operating margins in the quarter for the Charter business doubled to 22% from 11% a year ago on earnings of $1.9 million.

Several factors contributed to the strong performance in the Charter segment for the quarter and the year. First, we were able to quickly integrate the four Boeing 767 freighters used in the ACMI Charter business, achieving high utilization of each aircraft as soon as it was placed into service. Although excellent aircraft utilization was probably the most significant factor, we also benefitted from a seasonal contract for one 767 to transport mail to the Postal Service during December.

For the year, Charter revenues increased 76% to $24.4 million, while achieving a 15% operating margin on earnings of $3.7 million. In 2005, the Charter operations generated $13.9 million in revenues with an 8% margin, based on earnings of $1.1 million.

While we cannot promise that our revenues will grow or produce margins as strong as those we achieved last year, we do expect very favorable returns from the Charter business in 2007, as we place six additional 767 freighters into service, the majority of which will enter service during the first half of the year.

We also saw strong growth in our other nine DHL operations, with revenues up 56% for the quarter, to $11.2 million. Revenues for the full year increased 19%, to $24.1 million. However, margins were adversely impacted in the other non-DHL businesses we performed from costs incurred for the startup of regional United States Postal Service sorting facilities in Dallas and Memphis, and aircraft maintenance work we did during the quarter that had lower-than-usual margins. Those startup costs in the postal centers were offset by gains from the sale of surplus DC8 aircraft during the fourth quarter.

For the quarter, our other non-DHL earnings increased by 22% to $1.9 million, with 17% operating margins; versus last year's 22% margins. For the year, other non-DHL earnings were down 13% to $4.7 million, with operating margins of 20%.

We said when we took over the management of the Dallas and Memphis postal sort facilities last September that we did not expect them to be profitable for us until first quarter '07. Having completed much of the startup work, we now expect both centers will hit our targets in 2007.

With both strong results from our operating businesses, and twice as much interest income in 2006 as the year before, we continue to see strong operating cash flow. Cash flow generated from pretax earnings and depreciation and amortization was $81.7 million for the 2006 year, compared to $71.5 million for 2005. Depreciation and amortization expenses increased 8% for the quarter to $11.7 million, and 11% for the year to $45.7 million, in spite of fewer aircraft serving the DHL network, primarily from the four Boeing 767s we have added since last June, including the latest addition to the fleet, placed in service in the second half of the fourth quarter. We expect operating cash flow to continue to grow at least through 2008, as we add the eight other 767s we acquired from Delta to our fleet.

Now back to a discussion of the tax impact. We have to go back to 2003 to understand the noncash income tax benefit I talked about at the beginning of my presentation. When ABX Air separated from Airborne and executed the two commercial agreements with DHL in August of that year, it constituted an event that required us to evaluate the carrying value of our long-term assets under SFAS 144. Application of FAS 144 resulted in a pretax $601 million impairment of ABX assets, principally our aircraft and inventory, to reflect their fair value. This large impairment charge left ABX in a net-deferred tax asset position.

In accordance with FAS 109, at the time of our separation from Airborne in August 2003, a full valuation allowance was recorded against ABX Air's net-deferred tax assets. The allowance was originally recorded because at that time, ABX had a significant operating loss and uncertainty about its future earnings prospects. This indicated to us that it was more likely than not that the Company would be unable to realize the benefits of its deferred-tax assets.

Since 2003, ABX Air has generated annual pretax earnings in excess of $30 million in each of the last three years, while diversifying our business beyond our core DHL agreements. Management's projection of positive future earnings and our successful implementation of diversification strategies, combined with a three-year record of profitability, now indicates that we will more likely than not utilize our net operating loss carryforwards to offset taxable income in the coming years.

As a result, we completely removed the asset valuation allowance that had been placed on income tax carryforwards and other deferred-tax assets since the Company's separation from Airborne in August of 2003. This will affect our income statements going forward into 2007, although not our cash flow. ABX Air has not reflected a deferred income tax expense since its separation from Airborne in 2003, even though it has had pretax profits in each year since separation, because the tax expense has been offset by reductions in the valuation allowance on net-deferred tax assets.

