Air Transport Services Group Inc (ATSG) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Air Transport Services Group, Incorporated earnings conference call. My name is Regina, and I will be your operator for today. At this time all participants are in listen-only mode. Later we will be conducting a question and answer session. (Operator Instructions). As a reminder today's conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Joe Hete, Chief Executive Officer and President of Air Transport Services Group. Mr. Hete, you may begin.

Thank you, Regina.

Welcome to everyone joining us today for our first quarter conference call. I am Joe Hete, President and Chief Executive Officer of Air Transport Services Group. With me today are Quint Turner, our Chief Financial Officer, Joe Payne, our Senior Vice President and Corporate General Counsel and Rich Corrado, our Chief Commercial Officer.

We released our first quarter results and filed our 10-Q with the SEC last evening. If you haven't seen them yet copies of both are available from our website atsginc.com. It has only been six weeks since our last call, but a lot happened in a short time. Most important our new agreements with DHL were taking effect just as we were announcing them at the end of March. The transition has been smooth, thanks to hundreds of people at ATSG and DHL who worked very hard for many months to forge an approach that would allow DHL to achieve its goals in the US and provide ATSG with a reasonable return. Everything I know about early results points towards success against both objectives.

I will save the other news and answer your questions later in this call and first I will let Quint Turner briefly review our first quarter results. Quint?

Thanks, Joe, and good afternoon, everyone.

As always, I need to start by advising everyone that during the course of this call, we may make projections or other forward-looking statements that involve risks and uncertainties and our actual results and other future events may differ materially from those we may describe here. These forward-looking statements are based on information, plans, and estimates as of the date of this call and Air Transport Services Group undertakes no obligation to update any forward-looking statements to reflect changes in the underlying assumptions or factors, new information, or future or other changes. These factors include, but aren't limited to, changes in market demand for our assets and services, the timely completion of 767 freighter mods, modifications as anticipated under ABX Air's new operating agreement with DHL and ABX Air's ability to maintain on time service and control costs.

There are also other factors that are contained from time to time in ATSG's filings with the US Securities and Exchange Commission including its annual report on Form 10-K and the Form 10-Q for the first quarter which we filed last evening. We may also refer to a non-GAAP financial measure, EBITDA, which management believes it helpful to the investor in assessing ATSG's financial position and results. This non-GAAP measure is not meant as a substitute for the GAAP financials, and we advise you to you refer to the reconciliation to the GAAP measure which we have included in our news release for the first quarter put outlast evening.

The conclusion of our first quarter marks the end of a long transition period. In early 2009, we were still winding down DHL's domestic express operation, which involved idling more than 50 aircraft and thousands of employees in our flight and sorting operations. Over the ensuing months, we worked out a mutually beneficial long-term set of agreements that fit DHL's switch to international service and at the same time continued to diversify and grow our other businesses. The first quarter mirrored this period as we incurred some difficult operating challenges early on, but left the quarter on a positive trend. Revenues from continuing operations were $160.9 million including $61.2 million in reimbursed expenses and $4 million in non-recurring severance and retention expenses. First quarter 2009 revenues from continuing operations were $211.8 million including $106.8 million in reimbursed operating expenses and $19.2 million in severance and retention expenses. Excluding these reimbursements, continuing operation revenues were $95.7 million versus year ago first quarter revenues of $85.8 million for an 11.7% year-over-year increase.

Pre-tax earnings from continuing operations slipped by $2.4 million or 18.3% from a year ago. Gains from our DHL and leasing businesses were more than offset by losses in our ACMI services and other activities line items. We had $636,000 in pretax earnings from discontinued operations which constituted our hub services and fuel service operation that is ended in the third quarter last year. The earnings stemmed mainly from DHL reimbursements of vacation benefits paid previously to severed ABX Air employees. In first quarter 2009 pretax earnings from discontinued operations were $4.6 million, which was when both operations were still active. The progress to strengthen our balance sheet continued during the quarter. Debt was reduced by $9.1 million and post retirement liabilities by $23.2 million. At the same time cash on the balance sheet grew by 31% to $108.7 million and cash flow from operations more than doubled from the prior year quarter to $53.4 million as DHL began to pay down our accounts receivable.

