Air Transport Services Group Inc (ATSG) 2011 Q3 法說會逐字稿

Good day, Ladies and Gentlemen, and welcome to the third quarter 2011 Air Transport Services Group, Inc. earnings conference call. My name is Jasmine, and I'll be your coordinator today. At this time, all participants are in a listen only mode. We'll facilitate a Q&A session for today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

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

Thank you, Jasmine. Good morning, and welcome to our third quarter 2011 conference call. I'm Joe Hete, President and Chief Executive Officer. 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. Yesterday afternoon we released our third quarter results and filed our 10-Q with the SEC. Both are on our website, www.atsginc.com.

Our third quarter results represent a continuation of the trend we have been on since March 2010 when we restructured our business to place greater emphasis on generating strong cash flow returns from our unique fleet of midsize freighter aircraft. Those six quarters have produced more growth and more consistency on our cash flow progress than in any similar period thanks in the large part to the twenty-one 767 freighters we have deployed with external customers under long-term dry leases. The wind down of our direct relationship with Schenkers North American logistics network is likely to be completed by the end of the year.

Instead, we now expect an indirect relationship through our support of DHL, to which Schenker will outsource its air cargo requirements. Already, we're working with DHL to add aircraft and routes to the North American network to help them service their growth and volume, which includes freight previously handled in the Schenker network.

We're also beginning to phase out of our legacy 727 and DC-8 freighters, all of which led to the impairment charges that Quint will cover in his financial review. As usual, I'll talk about the third quarter from an operating prospective and, of course, fill you in on our continuing progress in acquiring, converting, and deploying more freighter aircraft before taking your questions.

Quint?

Thanks, Joe, good morning, everybody. As I always do I need to start by advising everyone during the course of the call we'll make projections or other forward-looking statements that involve risks and uncertainties. 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 completion 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. Also, the availability and cost to acquire used passenger aircraft for freighter conversion, and redeploy or sell surplus aircraft. Our operating airlines' ability to maintain on-time service and control cost and our ability to adapt our business operations and realize wind-down cost commitments associated with DB Schenker's restructuring of its North American air cargo operations.

There are also other factors contained from time to time in our filings with the US SEC, including the third quarter Form 10-Q. I'll also refer to non-GAAP financial measures from continuing operations, including EBITDA and Adjusted EBITDA, as well as adjusted pre-tax 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've included in our third-quarter news release, which can also be found on our website.

Despite the uncertain economy, and Schenker's decision to phase out its dedicated US air cargo network, primarily supported by our DC-8 and Boeing 727 aircraft, we continued the trend of solid operating results in the third quarter, generating strong operating and cash flow returns on a business model that offers customers converted freighter aircraft with the option of long-term dry leases or shorter-term wet leases, or ACMI agreements, and support through a wide range of services.

Third quarter revenues increased $27.8 million, or 17%, to $195.5 million over the 2010 third quarter, up by $24 million when excluding reimbursable revenues, with across-the-board growth achieved in both the company's operating segments as well as our other operations.

The increase reflects additional external aircraft leases by CAM, up $3.4 million, additional Boeing 767 aircraft operations being performed under the ACMI Services segment, which was up $16.6 million, and increased external revenues for aircraft maintenance services, up $2.8 million, which were reflected under the Other Operations category.

Revenues for the first nine months rose as compared to the first nine months of 2010 by $74.9 million, or 15.3%, to $563.7 million. And they increased by $38.8 million when excluding reimbursable revenues.

CAM's year-over-year external revenues were up $19 million, and ACMI Services were up $46 million. Pre-tax losses from continuing operations were $6.7 million, while net losses from continuing operations were $4.8 million, or $0.08 per share diluted.

Earnings for the quarter included $27.1 million in non-cash impairment charges related to our reduction in business with Schenker that began in September, and $1.9 million in unrealized losses on derivative instruments related to interest rate hedges required under the Company's credit facilities.

We did not implement hedge accounting. So unrealized derivative gains and losses affect our reported pre-tax earnings. Adjusted pre-tax earnings, excluding the impairment and derivative charges from continuing operations, increased 34% over the 2010 third quarter to $22.4 million, versus $16.7 million, primarily due to increased returns in our aircraft freighter leasing business. Net earnings from continuing operations, excluding those charges and related tax effects, were $13.9 million, up 22% from $11.4 million in the third quarter of 2010.

For the nine months, pre-tax earnings from continuing operations, including the $32.6 million in impairment and derivatives charges, were $17.6 million, versus $43.4 million for the first nine months of 2010.

