Air Transport Services Group Inc (ATSG) 2011 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Second Quarter 2011 Air Transport Services Group Inc. Earnings Conference Call. My name is Carol and I will be your coordinator for today.

At this time, all of our participants are in a listen-only mode. We will be facilitating a question and answer session at the end of the presentation. (Operator Instructions). As a reminder ladies and gentlemen, this conference is being recorded for replay purpose.

I would now like to turn your presentation over to the host for today's call, Mr. Joe Hete, President and Chief Executive Officer.

Thank you Carol. Good morning. Welcome to our second-quarter 2011 Conference Call. I am Joe Hete, President and Chief Executive Officer. With me today are Quint Turner, our Chief Financial Officer, and Joe Payne, our Senior Vice President and Corporate General Counsel.

We released our second-quarter results and filed 10-Q with the SEC yesterday. Both are on our website, ATSG Inc.com.

Our second-quarter results were exceptionally strong, as Quint will explain in a moment. Not just in absolute terms, but also in comparison with the second quarter of 2010. It's the first time in several years that our year-over-year comparisons haven't been affected by significant changes, such as our CHI acquisition, the restructuring of DHL's US business, and finally for the restructuring of our contractual relationship with DHL at the end of the first quarter last year.

As a result, we are now a much simpler, easier to analyze company, with two principal sources of attractive cash flow - long-term leasing of mid-size converted freighter aircraft, and a complementary set of businesses that can operate, maintain and support those freighters for our customers. It's a unique, very attractive business model that can deliver strong results for many years to come.

Quint is going to take you through the second-quarter financial comparisons as well as our recent investments and outlook. I'll tell you about the second quarter from an operating perspective, and of course fill you in on the latest developments in our DB Schenker relationship.

Quint?

Thanks Joe. Good morning, everybody. As I always do, I need to start by advising everyone that during the course of the call we'll 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 assets and services,

the timely completions of additional Boeing 767 and 757 freighter modifications scheduled during the remainder of 2011 and in 2012, and our continuing ability to place completed aircraft into commercial service.

The availability and cost to acquire used passenger aircraft for freighter conversion and redeploy or sell surplus aircraft,

and our operating airlines' ability to maintain on-time service and control costs.

And our ability to adapt our business operations and realize wind-down cost commitments as DB Schenker restructures its North American air cargo operations.

There are also other factors that are contained from time to time in ATSG's filings with the US Securities and Exchange Commission, including the second-quarter Form 10-Q.

I will also refer to non-GAAP financial measures from continuing operations, including EBITDA and adjusted EBITDA as well as adjusted pretax earnings, which management believes are useful to investors in assessing ATSG's financial position and results. These non-GAAP measures are not meant to substitute for the GAAP financials and we advise you to refer to the reconciliation to the GAAP measures which we have included in our second-quarter news release, which can also be found on our website.

The second quarter was a good example of what can happen when everything works as it should. We resolved the operating problems we faced in the first quarter, enabling our airlines to achieve superior performance levels in the second quarter.

We continue to gain momentum with 14 additional wide-body aircraft under lease since June 30, 2010, as our business model works to grow and diversify our operations. And the new five-year credit facility we put in place in May is already contributing to our bottom-line, with lower fees and interest costs that will provide us with efficient capital to grow our fleet into 2016.

Revenues increased $33 million or 21% to $193.1 million for the second quarter, or by $19.6 million when excluding reimbursements. As $12.5 million increase in airline service revenues and 6% more block hours, plus lease revenues from the six additional freighters CAM is leasing externally, contributed to the revenue gain.

Revenues for the first six months rose $47.1 million or 15% to $368.2 million, or by $14.8 million when excluding reimbursable revenue. That comparison includes $4 million paid to ABX in the first quarter of 2010 under the DHL severance and retention agreement.

Pretax earnings from continuing operations for the second quarter rose 24% to $19.7 million. Consolidated net earnings were up 27% to $12.3 million or $0.19 per share.

For the first six months, pretax earnings from continued operations were $24.2 million, down 9% from the first half of 2010, while consolidated net earnings decreased 11% to $15.1 million.

As you recall, pretax earnings from continuing operations were reduced in the first quarter by $6.8 million for expenses related to the refinancing of the Company's debt. When you adjust out the affects of the credit facility termination charges and pretax earnings from the S&R agreement recognized during the first quarter of 2010, adjusted pretax earnings from continuing operations for the first six months were -- are $30.7 million compared to $23.1 million for the same period a year ago, an increase of 33%.

Second quarter EBITDA -- Earnings Before Interest, Taxes, Depreciation and Amortization -- from continuing operations were $47 million, up 12% from the second quarter of 2010. This is the highest quarterly EBITDA result we have ever achieved and reflects the growing cash-generating potential of our core assets and businesses. Adjusted EBITDA, excluding second-quarter gains on derivatives and debt issuance write-offs, increased 11% to $46.7 million.