We contributed $4 million towards pension plans for the first quarter and added $25 million more in April to the ABX pilot pension trust as part of the collective bargaining agreement terms. We expect to pay an additional $11.1 million into pension plans during the remainder of 2010. Lower debt balances and declining interest rates resulted in a $2.5 million reduction in interest expense from the same period a year ago. The interest rate on the Company's variable interest unsubordinated term loan decreased from 4.2% in the first quarter 2009 to 2.9%.

Turning to our segments, revenues from the DHL agreement were $48.5 million and pretax earnings increased to $8.3 million. That was driven by the $4.7 million of fixed markups to which DHL and the Company had agreed in order to close out our legacy agreements as well as $3.5 million associated with DHL's reimbursement of accrued vacation paid out to employees severed as a result of their restructuring. At the end of the quarter our legacy ACMI cost plus contract with DHL was replaced with aircraft lease and defined fee crew maintenance and insurance agreements. As a result, we presently intend starting in the second quarter and subject to discussions with our auditors to report our DHL CMI results in our ACMI services segment and report result from the new DHL aircraft leases in the CAM segment.

ACMI services in the first quarter consisted of our three cargo airlines, including ABX Air's business from the DHL ACMI agreement and S&R agreements, excluding ABX Air's business from the DHL and S&R. ACMI services has revenues of $76.9 million before reimbursements for fuel and other items of $21.3 million. This is up 10% from last year's $69.9 million in revenues, which was before $16.1 million in reimbursements. The increase was driven by a 4% increase in block hours flown, which mainly reflects the additional Boeing 767s and 757s we've added since a year ago and additional revenues from fuel reimbursement from charter and block space contracts. Jet fuel prices increased 31% year-over-year. ACMI services had a $900,000 pre-tax loss for the quarter versus a $1.9 million gain a year ago.

There were three factors of note. The ABX Air blocked space charter service we ran with TNT lost money until late January when we replaced it with a standard ACMI service arrangement covering the same trans-Atlantic route. Additionally, a Capital cargo international aircraft sustained significant damage during a January wind storm requiring temporary substitution of a larger less efficient DC8. Finally, Air Transport International experienced unusual aircraft maintenance and operating challenges that prevented it from achieving expected customer service levels and associated incentive revenues during the quarter. CAM, our leasing segment, saw revenues rise 36.8% to $17.8 million from $13 million in the first quarter 2009. The Company added ten aircraft since first quarter 2009 bringing the total to 45 aircraft under lease, four of which are leased to outside customers. Pre-tax earnings for the CAM segment were $6.5 million, a 37.7% increase over the $4.8 million during the same period a year ago. At the beginning of the second quarter, CAM started leasing seven 767 aircraft to DHL which will increase to 13 as more non-standard freighters complete the modification process.

Revenues from other activities rose 50.9% to $17.5 million from $11.6 million last year. The segment had a $1.3 million pre-tax loss including a $500,000 charge reserved for the insurance deductible on the wind damage 727 I previously mentioned. First quarter 2009 had a $1.7 million pre-tax gain mainly due to the sale of engines and other aircraft parts items. EBITDA, earnings before interest, taxes, depreciation, and amortization, from continuing operations was $36.7 million for the first quarter versus $42.1 million a year ago. Please note the reconciliation of earnings from continuing operations to adjusted EBITDA in our earnings release published yesterday, which is available on the ATSG website. Capital expenditures for the quarter were 19.2 million compared to $10 million for the first three months of 2009.

During the quarter we spent $12.9 million for modification of three aircraft, $5 million for required heavy maintenance checks, and $1.3 million for other equipment costs. All of the $10 million we spent in the first quarter of 2009 was for the modification of three aircraft. We have increased our estimated total level for our 2010 CapEx since the filing of our form 10-K from $102 million to $114 million. The increase reflects the potential acquisition and part of the conversion of three Boeing 767-300 extended range aircraft we have deposits on. Capital spending for the Company in 2009 was $101 million. Our effective tax rate for the quarter was 37.4% compared to 37.9% for the first quarter of '09. Again, we don't expect to pay federal income tax until at least 2013 other than certain minimum taxes. That's a quick overview of the quarter.