Net earnings were $10.3 million, or $0.16 per share, compared to $28 million, or $0.45 per share. In comparing our nine-months results this year versus 2010, it's important to keep in mind we incurred a $6.8 million charge for expenses related to the refinancing of the Company's debt in the first quarter of 2011, and also about $400,000 in a net unrealized gain on our derivative agreements in the second quarter. Also, in the first quarter of 2010, ABX Air received $3.5 million under the DHL severance and retention agreement.

Adjusted pre-tax earnings from continuing operations for the first nine months of 2011, which excluded our impairment, derivatives, and debt refinancing charges this year, were $53 million, an increase of 33% over $39.8 million in the same period in 2010, excluding the severance and retention payment I mentioned.

We implemented impairment testing in the third quarter after Schenker's announcement in late July it would phase out its North American dedicated air cargo operations primarily served by our sixteen ATI and CCIA Boeing 727 and DC-8 aircraft. With the assistance of independent advisers, we appraised the carrying value of our aircraft assets plus the recorded goodwill and customer relationship intangible assets related to our Schenker business, and determined $27.1 million in impairments for those values, broken down as follows - $22.1 million for the Boeing 727 and DC-8 aircraft, engines, and related parts; $2.3 million for customer relationship intangible assets reflecting the closure of BAX Schenker's US dedicated network and the end of our exclusive contract to provide domestic airlift to them; and $2.8 million in purchase goodwill for our Air Transport International airline, reflecting lower forecasted cash flow in the near term as ATI replaces its DC-8 aircraft with 767s and 757s for use with other customers.

We understand that Schenker and DHL are discussing a potential outsourced air cargo agreement beginning in 2012. We expected that ABX Air, as the largest operator, and DHL's US cargo network, and potentially other ATSG airlines, will continue to provide airlift and route coverage that DHL requires to serve Schenker's customers.

Regardless of the outcome of those discussions, however, we intend to market our DC-8 and 727 freighter fleets and associated parts for sale, excluding the four DC-8 combi aircraft serving the US Military, while reducing our workforce and related operating expenses. With the phase-out of the DC-8 and 727 freighter aircraft, we expect to reduce our annual capitalized maintenance expenditures by between $15 million and $20 million in 2012.

Third quarter EBITDA, or earnings before interest, taxes, depreciation and amortization, adjusted for the non-cash impairment and derivatives losses, totaled $48.3 million for the quarter, up 10% from $44 million in the third quarter of 2010. Reconciliation of ATSG's third quarter Adjusted EBITDA to GAAP Net Income is provided at the end of the third quarter earnings release found on our website. We continue to project annual Adjusted EBITDA to exceed $200 million in 2012.

Our net cash flow provided by operating activities continued to be strong, totaling $106.9 million for the first nine months of 2011, compared to $81.7 million in the first nine months of 2010.

Reduced average debt levels compared to first nine months of last year, lower interest rates and increase in capitalized interest for aircraft undergoing freighter modifications, combined to lower interest expense by $1.3 million for the quarter, and $3.5 million for the first nine months of 2011.

Interest rates on the Company's variable interest unsubordinated term loan decreased from 2.9% in the third quarter 2010 to 2.3% for the third quarter 2011, in part due to more favorable pricing terms in our new credit facility adopted in May. Our debt-to-EBITDA ratio on a trailing 12-month basis was under two through the third quarter, with plenty of balance sheet liquidity to fund our growth plans.

Turning to our segment results, our Cargo Aircraft Management, or CAM business, had its best-ever pre-tax earnings for the quarter, up 35% to $16.2 million excluding an asset impairment charge on $37 million in revenues.

At the end of September the segment had 58 freighters under lease, including thirty-four 767-200 and two 767-300 freighters. Twenty-one of those leased aircraft, all 767s, are leased long-term to external customers. The average remaining lease term for these 21 aircraft is 5.3 years, which provides us excellent forward revenue and EBITDA visibility. As we've stated previously, more than 85% of our revenue and EBITDA come from customer agreements that are either contracted three years or more forward, and/or from established relationships which have been in place for more than three years.

During the quarter, two of CAM's 767-200 aircraft went into operation under long-term leases for Rio Airlines of Brazil. Also, during the third quarter, CAM purchased a 757-200 aircraft that we expect to modify to a full freighter by the end of the year. In October, we purchased another 757-200 that will become our second 757 combi aircraft next year.

We also bought our fifth 767-300 for freighter conversion in 2012. When our aircraft in mod or scheduled to be modified are completed, CAM will own 36 767-200 freighters, five 767-300 freighters, three 757-200 freighters, two 757-200 combi aircraft and four DC-8 combi aircraft in its fleet, excluding our legacy DC-8 and 727 freighters which as I mentioned will be marketed for sale. We expect to continue to add selectively to CAM's midsize fleet in 2012.