That strong cash flow, combined with the Company's more flexible credit facility we executed in May, works to strengthen our balance sheet while enabling us to rapidly grow the business. The reduction in the upfront loan initiation fees will reduce the amortization of those fees rolled into our interest expense by approximately $1.2 million a year. After completing the new credit facility, we paid off our $172 million term loan and drew $65 million from the $175 million revolver to support our aircraft purchase and conversion programs. Debt to EBITDA out leverage remains very low at well under two times on a trailing 12 month basis, with plenty of balance sheet liquidity to fund our growth plans.

Interest expenses decreased $1.1 million for the quarter and $2.1 million for the first half of 2011. The decline reflects the Company's reduced debt and lower interest rates. Interest rates on the Company's variable interest, unsubordinated term loan decreased from 3.2% in the second quarter of 2010 to 2.3% for the second quarter of 2011, in part due to more favorable pricing terms in our new credit facility.

Turning to our operations, as of June 30, CAM had 66 aircraft under lease, 47 of them to our internal airlines, ABX, ATI and CCIA. The remaining 19 are leased to external customers, including all 13 767s pledged to DHL under the agreement signed in March 2010. Factoring in the 767-200 CAM began leasing to RIO in July, and one more they will take later this quarter, CAM will have a minimum 21 of its 40 767 freighters externally leased by year-end. Revenues for the segment increased quarter-over-quarter by $7.9 million or 32% to $32.8 million. New external business accounted for $5.2 million of the increase.

Our airline operations improved substantially in the second quarter, compared with the first quarter. After resolving the operating problems over the winter, we were able to achieve significant performance improvements. Performance-based awards under contracts that provide such incentives increased $568,000 in the second quarter compared to the first quarter of 2011.

Excluding fuel and other reimbursement revenues, ACMI Services revenues rose 12% from second quarter 2010 to $115.1 million. Pretax earnings rose 12% for the quarter to $4.6 million. The increase in revenues was driven by a 6% increase in block hours.

Our airlines were operating six more wide-body aircraft at June 30, bringing the total to 48 in-service aircraft. These included four more DHL-owned 767 freighters operated by ABX Air under its Crew, Maintenance and Insurance agreement with DHL; a passenger 767-200 operated by ATI with a tour provider; an additional 767-200 in service at ABX; two 767-300s, less two aircraft removed from service with our airline subsidiary and placed on long-term external leases. One of the 300s was leased from a third party last fall for ACMI Service with DHL, and one CAM-owned 767-300 that just entered service for ACMI at the end of June.

Joe will cover the status of our DB Schenker relationship in a moment. But as we said in our press release, we expect that three of our DC-8 and four of our Boeing 727 aircraft will remain in service when Schenker adopts its new business plan on September 1. As a result, we will conduct an impairment analysis on CAM's entire aircraft fleet along with goodwill and other related intangibles during the third quarter. At the same time, we will explore options for redeployment or sale of the surplus aircraft.

Recall that we said in our July 22 statement that we estimate that each aircraft in the Schenker network generates approximately $0.01 per share in after-tax earnings, and that all 16 aircraft in the group on average have consumed between $10 million and $15 million of our maintenance CapEx cash expenditures per year. A reduction in required cash CapEx for the seven planes will help minimize the impact to free cash flow.

Revenues from Other Activities rose 12% to $25.5 million in the second quarter. The increased revenues came primarily from additional services for the United States Postal Service starting April 1, 2011. Pretax earnings were $1.7 million compared to $3.8 million in last year's second quarter, reflecting higher facility costs and increases in overhead support costs.

Capital spending in the first six months totaled $102.7 million as compared to $58.3 million for the first half of 2010. There were nine aircraft in mod during the first half this year, including our first 767-300, compared to seven during the first half of 2010. The first half breakdown for capital exposures included $84.2 million for aircraft acquisition and modification, $17.1 million for heavy maintenance and $1.4 million for other equipment costs.

We continue to estimate that our total capital expenditures in 2011 will be between $170 million and $200 million. That would include freighter modification costs related to six 767-200s, four 767-300s and two 757-200 aircraft that are either in modification or are expected to enter modification this year. Two of those 767-200 and one of the 767-300s were placed in service during the quarter.

Our effective tax rate for the quarter was 37.5% compared to 37.6% for the second quarter of 2010. We don't expect to pay federal income tax until at least 2013, other than certain alternative minimum taxes based on our deferred tax asset.

Now I will turn the call back to Joe Hete for his comments. Joe?

Thanks, Quint. Our second quarter was one of the best quarters in our history. And if we continue to execute as we did this spring, it will be the first of many strong quarters to come.