Now, I will turn the call back to Joe for his review of operations and some comments on our outlook. Joe.

Thanks, Quint.

The first quarter earnings Quint just reviewed for you are not as positive as we had hoped, especially in the non-DHL parts of our business. As we said in our news release, they're not indicative of our future for a number of reasons. All three of our cargo airlines made up ground quickly after rough starts in January. By March, all three were at or above break even. The causes were different in each case and only marginally related to the soft economy. Some of them were matters that were within our control and we have taken corrective actions where necessary.

One of the items Quint mentioned was our trans-Atlantic flight for TNT. While we had been losing money there, I think it is instructive to see what we entered the agreement and under the new arrangement we began in January it is proving to be a very valuable relationship for us. If you recall when we started trans-Atlantic service with TNT in January of '09 we were looking for an entry point in the European market with our 767s. We thought that having a presence in Europe in more visibility there for our 767 would lead to follow-on business with other carriers. The block space agreement we set up reflected the fact that ABX and TNT had customers interested in supporting this service so a cost-sharing deal made sense. The problems developed when volumes failed to meet our projections, fuel costs moved higher, and crew costs escalated. Ultimately, we worked out a deal to convert the service to ACMI agreement, where TNT bears the volume risk and we simply provide and operate the aircraft.

The diversion took place in late January and the results have been positive. We added a second 767 to the deal with TNT in March serving entry Europe markets. That makes three of ABX 767s in the European market, including service between Germany and Nigeria for DHL. We expect much better year-over-year comparison from this service through the rest of the year. We're still very focused on going after our opportunities in a faster growing inter-Asia markets. We regard Europe as an important opportunity to extend our existing global network. It is a great bridge to Africa and the Middle East. We have seen an increase in demand from other customers there about what our 767s might be able to do with them, as well as more talks with TNT. As DHL share of our total revenue declines, it is important for to us expand our relationships with our other customers that need what our 767s can deliver. Deals that give us footholds in those markets may require us to accept some up front investment. We will only pursue those that offer the greatest long-term return.

The other key element of our stronger go forward outlook is our collective bargaining agreement at ABX Air. While the terms we finally worked out with our ABX pilots last fall were geared toward allowing us to offer a competitive CMI solution for DHL, it is important to remember that they apply to all of the ABX Air pilots whether they fly on the DHL network or for other customers. Our pilots insisted that the new wage rates, benefits, and work rules with apply only if DHL made a significant commitment to use ABX Air crews in its US network. The CMI we signed with DHL does exactly that by stipulating to the degree that DHL leases our 767s from CAM to cover its US network, ABX pilots will fly them for at least five years. We project that the effect of the March 31 changes in the CBA will reduce ABX pilot wages and benefits by more than 14%. That means that had those terms been fully effective in the first quarter, ABX Air's first quarter pilot expense would have been over $600,000 lower than it actually was. Bottom line, if the ABX pilot contract and a trans-Atlantic service and ACMI had been in effect for the entire first quarter, our ACMI services segment would have been profitable.

In looking longer term, we expect that our ACMI services business even excluding the contributions from the CMI with DHL will get its margins for 2010 back to where they were in 2008. Margin leverage means a lot to ABX's ability to attract and win new ACMI business. We are already using it to secure additional business with new and existing customers. When I told on you our last call that all of our available 767 freighters were committed to customers, a lot of that can be tied to the pricing flexibility that we have gained under the new terms of the ABX's CBA.

The DHL CMI relationship is off to a good start, as I said at the outset. In our first month our on time and other service performance measures were good enough to reach the thresholds for incentive rewards, although I am not going to talk about dollar amounts at this point. Those rewards, as we have said, before represent a significant portion of the margin improvement we are aiming for from the CMI which is largely a $70 million annual operation against which we are initially targeting single-digit returns. The bulk of our cash flow from the DHL relationship, as indicated earlier, will flow from the aircraft leases where our return will be well within the guidelines we have set for our investments in the past. The lease terms we set with DHL are adjustments from the market only to the extent that they're backed by DHL's parent, Deutsche Post, and to reflect the number of aircraft in duration of the leases.