Turning to our ACMI services segment, revenues excluding reimbursements were up 16% from third quarter 2010, to $118.9 million on a 6% increase in block hours. Block hours rose on increased number of CAM-owned 767 freighters leased and operated by ABX Air under its CMI agreement with DHL, including one 767-300 freighter lease from a third party for ACMI service, as well as ABX Air's operation of four DHL-owned 767s under the CMI agreement. Offsetting these increases, in part, were block-hour reductions related to Schenker's restructuring.

Revenues from other activities rose 37% to $14.7 million in the third quarter, after excluding inter-company results. Pre-tax earnings rose 18% to $3.7 million. Results reflect improved earnings from Airborne Maintenance and Engineering Services, or AMES. Capital spending in the first nine months of this year totaled $162.6 million compared to $90.7 million for the first nine months of 2010.

There were 12 aircraft in mod during the first nine months of this year, compared to eight during the same period in 2010. The nine-months breakdown for capital expenditures included $138.9 million for aircraft acquisition and modification, $20.8 million for heavy maintenance, and $2.9 million for other equipment costs.

We currently project full-year 2011 capital spending of $195 million. That would include freighter purchase and modification costs related to six 767-200s, five 767-300s, and three 757-200 aircraft. We also expect CapEx roughly in the same range next year or about $180 million to $200 million, primarily for mods of aircraft CAM already owns or intends to purchase.

Breaking down that total, we expect roughly $20 million in required maintenance CapEx next year, as reduced maintenance for our legacy 727 and DC-8s is offset in part by CAM's leasing of 767s and 757s to ATI and CCIA, where heavy maintenance is capitalized. Most of the $160 to $180 million growth portion of our 2012 CapEx spending plan is discretionary. That means we could opt to substantially curtail our aircraft purchase and mod plans without significant cancellation penalty, if our deployment opportunities were to change dramatically from what we expect today.

Again, we will finance these investments through a combination of current cash reserves, future cash flows and our credit facilities. At September 30, we had cash balances of $28.8 million, and $73.1 million available through our credit facility. So, if you subtract from your own projection of our 2012 adjusted EBITDA, our $20 million in maintenance CapEx, you can see that our free cash flow outlook for next year is very solid.

One other item that we mentioned in our 10-Q is that the discount rates applicable to retirement obligations under our defined benefit pension plans were down about 100 basis points at the end of September from where those rates were at the end of 2010. The lower rates are consequence of the global economic environment and Federal Reserve policy and will impact all companies, including companies that are comparable to us with defined benefit retirement plans.

We said in the Q that we estimate that our 2012 pre-tax pension expense could increase by about $4 million for every 50 basis-points reduction in the discount rates. So, unless discount rates move higher by year end we would expect to see a sharp up tick in our 2012 pension expense as compared with the 2011 expense run rate.

Interest rates have moved up some since the end of the September, but are still not back to the year-end 2010 levels. Our effective tax rate for the quarter was 27.6% compared to 31.7% for the third quarter of 2010. After adjusting for the $2.8 million non-deductible goodwill impairment charge, the Company's effective tax rate for the three and nine month period ended September 30 was approximately 37%. 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 position. Now I'll turn the call back to Joe for his comments. Joe?

Thanks, Quint. As I said at the outset, our third quarter results are more evidence of the strength of our business model, and the effective way our team members continue to execute against it. I'm looking forward to more quarters like it in the year to come as our growth story continues to develop.

Once again, we took key steps during the quarter both to improve our operating metrics in aircraft deployment flexibility, including training more crews for our expanding fleet of 767s. We continued to invest in what is rapidly becoming one of the most efficient cost effective fleets of midsize freighters in the world.

With access to capital on attractive terms and the prospect of more midsize passenger aircraft becoming available as conversion candidates, the double-digit ROI targets built into our model look to remain very attainable even in uncertain economy.

One compelling positive from the third quarter is continuation of good operating performances from our continuing fleet, which includes 767s, 757s, and DC-8 combis. We are benefiting from the reliability enhancements and reorganizations that we put in place last spring, and earning bonus incentives under contracts that include those opportunities.

Our ACMI services business continued to exhibit revenue growth even after excluding the effect of high fuel prices. Margins, while lower than the second quarter of this year, were affected primarily by the investments in crew retraining and repositioning for pilots that are transitioning from DC-8s to 767s. We also were impacted by rate reductions from the routes we cover for the US Military.