Beginning in 2007, due to the removal of the valuation allowance, the Company expects to record a deferred income tax expense at an effective rate of approximately 38% of pretax earnings. However, we do not expect to be a cash payer of federal income taxes for at least the next two years, based on projected utilization of our net tax operating loss carryforwards. We may, however, have to pay alternative minimum taxes and certain state and local taxes before then.

Looking now at the other side of our balance sheet, you'll note that we show our defined-benefit plan liabilities in compliance with FAS 158 as of the end of '06. The new requirement mandates that the defined-benefit plan liabilities on the balance sheet reflect projected benefit obligations, including estimated benefits from expected salary levels in future years. In prior years, GAAP required that our balance sheet pension liabilities reflect actual salary rates, rather than projected future salary rates.

Like most other public companies, ABX Air adopted the requirement effective December 31st. As a result of adopting FAS 158, ABX Air's year-end 2006 balance sheet reflects an increase in our defined-benefits post-retirement liabilities of $144 million. The adoption of FAS 158 did not impact our 2006 earnings.

Now Joe Hete will review our operations for the quarter and our outlook for the rest of the year. Joe?

Thanks, Quint.

For me, the best news for 2006 is that we delivered such great service for DHL in the air and on the ground that we were able to grow pretax earnings, even after losing the line-haul business that DHL took over in May; and that we continue to produce strong growth in earnings in our non-DHL business.

Our improved service is obviously a plus for DHL and its customers. And the incentives we earned are a big win for ABX Air and our employees, who met the challenge through hard work and extra effort. Service quality for DHL was strong across the board, improving significantly on the 2005 results. A prime example is our on-time performance for DHL Air Network flights, which finished the year in excess of 99% on time and helped us earn 100% of our ACMI service-quality incentives. Package-handling performance in our Hub Services facilities was also up significantly from 2005, enough for us to earn 70% of our potential service incentives; whereas last year we earned none of this service incentive.

During our last Conference Call in November, we indicated that our performance through nine months put us on pace to earn 80% of our service-quality incentive in ACMI and 60% in Hub Services. I'm pleased to say that we outperformed our own projections during the fourth quarter, especially during the holiday rush. We also had some good luck with the weather, which can affect our ground operations as well as ACMI.

That independent survey I mentioned on our last call, showing DHL service quality ranking right up there with the other major carriers, is a source of great pride in our organization. As DHL's largest air carrier, and its principal ground network operator, we want them to be known for being the best in the business. We expect them to score just as well, or even better, in any future survey.

Performance against our budgeted cost was excellent in our ACMI operations, where we again earned the Maximum Available Annual Incentive award and most of the potential quarterly incentives available during the year. We did not meet DHL's very challenging annual cost target in Hub Services, mainly because volume over the course of the year was below forecast. We set staffing levels for each sort center based on those forecasts. When actual volume falls short, as it did for several months last year, meeting targeted cost-per-piece-handled for Hub Services becomes very difficult.

At the same time, we stayed focused on consistently meeting service quality goals in our sort centers during 2006, even as we worked with DHL to make improvements in the efficiency of the sort processes.

One such improvement was the installation and successful startup of an automated small-package sort in Wilmington during the fourth quarter. Our people worked very closely with DHL in planning and implementing the transition to that technology. And I'm happy to say that the integration of the autosort went extremely well, with no negative impact on service performance.

That is only one example of where ABX and DHL work together to adjust operational plans that allow us to be more flexible and cost-effective in Hub Services.

As Quint explained, the loss of line-haul reduced our DHL in overall revenues for both the quarter and the year. But our bottom-line performance was much better, especially in the fourth quarter. Pretax net earnings for the fourth quarter were up 64%. Our percentage gain in DHL-related pretax earnings was almost the same, at 62%. However, our non-DHL fourth quarter pretax earnings grew more rapidly, by 84%, reflecting the successful integration of additional 767 freighters into the non-DHL Charter segment of our business.