As you adjust your models to reflect the changes, keep in mind that just seven of the thirteen 767s we began flying for DHL were CAM leased aircraft as of April 1. The others were temporary supplements operated by ABX Air, operated under terms comparable to the leased aircraft They will eventually return to ABX and each of the remaining eight complete the modification process already first service CAM leases. That means that in the early stages of this transition, a large portion of the cash flow from the new DHL agreements will accrue to ACMI services via ABX Air, but the CAM share will steadily increase as more leases are completed. We currently expect to reach the full complement of 13 CAM-leased aircraft in service by this time next year.

The final item I want to mention is the announcement we executed a letter of intent to purchase three Boeing 767-300ER passenger aircraft with the intention of modifying and operating them as freighters starting next year. The 300s have both greater greater range and pay load capacity than our 767-200s. We still have work to do to make certain whether we can or should purchase these three aircraft versus others on the market. We intend to step up our commitment to becoming the leading and more cost effective independent source of medium wide body freighter capacity in the world. We can and should be leveraging all we know about buying, converting, and operating 767s against what is the most logical next stage of our fleet development program. We have never regarded ourselves as a source of air freight transport. The marketing strategy that we have developed takes us well beyond that to the next level of a bundled strategy. That approach begins with the optimal positioning and customer placement of our aircraft assets and then adds what we can bring to bear with of our capabilities such as maintenance, technical support, crew training, certification, and logistics to enhance the customer's value, while improving our returns.

The leased 767 we turned over to Amerijet International in March and a second one we expect to deliver to them in the third quarter are outstanding examples of this approach. Amerijet retained us on an ACMI basis for a couple of years to prove out with limited risk that its Latin America air cargo market was ideal for the 767 capabilities. We proved the concept with them via ACMI, and when they were satisfied we guided them through the entire process of pilot training, aircraft certification, maintenance and logistical support all as a turnkey package. That will be the approach that guides our investment strategy in the development philosophy we'll look to the readers of our ATSG businesses to encourage and embrace. You should expect to hear much more from us in the months to come about how that strategy is playing out across all lines of our business. In the meantime, I look forward to our next call when the initial rewards of the substantial business restructuring we have carried out over the last two years will be apparent. I hope you join us then.

Now, Regina, I am ready to take some questions.

(Operator Instructions). It will take us just a moment to compile a list of questions.

Your first question today comes from the line of Adam Ritzer with CRT Capital.

Joe, looks like we just talked a couple weeks ago.

Yes.

A real quick question on the potential acquisition you are talking about. How much would that cost to acquire and then how much would it cost you to reconfigure that to a standard freighter?

When you talk about the acquisition, Adam, it is going to be depend on what the conditions are. For example, if it has significant time left on its engines, it's going to have a higher valuation than if the engines are run out, and it is a mixed bag on all three aircraft we're looking at.

When you think about it in the terms of the actual end of service costs, it is within the parameters of what the current estimated market value of an asset of that type converted to a freighter is which is pegged at $28 million to $30 million.

That would be your all-in costs including what it costs you to reconfigure.

Yes. We expect to try to beat that cost, Adam.

If it costs you whatever, $90 million or so, all-in for all three, how would you finance that? Would you use your cash, would you use lines of credit? What's your thinking there?

Right now we would anticipate using our cash as well as our lines of credit.

Okay. So 50/50 or some kind of mix?

That's just really going to be dependent on the cash flows and the timing. For example, Adam, the earliest conversion opportunity we can see to get the asset into the conversion process itself which is it where a large portion of this spend will be is in the latter part of this year and into the first part of next year, so the timing is going to push that out aways, and of course that depends on what else is happening in regards to our 767 conversion line.

We know DHL, as we talked about on the last call, insert a couple of the 767-200 they own into the II mod, so we anticipate that probably the peak spending and the resultant cash flow and additional borrowing would probably be take place in the latter part of the next year and into the second quarter.

Okay.

And when you talk about returns, what kind of returns on investment do you think something like this could generate?

As kind of a target for us we target a minimum of 10% return on invested capital here, and we think we can beat that with these investments.