Finally, ABX transferred its last two owned 767s to CAM for lease directly to DHL, resulting in lower returns to ABX for operation of those aircraft under the CMI, as return associated with the assets shifted to CAM.

Our CAM leasing segment continues to deliver great results. After the leasing the first of its 767-300s to ATI for ACMI service within the Americas at the end of the second quarter, it delivered two leased 767-200s to Rio Airlines of Brazil in the third quarter. We recently placed the second 767-300 with TNT and expect to deploy a third 300 when it completes modification in early 2012.

The last of the 14 767-200s in our major mod program will be completed late in the fourth quarter. We expect to have a customer commitment for it when it is completed. That accounts for all of the 39 CAM-owned 767s that were included in the programs we outlined for 2011.

Looking to 2012, we also have announced purchases of four more aircraft since the start of the second quarter that are planned for deployment in 2012 -- two more 767-300s from Qantas, and two more 757-200s.

The 757 we purchased in April will become our prototype 757 combi. It has recently entered a mod program with Precision Conversions in Florida and should be completed by the third quarter 2012, to be followed by a second one by the end of next year. While we do not have a specific agreement with the military for the new combis, we remain very confident of its acceptance even in the event of significant overall reductions in the military spending next year.

The potential good news on the feedstock front can be traced to the rollout of the Boeing 787, which will replace 767s in many passenger fleets around the world. We expect many of those airlines to look for ways to pay down their 787 investments by retiring and selling their 767s starting next year. Although not yet completed, we're currently in negotiations on the purchase of two 767-300s, which would be modified for freighter service during 2012. If those two are acquired, that would increase our total number of 767-300 freighters to seven.

Turning to the status of our Schenker relationship, we now expect, as I said at the outset, to phase out all our air operations for Schenker by the end of the year. A few of our 727s and DC-8s could remain in place in either scheduled or backup mode for DHL in 2012, but only until we can replace them with additional 767 and 757 capacity. That means that all of our legacy 727 and DC-8 freighter air frames, parts, and equipment are up for sale. And our Schenker-dedicated employees and flight crews will either be severed, furloughed or retrained on other aircraft.

As we told you in August we have discussed re-fleeting options for the 727s and DC-8s in Schenker's network since we acquired the Schenker business via our CHI acquisition in 2007. Our position as their exclusive provider of main deck freighter capacity in North America was always subject to annual renewals, so we offered them a fleet upgrade program in exchange for a long-term commitment.

At the same time, we knew that Schenker and DHL had partnered on certain network routes in North America in the past with our support. In July, Schenker announced it intended to phase out the dedicated network we're providing and seek a more comprehensive air cargo outsourcing relationship with DHL. That relationship formalized on September 2 when Schenker closed the US hub in Toledo and shifted its operation to DHL's US hub in Cincinnati. The initial reduction of our fleet of 16 dedicated DC-8s and 727s to nine -- five DC-8s and four 727s -- was followed last month with removal of all of our DC-8s from scheduled service, while keeping two as spares.

The process of disposing of our legacy freighters has already begun, but the market is especially difficult now for older, less efficient freighters. The remaining book value of all those assets after impairment reflects the current market conditions, and is fairly insignificant at $18 million. Nonetheless, any sales proceeds from disposal will be additive to the annual maintenance CapEx avoidance of $15 million to $20 million in our free cash flow.

As Quint reminded you earlier, we placed a stake in the ground for 2012 -- that we continue to project to deliver in excess of $200 million in adjusted EBITDA for the entire year. This would imply, even with the effects of wind-down of our Schenker-related business, a potential 2012 EBITDA gain of approximately 10%, even in a very uncertain economy.

That level of return further demonstrates the resiliency of our business model. We recognize that our investors are very focused to our ability to preserve and grow our cash flow through long term leasing, supplemented with ACMI or other wet leasing arrangements. We believe that our model has unique attributes that make our continued success more likely than some other aircraft lessors and operators.

One such advantage is our focus on mid-size freighter aircraft, which are more versatile in operating profile and less sensitive to short-term swings and air freight demand.

Another is our strong preference in our deployment decisions for major air-cargo-network operators, which tend to be financially more stable and which maintain route coverages through peaks and valleys of short-term demand.

In particular, our positive outlook is based partly on our strong relationship with DHL, and our role as DHL's principal air network provider within the Americas and elsewhere. As you know, DHL is expanding its U.S. hub in Cincinnati and making commitments to fleet expansions. We're in regular discussions about ways we can help them meet their growth targets, not just here but around the globe.