We also took key actions to fortify our growth initiatives. We extended our access to growth capital on attractive terms, and we continued to add feedstock aircraft for conversion and deployment into the mid-size freighter market -- a global market that may tighten considerably, even if the US economy does not rebound quickly.

During our last call, we talked about a number of one-off items and timing considerations that led to a first-quarter pretax loss in our ACMI Services business.

As I said then, and reconfirm now, we found no evidence of a systemic problem in our aircraft operating units, after carefully reviewing each event. We adjusted personnel and added other resources in certain remote locations. Since then, as Quint mentioned, we have returned to the service quality levels that earn us bonus awards, and those awards added to our improved operating margins for the quarter.

As a result, our ACMI Services business rebounded sharply from a loss in the first quarter. It achieved a strong year-over-year revenue growth even after excluding the effect of higher fuel prices and a big jump in pre-tax income. As a run rate indicator for ACMI Services, the second quarter approached the levels we had expected to achieve from the aircraft assets and new customer agreements we have added, including the CMI agreement with DHL.

Our CAM leasing segment, which delivered great results in the first quarter, did so again in a second. It added the last two of thirteen 767s we pledged to lease for seven to DHL. It also benefited from nearly a full quarter of revenues from the externally leased 767-200 freighter we delivered to Amerijet, and for another one we leased to ATI that went into ACMI service with West Atlantic in Europe. At the end of the quarter, CAM also leased the first of three 767-300s to ATI for ACMI Services within the Americas.

On the rollout front, we're mostly on target. Of the eight aircraft we talked about on our first-quarter call in May, we deployed the last of the 13 leased 767-200s with DHL, the 767-300s I just mentioned in ACMI and one of the two 200s we're leasing to RIO went out in July. So we have five more due the balance of this year, one of which is the second RIO aircraft we're due to deliver this month.

Back in May, we indicated that the two 767-300s coming out of mod this quarter and next would be placed in ACMI service between the Americas and Europe under a three-year agreement. That commitment expired, so we have replaced it with a four-year ACMI agreement with a carrier in Europe. We also announced that we have purchased three more aircraft since the start of the second quarter -- another 767-300 from Qantas and two more 757-200s. The 300 will come out of mod in early 2012. The 757 we purchased in April will become our prototype 757 combi. It should be completed by the third quarter of 2012. The 757 we bought just last month will be converted into a standard freighter by the end of the year, and we already have a request to deploy it in ACMI service.

Of course, we're still hunting for more mid-sized feedstock, especially more 767-300s. But as we have told you before, they remain scarce due to mainly to the delays in the 787 program. Very few mid-size passenger aircraft from either the Boeing or Airbus families are available for conversion, and more DC-8 and A-300-B4s are likely to be retired. Despite the tight supply, we have no intention of overpaying for feedstock, and will not compromise on our return on invested capital targets for the sake of filling the modification pipeline.

While the short supply of airframes on the market is frustrating for us in one sense, it's also a big advantage because our fleets will be in even greater demand from organizations that need our kind of lift. We can expect more interest from people who want to make long-term commitments to our mid-sized aircraft when they begin to realize how few will become available over the next couple of years.

Now I want to update you on our Schenker relationship, beyond what we said in our earnings release and in our July 22 statement.

The good news is that Schenker wants us to continue to support its North American customers with their cargo services, even after its domestic hub closes September 1.

On our part, we want to be supportive vendor to a customer that is undergoing a major restructuring, just as we did with DHL. Schenker's new plan recognizes that while it will no longer support a dedicated network, some of his largest customers still need air options beyond what forwarders and other non-dedicated resources can offer.

Schenker intends to serve those customers with its mix of carriers, primarily DHL, with whom they have shared lift on certain flights we operate. Naturally, that means that some of the Schenker freight we're now carrying on our DC-8s and 727s will likely end up on our 767s in the DHL network. In some cities DHL serves, however, the added payload is expected to exceed what our 767s can carry.

For the short term, Schenker has asked us to dedicate seven of our 16 DC-8s and 727s to serve them via the Cincinnati/Northern Kentucky airport where DHL has its hub. That arrangement would run from September 1 through the end of the year, after which we would no longer directly contract the aircraft to Schenker.

DHL has notified us that it will assess 2012 incremental lift requirements based on the portion of the Schenker volume retained in its network, and that it intends to negotiate terms with us in the fourth quarter, under which all or some of the seven aircraft would continue to operate for them in 2012.

We have told Schenker that we will help them bridge into this new arrangement so long as it makes financial sense for us to do so. And for us, that equation includes not just our recurring operating costs, but also our wind-down costs both for the aircraft removed in September and for others that might be removed later.

We have successfully supported our customers during fleet and network restructurings in the past. As Schenker and DHL chart a course to service Schenker's air volumes, we will continue to focus on delivering high-quality service with as many of our aircraft as they require. We are uniquely positioned to provide the aircraft DHL may need to expand its US air network.