When you say return on capital, is that just your cash contribution, or your entire all-in cost?

That's our entire all-in cost.

Got you. That's all I had. Appreciate the color. We'll talk next time.

Thanks, Adam.

(Operator Instructions). Your next question comes from the line of Sean Nicholson with Kennedy Capital.

Good afternoon, guys.

Hey, Sean.

Can you guys speak at all to block hour outlook? I know you guys, obviously, have a minimum level that you fly or that you get paid on regardless, but the strength we have seen out of the international air freight markets and can you speak at all to what your customers are telling you?

I think if you look at from the customer, we operated pretty rigid schedule. You get peaks urge different parts of the year for example over the last 30 days, 45 days or so, you had a peak volume coming out of South America, which is part of our Miami base of operations related to Mother's Day and moving flowers northbound, and that was a positive impact for both ABX, which operates out of Miami as well as ATI.

I think when you look at it in terms of the number of increased calls we're receiving for available lift capacity, both on an ad hoc and scheduled basis, I think we're seeing a very positive trend and a strong positive trend I should say moving through 2010.

Okay. Great. Thanks, guys.

Your next question comes from the line of Jonathan Site with KNS Investments.

Good afternoon, gentlemen.

Jonathan.

Quick question.

Can you speak to what restrictions you have as it relates to capital allocation given where you are with the DHL agreement as it relates to dividends, buybacks, and how the 300 ER's stack up in the context of those three options as far as dividends, buybacks, and investments in new plains?

Are the new plain investments the only option on the table that you have because of different restrictions that you have in front of you or have those restrictions been removed and you still see these as the best opportunity ahead of you?

Well, the DHL note, and I think back when we negotiated with DHL early in 2009 and we struck an agreement where in they would write the note down to the $46 million, Jonathan, the covenants were changed at that time in the DHL note to permit, subject of course to restrictions and other debt agreements share repurchase or dividends, but $0.20 on the $1 of any such capital allocation was required to be paid on that unsecured remaining DHL promissory note balance. And now as I said, that's all subject to other restrictions that may be part of the credit agreement of our secured facility.

At that time I think what we said was that our projections were that really that wouldn't be an option anyway just based on our secured term loan and those restrictions until 2011 or later. In the near term, it is really -- that wouldn't be an option anyway under the terms of our existing credit agreement. As you know, the CMI that we negotiated with DHL calls out that part of our -- in effect, our consideration for our CMI services is the full amortization without any cash payment of the remaining balance of what will be the remaining balance of that unsecured DHL note of $31 million, so right now under the terms of the CMI we're set up to get that $31 million off the balance sheet without any cash requirements. If, for example, we were to pay a dividend or buy back shares, though, if we were to elect to do that, we would be under the terms that still exist to have to give them $0.20 on the dollar for any such capital allocation.

As far as the 767-300s and whether that is the only option for use of the Company's capital, no, it isn't. As Joe says, we feel that from an aircraft and fleet planning perspective, it is the most logical and would generate the best efficiencies and return potential for our capital, but of course there are other options, not excluding even some potential transactions that may make sense and be complementary to our existing business.

So we have to constantly look at what we believe the return potentials of all of those are and while I don't to want get into contrasting those on the call, rest assured that we have to look at that and make a decision accordingly.

I appreciate the refresher. Thanks, guys.

Thanks.

Ladies and gentlemen, this concludes the question and answer portion of the call. I would like to turn the call back over to Mr. Hete for closing remarks.

Thanks, Regina.

No doubt you're pleased as we are with the performance of our stock price since we announced the DHL agreement and our 2009 results. While we think we're still under valued in comparison to our nearest peers, we accept some investors want to see us perform under our new agreements before they jump in. We're fully aware of that point of view and on our need to deliver those results. The first quarter marked the end of the first phase of our development and the start of another. With many of the constraints that limited us in the past now removed, we're determined to earn returns that justify the valuations that our growing ranks of supporters expect.

Thank you for your support. Have a quality day.

Ladies and gentlemen, thank you so much for your participation in today's conference. This concludes our presentation. You may now disconnect. Have a wonderful day.