Third, our reliance on converted freighters allows us to carry less balance sheet risk and interest expense while offering our customers a more cost effective air transportation platform than the same aircraft in a factory-new freighter configuration.

As you assign values to companies in our space over the next year, we expect you will keep these risk-mitigating factors in mind, while also noting that the strong base of cash flow growth from a full year's worth of committed lease revenue from roughly half of our 767 fleet. We believe that is enviable position in our industry, and a strong basis for superior valuations looking ahead.

Thank you, and now, Jasmine, we're ready to handle some questions.

(Operator Instructions). And your first question comes from the line of Kevin Sterling with BB&T Capital Markets. Please proceed.

Thank you, operator. Good morning, gentlemen.

Hey, Kevin.

Joe, just a big-picture question. Listening to FedEx last month, and UPS and Atlas recently, and they all cited some strengths despite some of the headline numbers from air freight. They actually all cited some strength out of South America. Are you seeing similar trends?

In terms of our business, particularly the ACMIs that we've mentioned on previous calls, we have a very strong presence in Miami, servicing central and South America, and we continue to see an expansion of demand in that particular segment. So I guess we can say we see the same things they do.

Okay. We'll put you in that bucket. Joe, would you care to comment on some of the trends you've seen thus far in October? Could you give us an assessment there, if possible?

From our standpoint, since we don't sell freight directly, our view in terms of what the market looks like overall isn't as timely as what you would see out of somebody like a FedEx or UPS that sells cargo. We continue to see demand, though it's softened a tad from what we saw in prior quarters for the assets that we have, people are proceeding more cautiously. But I think as noted the other day by DHL, they are pretty bullish on their comments based on what they see through the balance of 2011 into 2012, and of course as our largest customer that's good news for us.

Right, right. Okay. Thank you. And, I believe you made a comment about the military business. I guess you don't have, still, not much clarity there. But, could we see it as a positive that you're keeping the DHL combis. Is that a fair assessment?

In terms of the military business, remember, we have the lock on that combi business, especially since we're the only provider right now, through June 30, 2012. We said on the last call for the quarter starting July 1 through September 30, that will be bid out, so if someone else has another combi opportunity they can potentially bid on that business. And then, the military for the fiscal year 2013 and 2014, will be bidding out a two-year arrangement for combi service. Since we're the incumbent today, we feel pretty strongly that we'll gain a significant portion of that business, if not all of it.

Okay. Thank you. You know, there's been chatter, Joe, about airplane financing possibly drying up, particularly over in Europe. Is this an impact on you guys? May not be at all on the feedstock opportunities. I know you mentioned the Dreamliner coming online, that seems like that's going to create, I think, some conversion opportunities. But, is airplane financing drying up? Is that a positive? Negative? Maybe no effect at all?

I guess hard to say from our perspective. We have significant liquidity with our recently redone credit facilities.

You're asking about guys buying 787s, though, aren't you, Kevin?

I am, yeah.

Yeah. I guess potentially, of course, the 787 is going to secure those financings. The value of that airplane, it's a very finance-able asset. I think most lending institutions would be pretty comfortable having it back up their financing. So, I believe that they will find a way to still update their fleets.

Okay. And then one last question, I'll get back in queue. Joe, in terms of your DC-8s or 727s, sounds like you haven't sold any yet. At what point is there no market and you say "Let's just scrap them?"

Seeing we just got started in the process of marketing, and you noted earlier things aren't all that rosy from a financing standpoint, especially for older assets like DC-8 or 727, it's too early in the game to say. Worst-case scenario, Kevin, you start to part the aircraft out. The DC-8 has the CFM-56 engines on it, which have market applicability to aircraft other than the DC-8, and of course the 727's got the old JT-8s on it, but there's still a small market for that particular engine.

Great. Thanks for your time today. Nice quarter and congratulations on a nice outlook for next year as well.

Thanks, Kevin.

Thanks, Kevin.

Your next question comes from the line of Jack Atkins with Stephens. Please proceed.

Good morning, thanks for taking my questions and congratulations on a great quarter here.

Thanks, Jack.

My first question relates to the 767 demand. I know you said you saw, or you've seen, demand soften just a touch, but could you, maybe, comment on how lease rates are trending? Have you seen any pressure there? And also, I know that you placed a plane in October, could maybe talk about where those planes are going geographically?

To the earlier question in terms of softening demand, our gauge is kind of like how many phone calls we receive about potential availability of assets. While we're still getting calls, just not receiving as many as we had in the past. We view that as little bit of softening or hesitancy on people's part, especially coming into the fourth quarter. Because by the time we could deliver an asset to them it would be early next year. Overall, in terms of the placement of the aircraft from October that went into the DHL network, and is flying out of Central America into their hub in CVG [Cincinnati] for placement.