As we have met with many of you this year, we have affirmed our expectation that if we execute our business plan as we have outlined it, we expect our adjusted EBITDA run rate to exceed $200 million on an annualized basis by the end of 2011. I want to emphasize that no matter how our Schenker relationship changes, we currently project that we can still reach that target. Our second-quarter adjusted EBITDA of $47 million, $5 million more than a year ago and $9 million more than in the first quarter, is fully consistent with our goal. Looking ahead to 2012, even if you exclude the contribution we currently project from Schenker-related business, we still expect we will exceed $200 million in EBITDA for the full year.

The future of ATSG and our fundamental investment appeal continues to be based on the attractive cash returns we're able to generate from acquiring, converting and leasing our unique 767 freighter assets, supplemented with the incremental benefits we earn from operating, maintaining and customizing them to meet unique customer requirements. That continues to be the core asset and growth strategy that guides our decisions, and the path that we believe will best reward our shareholders in the years to come.

That concludes my prepared remarks, Carol. Now I'm ready to take some questions from investors on the call.

(Operator Instructions) Kevin Sterling, BB&T Capital Markets.

Thank you operator. Good morning gentlemen. Joe, you were talking a little bit about the feedstock and you had a nice acquisition there in July. Do you think more feedstock is becoming available or is it more of a special situation?

I think it's more of a special situation right now, Kevin. I mean there's just not a lot of stuff out there available, at least not at prices that make sense for us to pull the trigger on.

We have a target return on invested capital that we don't want to blow by, as I said, just for the sake of filling a pipeline. I will tell you that were in the process of trying to nail down a fifth aircraft at this point. And hopefully we'll be able to announce to the marketplace that we have it under contract in the coming weeks.

Okay, along those lines, do you think as the Dreamliner ramps up production we will see more feedstock become available? Is that the right way to think about it?

Yes, I think over time. But the launch customer, for example, for the Dreamliner, is All Nippon Airways, who we have a long-term relationship with. And we bought their 767-200 fleet back in 1995.

And we have talked to them about what their fleet plans look like and whether it's a result of the bankruptcy that JAL went through, they have to revise their fleet plan and said the earliest they anticipate cutting any of their aircraft loose would be 2013.

Now, that's not to say somewhere in between someone else may decide that they're going to go with a different aircraft type, say, the A330 or something like that. But I see the supply remaining pretty tight at least through probably the middle of 2013.

Okay, thank you. Could you remind me what your target return on capital is when you're looking for conversion opportunities?

Sure. We set a minimum threshold of 10% on an unlevered basis.

Okay, thank you. How should we think about a value for the older DC-8s and 727s that you might sell or scrap that might not go into the DHL network?

There's not a huge demand for that aircraft, although there are still a number of them flying around the globe someplace. But one of the things we will do initially, depending upon how many remain in service -- keep in mind we not only have the freighters, we have the combis that we're still operating for the military -- we will cannibalize things like engines and some of the higher-value components that you can transition from one airframe to the other. But if you looked at it from the standpoint of what the market value of one is, if you think about the engines for example, the market value for a CFM-56 -- because these are 70-series aircraft -- is probably on the order depending upon -- call it the midlife time, three quarters of a million dollars apiece.

Okay, thank you. Quint, I've got a question for you. Any large C or D checks coming the next couple quarters? How should we be thinking about maintenance?

You know, I think it is pretty steady. I don't think you see a spike in a particular quarter. We had -- sort of the -- what tends to show up on our bottom-line is sort of unplanned maintenance that you have. And essentially as we had in the first quarter was some of the unscheduled maintenance.

One of the things that I will point out is maintenance that is done with aircraft scheduled maintenance and ATI and CCIA is -- their policy is to capitalize that maintenance and then amortize that over the term of the C-check which typically is a couple years. So that tends to have a smoothing effect.

Where you see some quarter to quarter volatility would be with ABX Air. Their policy is to expense scheduled maintenance as incurred. And so you can see some impact resulting from that.

Now, ABX doesn't do D-checks which are the heavier type visits on the 767s. We have a phase program for the airframe inspections. And so, you kind of avoid that big giant man-hour intensive D-check that some airline maintenance programs see occurring.

Okay, thank you. Joe, with the new 757-200 combi that you plan to deliver to the military in the third quarter of 2012, should we see this as a positive development and view it as an endorsement by the military of this type of aircraft?

I think if you look at the solicitation they put out, Kevin, basically we have the DC-8 combi service locked up through June 30 of next year. And then for the three-month period between June 30 and the end of the military fiscal year, which is September 30, they put out a bid for expansion businesses as they call it -- so it's not locked in today, and that would include a more modern version of a combi. Now, based on the specifications they called for in terms of the number of pallet positions, which is like 10 to 14, and the number of passengers you could carry which, depending upon what configuration you put it in, anywhere from 30 to -- we will call it 60, the 757 appears to be the target aircraft.

