Air Transport Services Group Inc (ATSG) 2013 Q3 法說會逐字稿

Hello. And welcome to the Q3 2013 Air Transport Services Group, Inc. Earnings Conference Call. My name is Miesha. I will be your operator for today's call.

(Operator Instructions)

At this time, all participants are in a listen only mode. Later we will conduct a question and answer session. I will now turn the call over to Mr. Joe Hete, President and Chief Executive Officer of Air Transport Services Group. Mr. Hete, you may begin.

Thank you, Miesha. Good morning. And welcome to our Third Quarter 2013 Earnings Conference Call. I'm Joe Hete, President and Chief Executive Officer of ATSG. With me today are Quint Turner, our Chief Financial Officer; Joe Payne, our Senior Vice President and Corporate General Counsel; and Rich Corrado, our Chief Commercial Officer.

We issued our third-quarter earnings release and filed our 10-Q with the SEC yesterday afternoon. So you can find both on our website, atsginc.com.

Our results for the third quarter represent progress against the new 2013 guidance we provided in August and represent a significant improvement over second-quarter 2013 results.

We have completed the principal regulatory matters involving the transition to our 757 combis that we discussed with you last quarter. That includes certification of our third 757 combi in September and approval earlier this week for them to fly to all the remote military installations we serve.

We have also integrated more of the administrative and accounting functions at ATI through implementation of a shared services approach at corporate, providing additional cost savings.

We're also achieving consecutive-quarter growth in both revenues and earnings, and are continuing to work towards executing agreements with potential customers, most of which are outside the US.

In a nutshell, we're on track to achieve greater returns from the assets we have today, even in a market that remains especially challenging for all, but particularly for those more heavily dependent on commercial charter volumes and military cargo moves related to the Mideast conflict.

The consistent revenue contributions from our leased aircraft portfolio and its express network based CMI and ACMI operations have proven to be more resilient than revenue streams driven strictly by commercial cargo demand.

Quint is ready to review our third-quarter results, including a balance sheet update. I'll follow him with another update on our major developments during the quarter, expand on what I expect in the current quarter, and offer some perspective on current and future market conditions before I take your questions.

Quint?

Thanks, Joe, and good morning everyone. Let me begin by advising you that during the course of this call, we will 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 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 obligations to update any forward-looking statements to reflect changes in the underlying assumptions, factors, new information, or other changes.

These include but aren't limited to,

- changes in the market demand for our assets and services;

- timely completion of final Boeing 757 combi certifications and deployment of aircraft to customers;

- continued achievement of the benefits we anticipated from the merger of two of our airline businesses;

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

Other factors are contained from time-to-time in our filings with the SEC, including our 2013 third- quarter Form 10Q, which we filed yesterday afternoon and is available on our website.

We will also refer to non-GAAP financial measures from continuing operations, including adjusted EBITDA and adjusted pre-tax earnings which management believes are useful to investors in assessing ATSG's financial position and results. These non-GAAP measures aren't meant to substitute for our GAAP financials. We advise you to refer to the reconciliations to GAAP measures, which are included in our earnings' release and also on our website.

Joe's overview comment that we're on track and making progress toward our updated 2013 adjusted EBITDA goal, is evident from a review of our results.

Our revenues on a consolidated basis were $140.9 million, up $2 million from the second quarter, and down $13 million from a year ago.

We had fewer aircraft in service during the third quarter than we did a year ago, and are serving fewer high-revenue international routes, but we also picked up more ad-hoc ACMI and charter revenue than we had in the second quarter and benefited from some good growth in our other businesses.

Net earnings from continuing operations for the quarter were down 33% to $7.8 million or 12 cents per share. That's up a penny from the second quarter, but down $0.06 year-over-year. Again, we are not currently a cash taxpayer, and don't expect to become one until 2016.

Third-quarter adjusted EBITDA, which excludes derivative gains or losses, was $40 million, down about $3.4 million year-over-year, and up $4 million sequentially. We were at $113.3 million of EBITDA through nine months.

Third-quarter expenses are down by $7 million year-over-year and flat with the second quarter.

They're down nearly $20 million year-to-date.