On the ACMI side of our DHL service, we flew less block hours, and with a smaller fleet than we did in the fourth quarter a year ago, which reduced our base markup revenues by about $2 million. On the Hub Services side, base markup revenue was down $81 million, nearly all of which is attributable to the loss of the line-haul truck business.

Our fourth quarter base markup revenues in Hub Services were still a little better than our volumes might suggest. In the second half of 2005, we traded off a half point of our base markup percentage for more incremental markup opportunity during the network-consolidation projects. The base markup rate for Hub Services went back up to 1.75% from 1.25% in January of '06.

We also told you on our last Conference Call that we intended to sell some of the 21 DC9s and DC8s that DHL removed from our fleet in August. Excluding the eight they're paying us to keep for spare engines, we sold two aircraft, a spare engine and five airframes during the fourth quarter. I can't give you too many details on that, because we're still in the market to sell some of the remaining aircraft and spare engines. However, we did make money on what was sold, roughly in line with what our projections were.

On the non-DHL side, our results for the fourth quarter were very strong, especially for our ACMI charters, where our revenues nearly doubled in the fourth quarter. By the end of the year, we had four 767s in service, and all were booked for nearly every available hour.

While our opportunities for those planes looked great in early November, block-hour utilization of the 767s turned out to be even higher than expected, aided somewhat by some seasonal flying we did for the U.S. Postal Service. That excellent aircraft utilization allowed us to earn an overall 22% operating margin on our Air Charter Services in the fourth quarter, and that was double the margin we earned in 2005.

Our Air Charter block hours for the fourth quarter were up 90% versus the fourth quarter of 2005 and up 57% for the year. We don't expect to have any problems working with six additional 767s we will add this year, including three in the first quarter and one each in the last three quarters. One arrived in January and is already in service. Customer interest in these reliable and cost-efficient aircraft remains extremely high.

We are aware that other carriers are planning to add 767 freighters to their own fleets. But based on our favorable conversion slotting rights, we expect to be the only independent charter operator of these highly efficient cargo aircraft for some time to come.

In our other non-DHL business, revenues were up substantially by 56%, with pretax earnings increasing 22% as compared to the fourth quarter of 2005.

As mentioned on our last call, we had to deal with startup issues of the two newly added sorting centers we are managing for the U.S. Postal Service in Memphis and Dallas. We expect the centers will become profitable in the first quarter. And like the Indianapolis center we have been managing since 2004, they will be profitable and successful operations.

We've booked substantially more contract maintenance business than we had in the past -- in particular one major project -- but at lower margins than in prior periods. As noted in our press release, we were advised this week that DHL plans to assume management of the Riverside, California regional hub, effective in June of this year. The financial impact of this decision to our revenues in bottom line will not be significant, as during the full year 2006 it contributed less than 1% to both our revenues and pretax earnings.

Our focus on the DHL side continues to be on maintaining great service, while trying to drive out cost. We have a solid working relationship with DHL and speak with them regularly about current and long-term matters.

As for the non-DHL portion of our business, we will continue to focus on expanding our ACMI air charter operations, through contracting with companies to lock up access to our aircraft and crews under long-term arrangements. I know we can also grow the rest of our non-DHL business with a combination of engineering and maintenance work, along with better results from our sorting business for the U.S. Postal Service.

With both parts of that business moving forward sharply, we are very optimistic about our prospects for the rest of 2007.

Now, moderator, we are ready to take some questions.

Thank you, sir. [Operator Instructions] Monica Logani, with Wall Street Access.

Okay, hello, gentlemen. First of all, congratulations on a really great quarter.