So we're going to move forward with that program since it fits the profile. And seeing as how we have been the sole provider of that business for a number of years, we're pretty confident that we will secure at least significant portion of the business going forward, if not all of it.

Okay, thanks, makes sense. One last question Joe and I will turn it over to some others. You're generating nice cash flow. And if you can't find any additional feedstock, what do you think about a stock buyback?

Well, as we have said before, we've got some restrictions in our agreements. And while feedstock is a little bit scarce, if you ask Quint and company around here they will tell you they are pretty confident in my ability to find aircraft to spend money on.

He has not disappointed us there so far, Kevin.

Okay, thanks a lot for your time today.

Sterling Adlakha , SunTrust Robinson Humphrey.

This is Sterling in for Alex this morning. Taking off where Kevin left off there on the stock buyback issue, I think what has held you back in the past was a 20-cent dividend to DHL for any buybacks. But given where the stock is today, not just a lack of feedstock but what about a return of shareholder value? I'm not sure I understand why purchasing new aircraft at this point is a better return of shareholder value than buying back stock and paying that penalty.

Well, Sterling, this is Quint. Certainly if the stock price, which Joe will probably have a little bit more to say on in his concluding remarks, but if the stock price were to stay significantly below what we would perceive as value -- and certainly we're not satisfied or happy exactly where we sit here today -- it's not -- the point you're making about a buyback is valid. The reality is I don't think we expect the stock to stay there, because there's just too much going on with the business in terms of the cash flow, the earnings generation, and the demand for our assets that make the stock in our view something that is going to be compelling for investors.

So we expect to see appreciation in the value. If somehow we don't, then I think your point is more relevant.

Okay. And can you contrast that little bit with your view of a dividend versus a buyback?

Well, I guess everybody has their own personal view. Certainly dividend -- I don't think is -- it would not be as attractive to us. Even in the event we were considering that way of returning capital to shareholders, it would probably more likely be a buyback.

Thanks Quint. I'm wondering, taking it up a few thousand feet, if you could just give us a view of demand. We've heard a lot about softening. Panalpina this morning was saying they don't expect any kind of peak season. Just wondering if you could talk about what you're seeing in the medium widebody space, if you're still seeing the type of strong customer demand you have talked about in previous quarters.

We haven't seen any abatement in the demand for the aircraft we have. Like I said, it's a little bit frustrating at times because they're not coming out of the modification pipeline as fast as what the customer requirements are. And of course the key part of that is evidenced by the fact that we leased one in late last year to meet a customer's requirements.

Keep in mind when you look at the Panalpinas of the world and some of the others, contrast that with what you heard out of Atlas the other day on their call. They were pretty bullish on the cargo forecast for the balance of this year.

So, I mean everybody's got different opinions depending upon markets. But from our standpoint, because it is a regional freighter, it doesn't do the long haul, it's more resilient at least as far as what we've seen to ebbs and flows and the economy overall.

A lot of the aircraft we have are in the networks whether it is with DHL, TNT. We had the DC-8s and 727s with BAX Schenker. And in the network operations they don't fluctuate with demand. It is more about having to hit certain cities within a network, and whether the aircraft is running at 100% payload or a 75% payload doesn't change the requirements for an aircraft to move from point A to point B.

That's very helpful. Thank you for that, Joe. And just one last one, maybe with a follow-up on the DB Schenker fleet. With DHL taking over some of those planes at least through the end of this year, what gives you confidence that you can keep those in a DHL network for next year given that they are such inefficient, so much older aircraft?

I don't think they're -- they have never been part of our long-term plan for starters, Sterling. It was something that came with the CHI acquisition. They were assets that were employed and they work well as long as the utilization is low overall.

So if you have short routes that you're putting them on, you are weighing the asset cost against the higher direct operating cost. So over time, yes, let's just say those seven are requirements on a long-term basis. At some point in time we would have to go through a process of replacing those with 767s or 757s, depending upon the individual route.

Can you just give us some kind of sense qualitatively on what type of timeframe you are talking about as far as upgrading that fleet? Is that next year?

Sterling, a lot of that will depend. First of all, nobody knows how much of the Schenker business they will be able to retain since they shut down their own dedicated network. And that is kind of the premise for contracting with Schenker between now and the end of the year and then transitioning next year to DHL taking over the contracts for the lift requirements.

Everybody has to see what shakes out in terms of how much of the business they retain. If they retain a lot of it and demand seems to be strong, then I'm sure we'll start down a path of trying to come up with newer generation air assets that DHL would be interested in. If, however, the volume falls off because some of the customers don't stick, obviously the requirement would be less. And depending upon the utilization, they may stretch out to 2012 and beyond.