Principal costs savings versus the third quarter last year were -

A $3 million reduction in the salary line from a year ago to $41.5 million, including half a million dollars lower than the second quarter.

$2 million in maintenance expense which reflects the net effect of fewer but more extensive airframe maintenance checks compared to a year ago and higher rates for engine maintenance.

And a $3 million reduction in flight-related costs for travel, landing and ramp, and insurance, which were roughly flat with the second quarter, reflecting a lower level of flight operations and lower costs for domestic operations versus international.

Turning to our segment results, our leasing business, CAM, had pre-tax earnings after interest expense of $15.9 million for the quarter, which was down both on a consecutive and year-over-year basis. Higher depreciation and interest expense, plus expenses to support the additional freighters, offset revenue gains from our more modern fleet versus those prior periods.

CAM added one 767-300 freighter, one 757 freighter, and three 757 combis in the 12 months ended September 30 this year. It also removed eight legacy 727 and DC-8 aircraft from service.

At the end of the quarter, CAM owned 50 aircraft available for service. Twenty of those were leased to external customers, and 30 to our airlines.

We anticipate dry leasing an additional 767, a 300 series to a European operator under a multi-year term starting before the end of the year. This would bring the number of externally leased 767s to 21.

In ACMI Services, we had a pretax loss for the quarter of $7.1 million, compared to a loss of $1.7 million for the third quarter of 2012 and a $9.1 million pretax loss in the second quarter this year.

We continued to have expense affects from delays in our 757 combi rollout, including higher costs to maintain additional DC-8 crews and maintenance capabilities. Airline services revenues, which exclude fuel and other reimbursables, were down $9 million year-over-year but up $3 million from the second quarter.

A portion of the revenue shortfall on this segment stemmed from reduced results from charter and other ACMI operations at both airlines, especially over international routes. ATI, in particular grew its revenue from the second quarter to the third, thanks to additional ad-hoc business and also increased its military flying with the additional availability of 757 combis.

ACMI block hours for both airlines declined 14% year-over-year in the third quarter, but were up 2% from the second quarter. The reduction versus the prior year period mainly reflects fewer long distance international routes operated in favor of more shorter route domestic flying.

Pre-tax earnings from our other business activities, driven largely by our maintenance, MRO, and postal operations, were $4.4 million for the quarter, up significantly from the $3.4 million we had in the same quarter last year. Revenues and earnings from our maintenance and sort center management services for the US Postal Service were up sharply on increased volumes.

We are on schedule for the completion of the new hangar facility here in Wilmington, which will better match our maintenance capacity to our fleet size and give us room to take on more third party work as well. We hope to begin operations there in the second quarter next year.

Net cash flow provided by operating activities through nine months of 2013 was $61.5 million, down from $87 million for the same 2012 period. Higher pension contributions and lower payments from DHL were the principal change factors.

As we look forward at funding requirements under our pension plans in 2014, we are encouraged by the interest-rate trend prevailing so far this year, and its likely affect our funding requirements and balance sheet. Long-term rates are trending around 75 basis points higher than a year ago. If that persists, it could mean our obligation to fund our pension plans could be half or less of the $27 million we've invested so far this year.

We also expect a significant reduction in our balance sheet post-retirement obligations at year-end due to the sensitivity of those obligations to long interest rates. As an example of that sensitivity, each 50 basis point increase in the interest rates as compared to a year ago is anticipated to lower our pension obligation and improve our year-end equity by approximately $60 million. We will be able to give you the specifics about that significant equity improvement during our fourth quarter call next year.

Capital expenditures through September remained on track with the plan we outlined for you in our prior-quarter filings of $110 million for the full year. We spent $97 million through September versus $108 million for the first nine months of 2012. The bulk of the capital spent was for fleet modernization, including the two 757 combis we bought back in January, plus modification costs for the last of our 767-300s.

Today, the major remaining non-maintenance pieces of that budget are our new hangar here in Wilmington, and the completion of our two 767-300s. We do not plan to acquire more aircraft assets without a specific multi-year customer commitment. That does not rule out, however, the possibility of strategic investments where we believe they would expand our set of related capabilities, reduce our costs, or expand our access to new markets.