Ok, great. That's helpful. When I think about the planes that you plan on placing later on this year and into next year, could you give us a sense for, just bit of a picture geographically where you think those planes will end up going? In the domestic market, or will they also go into the South American market as well?

Jack, I'll let Rich Corrado field that question since he's in charge of all the marketing aspects of the Company. Rich?

The next 767-200 is under negotiations with the customer currently, and we think that's going to end up predominantly flying out of the US network. The two 767-300s we'll be deploying in the first quarter are currently under negotiations with two separate customers, which will end up flying predominantly from Europe down through South Africa.

And to build on Joe's comments on the market, we still have multiple customers interested in every aircraft asset that we have. Some folks are hedging a little bit on timing, pushing things out to the Spring schedules and things like that. But for the most part, we still see very strong demand.

In looking at the global overall demand, 2011 is a flat year over 2010, but 2010 was in the mid-20s in terms of growth coming out of the recessionary period. Actually, 2011 holding that growth up is a good sign. That is, it wasn't just a replenishment of a supply chain, but a stability of the global economy.

Going forward, given the flexibility of our assets and our ability to both deploy from a short-term perspective and our ability to move them into hot growth markets and regions of the world, we feel our demand will remain strong through 2012.

Great. That's very helpful, thank you for that color. Then, when I think about the ACMI segment, I know margins were under a little bit of pressure this quarter because of retraining activities, which you're going through with some of your DC-8 pilots. Can you, maybe talk about how we should think about margins in that business directionally next year, given that mix is improving in that segment with the wind-down of the BAX contract?

Certainly there was a lot of noise included in the latter part of the third quarter, and we'll continue to see some of that into the fourth quarter related to the BAX wind-down. We have ATI with the DC-8s, transitioning people from DC-8s into the 767s. You have CCIA, you have the 727 and 757 switch with crew members. So, we'll continue to bear some of that. Then, as you move into 2012, we should have a more stabilized network.

We expect to receive DHL's final fleet plans within the coming weeks, which will allow us to put a stake in the ground in terms of what numbers may look like as far as aircraft requirements.

Keep in mind that first quarter is traditionally a soft quarter. You have a lot of expenses that pop up that kind of get mitigated through the course of the year. Something as basic as payroll taxes related to salary and wages, unemployment taxes, et cetera. First quarter will be a little bit softer as you saw the past year, 2011, and then build as we move through 2012.

Okay. That's helpful. The last question I've got, and I'll jump back in queue. Quint, you know the salaries and wages line was down 7% sequentially. Could you maybe talk about what drove that reduction? Is that sustainable do you think going forward? Or was that just something one time in the...

One of the factors is what Joe just mentioned. You've got folks who sort of cap out on their deduction of their payroll taxes, you know, in terms of some of the pilots, which helps. And, Jack, in the 10-Q, we gave commentary on that. We've got a 6% -- comparing the nine-month periods -- there was a 6% increase in the number of crew members since September 30, 2010, for additional aircraft block hours and revenue. Also, we've got labor expenses for the AMES group, as AMES has grown its book of business, which we're very encouraged to see in the maintenance business. They've increased some of the salary and mechanic salary requirements to service that business. Those are some of the factors that are at play here.

The fourth quarter we will see a bit of a spike because we have a ramp-up in some of the work we do for the US Postal Service. We traditionally see a spike in the volume moving through the three hubs that we operate for USPS so we'll see a little bit of an uptick on that piece of business as well.

Thanks for the color, guys, I appreciate it.

Your next question comes from the line of Alex Brand from SunTrust Robinson Humphrey. You may proceed.

Hey guys, good morning.

Hi Alex.

I need a little more help on how you're transitioning the BAX Schenker business. It sounds like you're saying that although it's winding down, you're also expecting to fly some DHL aircraft in support of that. So, maybe not all of the $0.16 you talked about before is actually going to go away next year because they still want to have some significant access to putting that freight in the air? Can you give me any color on that?

If you go back, Alex, historically, remember, we had eight DC-8s and eight 727s in the BAX network prior to September 2nd.

Right.

Then, on September 2nd when they relocated their operation to DHL's hub in CVG, that 16 went to nine, which was five DC-8s and four 727s. As we noted in our press release on October 23, essentially, they reduced the number of DC-8s from five to two. Essentially today, what would be considered supporting the legacy BAX network, we have four 727s and two DC-8s operating out of DHL's operation in CVG.