Steve O'Hara, Sidoti & Co.

When you talk about the feedstock for 767 aircraft and getting the additional cargo aircraft kind of online, at some point does the addition of, let's say, feedstock become a dampening impact on, let's say, supply and pricing?

I think as we said, Steve, first of all, whether it impacts pricing or not we have our ROIC hurdles that we put out there, and don't want to make an investment at a higher price than what gives us that return that we expect. But from a dampening standpoint, it's really tough to say in terms of how many would hit the market at any one point in time.

If somebody came up with a large fleet all of a sudden and said, hey, I'm going to dump 20 airplanes onto the market place that would certainly have an impact in terms of acquisition pricing as well as bringing up that feedstock. But so far, with knocking on all the doors that we do, none of that appears to be imminent for many current 767 owners or operators.

Okay, so it might have a dampening impact on pricing on both ends, so you might -- the margin still might be pretty good.

Yes.

Okay, and then in terms of the Panalpina outlook, I mean you guys said that -- I guess I wasn't sure what your thought on it was. You kind of pointed to Atlas. Do you have an outlook? I mean, I know it doesn't really impact your business day to day.

Like I said, we do -- I did not listen to the Panalpina call, so I'm kind of at a loss on that one. But certainly listened to the Atlas call the other day and they said they have a pretty bullish outlook. We tend to look at it a little bit differently because they do play in a different marketplace than we do.

They're into that long haul Asia to North America, those kind of routes, where ours is on a regionalized basis. In some sense it's a feeder to those 747s or 747-8s that Atlas has coming on, makes great feeder aircraft for that.

But, again, the lion's share of the assets we have are going to be tied up in network operations and/or lane segments, for example, like we operate a significant number of flights a day between Miami and South and Central America, moving things like perishables where there is no alternative means of lift. And the perishable pipeline is pretty consistent on a year-over-year basis. It's not like it's driven by somebody coming up with a new iPad or something like that which drives extensive demand during peak seasons.

(Operator Instructions) Howard Rosencrans, Value Advisory.

Hi, it's Howard Rosencrans from Value Advisory. Hi, guys. A couple of questions here that you have begun to address, and I thank you for all the color. And you don't have to go into all the granularity on it.

If you could just provide a little bit more color on the rate -- so, the military, you basically are more confident to this juncture that you're going to be a long-term player with the military. You believe -- if I'm understanding you, plenty of the uncertainty has been lifted there if I'm getting the tone of what you are saying.

Could you give us a sense of what the CapEx -- because you have for the new 757, what else do you envision the balance of the CapEx for military is? And my second question is, if we remove that balance of the military CapEx, because if they're making you pony up more CapEx to get new planes for them, you said in the past you are going to make sure you get compensated for it. If we remove that from the mix and we assume DB Schenker is a zero or the DHL planes, that that business all goes away. You had the number of $200 million in EBITDA as your run rate, even without the DB Schenker DHL-related business on that front. So your CapEx in -- your CapEx, therefore, in '12 assuming you didn't buy any planes, is it like $30 million? I will leave it there for you to provide color, thank you.

Howard as far as the combi goes, it's as we said in our prepared remarks, we did acquire a 757 earlier this year which was a feedstock aircraft for the combi program. A lot in terms of how much we will invest in the combi program will be dependent upon how many we ultimately think we will get.

Today we operate three DC-8s and have one backup aircraft for that, so essentially four aircraft dedicated to that combi business. We launched the first one only because we have a high degree of confidence that we will at least be able to place one and possibly two aircraft in the combi bid, because the allocation of the newer generation will be based on the team points for whatever team you belong to under the AMC program.

And with the team we are on, we would at a bare minimum receive the allocation for at least one combi aircraft under that scenario. Depending upon how many other potential bidders there are, we could get two aircraft if there's one other bidder. And if there's no other bidders, then we would get three, plus whatever the spare requirement is.

The unique advantage that we have is that when you look at the aircraft we operate today, three DC-8s are scheduled and one backup. One of those DC-8s would fall into the category of a newer generation combi, even though it is an older aircraft, because it was re-engined with the CFM-56. So we do have a distinct advantage over potential competitors of being able to provide a spare aircraft in the near-term.

Figure on average that if you do the aircraft, the range of values are going to be between $20 million and $24 million apiece, depending upon how many you ultimately do. There is a significant amount of non-recurring engineering that is required to design and develop this combi, since it is a unique asset.

So if you look at it on bare minimum, we're going to have $24 million invested in it. If we do two of the aircraft, we're going to call it between $44 million and $48 million invested. And if you add a third one the average cost goes down because of the amortization to those nonrecurring engineering.