Just a few questions for you -- first of all, on the non-DHL, the ACMI side of the segment, you talked about these trends coming also from a seasonal contract for U.S. Postal Service to transport some of their mail. I was just wondering if you could break that down for us in terms of how many block hours, or how much revenue came from the U.S. Postal Service versus the regular flying that you do in Central and South America.

Well, Monica, thanks for the kudos on the quarter.

We usually don't talk about the revenue for specific customers. But I can tell you that out of a total of almost 2,400 block hours for the quarter, roughly 112 of those were for the U.S. Postal Service.

Okay, so only 112 of the 2,400?

Yes, ma'am.

Okay. And would you have been able to fill that up anyway, if that contract wasn't there for the Postal Service?

Yes, I don't think we would have had any problems if Postal Service -- and we've obviously had a pretty good relationship over the last couple of years -- had a need for the aircraft, and so we gave them first priority.

And was it at a higher margin than you would have -- that you would have normally?

Yes, any time you have an operation [is that of a] short-term duration like that for a peak period's going to command a higher revenue-per block hour component. Because you've got a lot of additional costs also that are associated with trying to gin up a short-term operation.

Okay. So I'm just trying to understand. I mean, obviously the operating margin was very strong; I think you said 22%. And if I remember correctly -- and I may be wrong -- but in general, you said that your hurdle for that was like a 12 to 15% operating margin. Is that correct?

Yes, that's correct. And you also have to keep in mind that during a seasonal period like that -- like I said, in addition to having the ability to garner a little bit higher rate, part of the cost that we will incur over a long pull are not included in that margin, such as doing heavy checks on the airframes, et cetera. So as time goes on, we'll see some costs come in, every time we do one of those major airframe checks, that will have a dilution effect on that margin.

Okay. Got you. But the 22%, just in general, was probably higher than it would have been, just because the U.S. Postal Service was in there?

Yes, correct. That will not [expect it] to continue at that rate, at least not --

Okay. So it more like mid-teens type of rate?

Right in line with our previous guidance.

Okay. All right, that sounds good.

And then also, just on your -- the Dallas and Memphis hubs -- I just want to make sure I understand this -- so, that was a loss? I mean, the startup costs was more than the revenue that you generated?

Yes. And we really saw a similar thing occur when we started up the Indianapolis facility way back in 2004. As you work through the process of the arrivals of trucks, and et cetera, and then deal with the volume flows, it takes you awhile to get in sync, and get your employees up to speed in terms of being efficient in processing that volume. So we anticipate them being in the black in the first quarter.

In the first quarter, okay.

And Monica, they were -- both those facilities were showing incremental improvement throughout the quarter. So the signs are positive that they're going to perform as expected for us in '07.

Okay. So, you mean in terms of -- the startup costs were less in the prior quarter?

No, each succeeding month, they were improving in terms of the deficit.

I got you. Okay.

And then just finally, could you just tell us what your free cash flow was? I mean, did you -- because I didn't see a Q -- I'm sorry, I didn't see a free cash flow -- or a cash flow statement in the press release. Did you file a Q as well?

No, the 10-K will --

I mean the K.

Yes, the K comes out in two to three weeks. The cash flow statement we do not put in the press release; we save that for the K. So you'll note that we talk about cash flow from earnings and from depreciation and amortization. And that certainly was significantly improved over the prior year. But the K will contain the full cash flow statement.

Okay, so we have to wait for that to figure out the free cash flow.

Correct.

Okay.

All right. Thank you so much.

[Sure].

[David Campbell of Thompson Davis & Company].

Hi. Good morning. I wanted to ask a couple of questions.

One is the -- I think Quint --

Morning, Dave.

Good morning, how are you?

The line-haul profits --

[inaudible]

Mr. Campbell, your line is currently open.

Yes, I'm sorry you can't hear me; I can hear you. Can you hear me now?

[Eric Holmes of Stem].

Hi.

With the bad weather we've had the last couple weeks, how's that impacted your service-related goals for the first quarter?