Going forward into 2012, as it was explained to us by both BAX and DHL, is that BAX, the contract that we have with them for those particular assets, will terminate and then any requirement for lift to move what piece of business BAX retains, would be covered by DHL, under a contract with DHL. And as I've mentioned a minute ago, we don't know yet what their requirement is going to be in the way of 727s and/or DC-8s. But I guess you could start with the premise it will continue to be the six that we have today. Ultimately, DHL has indicated they'd like to have an all 767 and all 757 network. So over time, depending upon how soon us or some other operator could bring assets to bear, those 727s and DC-8s would get phased out.

Okay. That's kind of my question. So, this could just flip around and end up being 767 and 757 base DHL business that's still indirectly, from your perspective, indirectly supports that network because BAX Schenker still wants an air product domestically?

That is correct.

Okay. What about Atlas Air flying 767s for DHL? How does that affect the competitive landscape domestically or internationally?

The five aircraft that Atlas announced they'd operate for DHL are actually aircraft that at one time were owned by us. They were Pratt and Whitney powered as opposed to the GE, which is what our remaining fleet is. And we put those back to DHL as part of the wind-down of their dedicated network here where they served in the domestic marketplace.

DHL sat on those aircraft for a while and then determined the best use for them was to have them converted to a full freighter configuration and deploy them in replacement, as we understand, of the DC-8s currently operated by Astar in their North America network.

Atlas essentially doesn't own any 767 freighters, they don't directly lease, it's kind of an indirect, for an asset owned by DHL and operated for DHL similar to what we do with four aircraft that are GE powered that DHL owns outright. So, it certainly puts them in the 767 freighter business. I think their focus right now, at least based on what they've told the marketplace, is flying passenger 767-300s for the US military, and to our knowledge they are not pursuing any 767 freighter aircraft of their own.

Okay. Did you expect the rate reductions from the military? Does that give you any pause to what their demand might be for 757 combis at the end of next year? Or that's just their annual?

No, it's just their annual. What they do is they benchmark against all of the operators of particular equipment type. So if somebody comes in with lower cost of operation they blend it all together. Depending upon the equipment you operate you may see an increase in any given year or reduction in any given year. So it's not in any way, shape, or form, related to any kind of military wind-down, it's just the pricing mechanism they use.

Okay. My last question, the DC-8 pilots that are being displaced -- are you retraining all of them? I guess I'm just trying to figure out, does that help your cost basis eventually after you retrain them because you don't have to go hire additional 767 pilots?

Yes. Ultimately you go through a period, because the seniority system, if you have two aircraft in any fleet. For example, if you have a DC-8 that's taken out of service, the flight engineer that's in the DC-8, the lowest seniority guy, he just goes away. The guy in the right seat, the first officer, if he's the lowest in seniority, he may go away. Now the captain in that particular DC-8 may have the ability to bump down to a 767 first officer, for example, which is the next tranche in the pay scale. You have to train him while you continue to hold on to the guy that's going to get displaced in that 767. It's a cascading effect that drives a lot of your cost. Ultimately, the ideal situation will be for us when we get to an all 767, 757 combi fleet with ATI, because that's a common type rating and you wouldn't have to go through the multiple retraining cycles.

I got it. Thanks for time, guys.

Yes.

Your next question comes from the line of Steve O'Hara with Sidoti & Company. Please proceed.

Hi, good morning.

Hi Steve.

Hi Steve.

Just to kind of building on Alex's question. The EBITDA run rate of $200 million, or in excess of $200 million, for next year -- does that include any flying with Schenker at all, or a continuation of that flying?

I think what we said, Steve, is that even if the Schenker business goes away in its entirety, we expect to meet that metric.

Okay.

$200 million.

Perfect. Then, the second question is, what is a good sweet spot in terms of the number of aircraft? And how comfortable are you in buying aircraft? Do you have fairly firm customer commitments, or are you comfortable buying them on spec or something like that?

I think we remain comfortable, even given the comments Rich had earlier about people being a little bit more hesitant. We're very comfortable buying 767s on spec and we said that in the past, on an annual basis, given the free cash flow and so forth, we're quite comfortable, say, targeting something in the four to six range for 767-300 deployments annually. Obviously, next year, we've got some continued investment in the newer generation combi platform, which as Joe mentioned, we are on our way to at least the first two combis. And we also potentially could invest in the 757 asset under the right circumstance.

Okay. Following up on that combi comment, has that aircraft been chosen by the military already?

Based on the specification the military has, essentially the 757 is the only asset that would fill the bill in terms of size and number of passengers, cargo container positions, et cetera. They are very much similar to the DC-8-size fuselage that we operate today.