Through September, our revolver balance dropped to $190.5 million from a third quarter peak of $200 million. The net of both incremental spending and repayments. As you may have noticed in our 10Q, our bank syndicate has agreed to make another $50 million available to us as provided under the accordion feature of our credit facility, raising the aggregate funds available to us to $275 million under that revolver.

We don't have any current plans to exercise that additional capacity, but we considered it prudent to take advantage of the flexibility it provides, at minimal incremental costs. There now is no additional accordion option under the current credit agreement, which runs through July 2017. Our current debt-to-EBITDA ratio of 2.49 continues to qualify us for a low interest rate of 2.56% under revolver and term-loan throughout the fourth quarter.

That's the summary of our position at the end of the first nine months. Joe will guide you through the events of the quarter, including the progress we have made in completing the combi upgrade program and our near and longer term business opportunities.

Joe?

Thanks, Quint.

The quarter we just completed was a time for winding up the key elements of the last of our two principal 2013 projects, the modernization of our combi fleet, and for beginning to restore the profitability of our ACMI services segment.

Those two elements are closely related. Delays in our combi program have hurt the performance of our ACMI Services segment, particularly as it affects EBITDA. In fact, it's the one factor not subject to broader market forces, and the one we can say with certainty will be fixed soonest.

Our combi program for the US military does not serve active military operations in the Mideast and cannot easily be replaced by any aircraft in the military zone fleet. These aircraft are specifically designed to provide a regular resupply and personnel ferrying service between some of the most remote military facilities around the world, from Greenland in the north, to islands in the South Pacific in Indian Ocean.

The challenge has been to implement a completely new 757 combi operation within ATI, while simultaneously bearing the costs of maintaining strong service levels with the DC-8s and related personnel. Our plans for 2013 had this process moving forward in the early part of the year, with the full cooperation and support of the FAA. Their extended review along with additional crew training they required pushed us off schedule by almost two months.

We deployed our first two combis in late June and early July and the third in September. The sole remaining regulatory issue has been the FAA's assessment of the two-engine 757 combi for Extended Range Twin Operations or ETOPS certification for its longest Pacific and Indian Ocean routes.

When we talked to you in August, those evaluation flights were scheduled to take place before the end of the government's fiscal year in September. They were, however, delayed by the shutdown. I am pleased to report we completed our final proving run this week over the Indian Ocean and have now completed ETOPS and all our 757 operating requirements.

The operating cost reductions these aircraft bring, and that are driving our second half EBITDA gains, are already flowing through our results. The cost savings from retiring the DC-8s are beginning to arrive as well. We are finally at the point where we can claim that our all Boeing 767 and 757 fleets is achieving the efficiency, reliability, and fuel savings we projected a year ago.

The next key objective is growing our consolidated top line and capturing the margin benefits on new revenue from both leasing and operations that our fleet upgrades and airline merger were intended to yield. That's been a challenge for us and it has for most other cargo airline companies. We continue to have four 767s, not including the two completing mod, that are underutilized.

In that regard, some of the best opportunities we are seeing are coming from established operators outside the US who want to establish links to markets in the Americas, and among carriers currently operating in Europe and the Mideast. One such opportunity involving the lease of 767-300 freighter could be finalized before year end.

Rich Corrado is just back from some industry conferences and customer meetings, and during Q&A he will be happy to provide you with his fresh assessment of how the markets we serve are developing.

But no matter when consistent growth returns to the airfreight market, our progress is likely to be more rapid than some, because we have already made investments in growth assets, and we're not directly affected by aggregate freight volumes or yield volatility.

The majority of our aircraft, our 767-200 series, are best suited for hub-and-spoke service within networks. And the current airlines of those networks may be changing. Our service record, fleet quality, and strong balance sheet position us well to play a role in these other networks.

The final piece of our strategy involves the appropriate allocation of our cash flow among a range of strategic options. I'm not going to forecast how much free cash we will generate next year, although we have said it could be more than a dollar per share. We're sticking to our principles on additional aircraft purchases, which means that we're not in the market for more of them except on behalf of a customer willing to backstop the investment. And as Quint mentioned, we're expecting that higher interest rates will reduce the size of our required investment and our post-retirement plans in 2014.