Wintertime is always a challenging period. You have to remember that the way the agreements are structured -- any impact that's directly attributable to weather does not count against our service performance, either under the ACMI or the Hub Services Agreement.

Great. Thank you.

[Operator Instructions] David Campbell of Thompson Davis & Company.

Yes, I'm sorry you couldn't hear me the first time. Can you hear me now?

Mr. Campbell, your line is currently open.

I'm sorry, it's not open.

Must be having technical difficulties.

Yes, there are --

Operator?

Yes, sir?

You might want to [go] to the next question, if you have one.

Okay. [Adam France of Keane Capital].

Hey, good morning, guys.

A quick question for you, Joe. And you may want to beg off this, you may want to answer it; up to you. But the black-hour expectation for '07 -- can you ballpark that for us, so we can do some good modeling?

As we've said in prior calls, it's difficult to come up with a specific number. But you can usually figure it's going to be somewhere between -- [call] $3,000 to $3,500, $3,600 a block hour, depending upon the amount of utilization, the frequency, terms of flights. One of the key determinants in determining the revenue component is what the costs are. And the big cost driver there is what your crew requirements are for the specific runs.

But Adam, are you asking about hours?

Hours, yes sir, Quint.

[inaudible]

I thought you were talking about the yields. The hours we're targeting to have the hours at a minimum of about 200 block hours per aircraft.

Per month.

Per --

Per month, okay. That's consistent with what you've been doing.

As Joe says, it's -- typically, if it's less, it's usually at a little higher rate.

Sure. Got you. Super.

Thank you, guys.

[Operator Instructions] Christina Whitehead of Thompson Davis.

Hi, this is David Campbell. We had some technical difficulties. Can you hear me?

Mrs. Whitehead, your line is currently open.

David Campbell here. Can you hear us?

[Monica Logani of Wall Street Access].

[inaudible]

Yes, just a few quick follow-ups.

I guess in the past, or at least last quarter, I was under the impression there would be five new planes coming in '07. So now it sounds like there's six. So what's going on here? Are they just being able to convert these planes quicker than initially expected?

Yes, Monica, in terms of the slots, obviously with the demand that's out there, we'd like to accelerate that. And the folks at IAI have been good enough to open up some additional slots in 2007 that otherwise would have originally been in '08.

Okay. And then the two that are coming in '08, what -- just in terms of what part of the year would they be coming in on?

in the first half of the year, Monica.

Okay, first half, okay.

And then, just on the Riverside hub -- was this already partially automated?

Yes, the Riverside hub was originally designed to be a fully automated hub, but it was open prior to the automation being completed, so it was operated as a manual facility. The automation is now up and running. And with that, since DHL's used the automated portion, is a core competency for them, as well as the fact that it will be opened up as a gateway operation, handling the international freight, which is something that they took over even in the Wilmington operation last year. They elected to take over full operation of that hub.

Okay.

And just in terms of looking at their other hubs that kind of are in the same situation, where they're ready to be automated, but they're just currently manual -- are there any others?

There are none that are currently in the works, Monica, as far as going through an automation upgrade.

Okay. So this is really the only one that was in that situation?

You had Allentown, which we --

Right.

-- talked about last year, the transition --

Right.

-- from DHL January 1st of this year.

Right, but other than that?

That's it.

Okay.

All right. Thank you very much.

[Operator Instructions]

There appears to be no further questions at this time. I would now like to turn the call over to Mr. Joe Hete for any closing remarks.

Thank you, Cherelle.

When I last talked with you in November, our stock price was about $5.50 per share. This morning, we opened up at $7.50. I said in November that we are a much strong company than our stock price indicated back then. And I think the 2006 results we announced yesterday support that.

We appreciate the support you have shown for the progress we are making. We intend to keep working hard in building ABX Air into an even stronger company than it is today.

Thank you for your time.

Ladies and gentlemen, this concludes the presentation. You may now disconnect, and have a most pleasant day.