Does anybody else have any scale on that asset right now?

I'm sorry?

Does anybody else have scale in the combi 757 right now?

No. Essentially from a combi standpoint, one that's certified in the US, there really isn't a product today that's certified by the FAA. There's another combi program under way today with a potential competitor. I'm not sure where they stand at this date in terms of getting that project certified.

Okay. Thank you.

Your next question comes from the line of Adam Ritzer with CRT Capital. Please proceed.

Thanks for taking the call.

Hi Adam.

Couple of questions. How much more of a valuation do you have in the balance sheet for the legacy 727s and DC-8s? Were those written down completely? Can you give us more color there?

In the 10-Q we talk about having $18 million still on the books, after the impairment.

Got it. Okay. And I know you gave out a lot of fleet information, can you kind of recap where you stand? How many planes do you have available now? And how many have you bought and potentially contracted for next year? Just so I can get this straight.

The easy question is how many we have available now, the answer is none. We're fully deployed as far as the 767 and 757s. When you look into next year, we've got one more 767-300 and one 200 that will complete their modification process between now, and -- call it the very end of the year. Moving into 2012, we have 767-300s number four and five under contract that will come out during the first half of the year. And as I mentioned, we're currently in negotiations on number six and seven, 767-300s. We also have a 757 that is in modification today, due out at the end of the month. That will be a full freighter 757. And then of course, the two combi aircraft, the first one out and in, call it the third quarter, and the second one out in the fourth quarter next year.

Okay. Quick math, so that gets me to eight?

I think that is correct.

Okay. And is the cost all (inaudible) fairly similar? Maybe you can run by the math on that again -- the cost to purchase these plus the mods?

Rather than break it up, let's just concentrate on the into service cost.

Okay.

Because the pieces can vary but usually it winds up in about the same place. In terms of the 767-300 platform, typically they go into service after mods with about $28 million or less on the balance sheet. On the 757 combi, given the uniqueness of the program and the requirement to do some engineering for a pretty small fleet, you're going to see values more north of $20 [million], somewhere in that range, for those assets once they go online.

Okay. So maybe an average of $25 million, eyeballing it. I know you talked about your returns on that, in excess of 10%, is that still fair to use?

Correct. On an unlevered basis, yes.

Okay. And is that an EBIT margin or EBITDA margin?

That's an EBIT.

Okay. And what do you think depreciation is roughly on those planes once you have them on the balance sheet?

We'd depreciate our 300s over 20 years.

Okay.

And the 757s, I would guess 15 that we'll establish for their depreciable years.

Okay. So, maybe million, million-and-a-half, something like that?

Right.

Got it. So, you talking EBITDA of, I don't know, $3.5, $4 million a plane? Would that make sense?

That's in the ballpark.

Okay. Got it. So, if you have that many potentially coming in next year, I know you've used the $200 million forecast, you've been at that for about a year now. Is there any reason you wouldn't potentially want to upgrade that? With these planes coming in, it seems like you could add.

Remember, some of them come in, in the latter part of the year.

Okay.

We're not giving guidance by the year-end run rate. We're talking about for next year. And I think what we said is we intend to -- we project exceeding $200 million next year.

Got it. So potentially by a year from now, again, I'm not asking you to comment, you can if you like, you might maybe have a $55 million EBITDA quarter, but throughout the year, it wouldn't average that, I guess what you're saying?

We would expect to see, of course, an increase. What's going to drive the EBITDA, obviously, is putting these planes into service. So, we would expect to see that increase next year.

Got it. Got it. Okay. That's all I had, appreciate it. Appreciate it.

All right.

At this time, we have no further questions. I'd like to turn the call back to Mr. Joe Hete for closing remarks.

Thanks, Jasmine.

I know most you are very focused on the current economic climate and are watching every piece of data for guidance on where the cyclical industries are going to wind up. There's no doubt that commercial transportation in general, and air freight in particular, are about as cyclical as they come. But if you're listening to me today, it's because you also know that even in cyclical industries there's companies with strategies that can deliver consistent performance through the peaks and valleys.

We believe we've proven we're one of those companies through our performance over the last six quarters under our new Business Plan, and what we believe we can deliver in the future. We're in a special marketing niche with special assets, and unique ways of deploying and supporting them, that big, growing global organizations like DHL want to work with. We're confident that we can continue to deliver, no matter which way the economy might turn on the future.

Thank you for your time. We look forward to seeing many of you as we head out on the road this fall and again on our fourth quarter conference call next year.

Remember to vote today. And have a quality day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.