So are they going to therefore pay you more now because you are upgrading the fleet for the military?

If they want a newer generation asset, it costs a lot to replace an asset whether it's a 40-year-old one fully amortized. But keep in mind there's efficiencies with the newer generation one, in terms of fuel burn is significantly less. Maintenance costs are significantly less than the older aircraft. But they will all be based on a bid basis.

Okay, and in terms of the maintenance CapEx for '12 if I was to -- if I'm to remove the -- I guess whatever portion of the military you would throw out as not being maintenance, and if I assume that the DB Schenker or the DHL taking over their planes, I assume that's -- if I assume that that's a non-event, that that doesn't really happen, what are you looking at as maintenance CapEx for '12?

Well, Howard, in the past we said it is, what, between $30 million and $40 million, call it $35 million a year for maintenance CapEx. With the removal from service of the DC-8s and 727s associated with BAX's restructuring of its operations, we will see a reduction in that I would say on the order of about, you know, $7 million to $10 million in 2012.

That will be achieved by, in part, just less aircraft in service and also utilizing perhaps some of the parts aircraft to avoid the spend on maintenance CapEx for parts. As we said in our release, if all the DC-8s and the 727s were to come out of service, we would probably see a number of 15 or more a year that would come off of our run rate average for maintenance CapEx. So we will get sort of a partial benefit of that in 2012, and then to the extent that the fleets are reduced in the ensuing years, you will see some additional.

Okay and you are looking at ballpark $15 million in interest expense?

Yes, that is probably a pretty decent projection.

Thank you very much gentlemen.

(Operator Instructions) Michael Chapman, Private Capital Management.

A couple, I guess on number of planes you have scheduled for mod in 2012, how many do you have scheduled for mod in 2012?

Right now we have the fourth 767-300 we talked about. And we start mod in 2011 but come out in early 2012.

As I mentioned, we're in the process of negotiating for a fifth 767-300 that would go into the pipeline in 2012 as well. That is on the 767 front. That is all we had that we can point to today.

And then we've got the 757 combi which is a -- it's a pretty long tail in terms of that would get inducted in the coming weeks for the initial combi modification, but not be finished to call at the end of the second quarter next year. We will continue to look for additional assets in the intervening period.

We believe that from a planning standpoint we look at four to six 767-300s coming out if we can fill the pipeline, as per our plan. So we're still a couple short right now.

So, given that this year you said you are going to have nine in mod for the year, unless you make additional airframe acquisitions that number is coming down?

For next year.

Okay. So given that you guys have pointed out that the operating cash flow we should have, everybody has kind of figured out the maintenance CapEx and the interest. That leaves quite a bit of cash flow. You also said that you're not overly levered at two times EBITDA.

Is that two times EBITDA a level that you are comfortable maintaining? Do you think that can go up over time if you have assets that you feel would meet your hurdle rates?

Well, as we said in the past, Michael, certainly we were levered at more on the order of three times when we did the acquisition of CHI or little bit above that. I think that is certainly -- not an impossibility at all that you would see that, if we had the right investment opportunity. So we would be comfortable at a higher leverage.

One of the things we want to maintain some flexibility for, Michael, is once in a while you come across somebody that wants to sell off an entire fleet at once, or at least a significant portion of their fleet. And either we take that and put them into the modification pipeline itself, or in some cases they like to sell them to you and then lease them back until they've got their replacements coming online.

So we're also trying to maintain some flexibility to maybe potentially have to do one of those multi-aircraft buys at one time from a balance sheet perspective.

Okay. But given what you presently have in the pipeline, there will be quite a bit of cash available just for outright purchases without taking on any financing?

No question.

Okay. Maybe just talk to me then about strategically the size limits you would have for the number of aircraft you could manage, given your corporate infrastructure?

In terms of - are you talking about just the sheer number of units versus what we could support?

Yes. If you guys, from where you are, 60-odd, you are close to 70 by the end of this year, aircraft, where do you think that size will be three, five years down the road given what you're thinking you can manage from the standpoint of the rate of growth?

You don't want to grow too fast. That kind of overloads systems. You don't want to grow too slow because then you become under-levered. So, I'm trying to get a feel for how big a business you think this can be over time.

A lot of it depends on whether they go to pure dry lease, which doesn't really require lot of overhead from a leasing standpoint, or whether they going to into ACMI operations which requires pilots and mechanics and things of that nature. But we think we have the baseline infrastructure that can easily be flexed up on both fronts. Dry leasing just takes a handful of people.

The way we have our corporate structure set up with the MRO as well, we have the flexibility to reach into the MRO, for example, if we need additional assistance in the dry-leasing side to help do inspections on aircraft. So, we have a lot of flexibility built into our model when you are just talking about the pure operation side of the equation, the financial and balance sheet piece of the equation aside.

As I said, when we look at the fleet growth opportunities, call it four to six 767-300s into service annually, our target price has got to be under $28 million. So you can do the math on that in terms of how much you think we can add on an annual basis. And the ultimate size of the market is going to be dependent upon what the demand is and how quickly people take out the remaining older generation aircraft that are still flying around out there with A-300s, DC-8. The 767-300s is a good replacement for the DC-10, 10-10s and 10-30s, which are still flying today. So there's still quite a bit, as we believe it, of an untapped marketplace out there.

What percentage -- what is the target of your fleet that you would like to have on long-term lease?

Well, right now, as we have said, we -- with what we own today freighter-wise we know that by year-end, 21 of 40 will be on long-term lease. I think one of those rolls over this year but the other 20 have five years or so to run at minimum. I think we like to maintain that balance. You can really pick a -- it just happens to be around 50-50 at present. But again, it just depends upon the opportunities that present themselves. We have that flexibility, as Joe said, to address different customers and we like that about our model.

Keep in mind, you're going to get better returns on the ACMI piece because you have not only have the return on your invested capital by leasing it to the affiliate airline, and then you add the margin on the ACMI piece.

But with ACMI business as a general rule it's going to be shorter duration contracts and you're assuming a bit more risk from an operation standpoint. The nice thing about the dry lease is you've got a nice steady cash flow and they are generally long-term arrangements. When you talk about those 21 we have, one of them is a three-year which comes due next year. Two of them is -- the RIO aircraft are five-year deals and then all of the rest of them are seven years in duration, so you have long-term certainty of cash flow and profitability.

And with the dry lease, and this is a case where I think about all of them, is we are tacking on additional services. While we may not be crewing and manning the cockpits, we are performing the maintenance, or we're selling them or giving them access to engine maintenance through our agreements with the providers. And so we're able to tack on some margin even in these long-term dry leases. Maybe not the C, but the M.

Okay. And then just from the standpoint of the four to six planes that you would want to put on each year, is that where they end up? Or what markets they end up running, is that relatively ad hoc? Or are you targeting specific geographies where you would like to have I guess more density?

Two places that we have targeted on our list for this year in terms of getting more density is certainly the Asian marketplace. We do have one aircraft over there today that runs between Japan and China. We want some deeper penetration there in terms of the 767. And the other one is the Middle East. We have one aircraft we operate there today between Bahrain and Afghanistan, actually running mail I believe for the US military, but it is under contract to DHL.

And we think that is a marketplace which has been dominated for the most part in this size aircraft by the A-300, specifically the B-4, which is an older generation airplane. And we see that as a good target environment in the Middle East.

Do you need to deploy sales guys to those regions to really effectively exploit them?

We want to get a broader presence. We have a sales force today, but most of them are based here in the U.S. And that is one of our strategic initiatives for this year is to put people in place in those marketplaces, so they're constantly knocking on doors rather than people going back and forth. We've got a couple of potential targets out there.

We certainly do -- their frequent flyer miles are up. We have a couple of guys, a matter of fact, right now are overseas. And so we are making contacts in all those geographies.

And I guess one final one, just a quick question, are the freighter mods eligible for accelerated depreciation, Quint?

Yes. In terms of the tax accelerated depreciation?

Yes, yes.

We believe the way the reg is written that it's a very good candidate for that. And we expect to take advantage of that through acceleration of a pretty significant part of that. And so that is a good point. It's going to benefit us.

And that just -- since you have NOLs there, that just basically pushes out when you are going to be a non-cash tax payer?

It does.

just roll on as an NOL.

Except to the extent -- this is the good news -- that you're profits are higher. If profitability forecasts improve, you may not see us changing the forecasted end of our NOL eligibility. But that doesn't mean we're not getting a greater benefit. It just means that it is being offset by more earnings.

Great. I appreciate the time. Thanks a lot guys.

Ladies and gentlemen, this concludes the question and answer portion of your conference. I will now turn the presentation back to Mr. Joe Hete for his closing remarks.

Thanks Carol. Like many of you, we were surprised and disappointed by the impact on our stock price from the potential changes in our business with DB Schenker. We understand that investors dislike uncertainty most of all, but we believe that the facts as we have shared them so far suggest that the effect will be less severe compared with the substantial cash-generating potential of our core businesses than our market multiples would indicate.

Long-term investors who seize the opportunity that our recent share prices represent are likely, in our opinion, to be very well-rewarded. We will continue to focus most on our ability to generate superior cash returns from developing and applying our more modern midsized freighter fleet. We intend to make sure that the goals we set are achieved and that we gain every last measure of return from the assets and services that your investments have allowed us to deploy.

Thank you again for your support. Have a quality day.

Ladies and gentlemen this concludes your presentation for today. Go off and have a wonderful day.