We're hearing regularly from those of you who feel strongly about a cash return for shareholders. Your case has merit, but we continue to give equal weight to deleveraging and growth investments whether in customer-backed purchases of aircraft that we don't have today, our acquisitions that enhance our value or open new markets for our fleet. Capital allocation decisions will always turn on which option that delivers the best long-term return for shareholders.

Before we turn to your questions, I want to express our appreciation for your continued strong support as evidence by a sharp rebound in our stock price since our last call in August. We are confident that resolved the major internal issues we face. All that stands between us and an acceleration in our earnings is the recovery of the markets we serve and we are determined to seize the opportunities that recovery presents. And now Miesha, we're ready for the first question.

Thank you. (Operator Instructions). We will now begin the question and answer session.

(Operator Instructions)

Our first question comes from Jack Atkins from Stephens. Please go ahead.

Good morning Quint and Joe. Thanks for taking my questions this morning.

Hi, Jack.

And so I guess to start off with here on the ATMI segment, you know, the operating losses there improved sequentially. But, Joe, I guess in your mind, you know, what needs to happen to get that segment back to profitable on a stand-alone basis? Is it just a function of getting those other utilized assets flying again? Or do you think there are additional cost actions that you can take to right-size that?

Look, Jack, there's a couple of, you know, some opportunities for some further cost reductions. But the key is, as you've hit early on, was we've got to get the assets that are underutilized to-date deployed. I mean we're carrying the costs for those assets whether it's on the leased side of the equation or the amortization of some the heavy maintenance items. So the revenue stream is certainly critical.

Got you. Got you. And then, you know, Joe and Quint, you both mentioned strategic investments as far as a potential use of cash. Could you maybe - I know you don't get into specifics, but could you maybe highlight, you know, a couple potential avenues that you would view as strategic just for, you know, the folks on the call just to kind of understand what you guys are looking at as potential uses of cash.

From our standpoint, we look at things that would be synergistic to the operations we have, whether it's on the airline operations side or on the maintenance side is - they are the two largest areas obviously in terms of things that would be synergistic. We also, as you know, do some work for the US Postal Service which is a nice little piece of business for us. It's not a key driver but it certainly generates some nice cash flow. So anything that would dovetail with any of those three areas would be the ones we'd focus on from an opportunity standpoint.

Okay, great. Then one last question from me and I'll jump back in the queue. You know, Quint, you mentioned the potential EBIT tailwind from lower pension expense because of the changes in interest rates. Could you maybe go through that math one more time, and you know, if we were to see, you know, the 75 basis point higher rate sustain itself through the end of the year, what's the potential, I guess, P&L tailwind?

Well from the P&L standpoint, Jack, it's probably, you know, a few million dollars compared to the 2013 run-rate, you know, call it maybe as much as $3 million. The real big benefit, of course, at least in terms of the -is the obligation - is the reduction of the obligation itself on the - and the increase in equity correspondingly. You know, as I say there's a lot of leverage and a lot of sensitivity to that rate in that obligation.

And, you know, if you're talking 75 basis points, you could see, you know, $80 million, you know, call it $80 million swing in the equity and in lowering the obligation on the balance sheet which, you know, is pretty significant certainly.

Absolutely---

There's a piece that goes with that, Jack, is also we noted, you know, the cash contributions for next year would be, you know, significantly less than what they were this year.

And if we put in about, you know, as we said about $27 million, you know, between the qualified plans and the non-qualified plans in the current year, next year we could see that drop to half or less of that $27 million.

OK, that's great. Thanks so much for the time, guys.

Thanks, Jack.

Thank you. Our next question comes from Helane Becker, from Cowen. Please go ahead.

Thank you very much, operator. Hi, guys. Thanks for the time. Just a couple of little questions here. In terms of the guidance. I was just kind of wondering about this language where you talk about the seasonal opportunities. Can you kind of break out what it would look like, you know, the core business for the fourth quarter versus the seasonal opportunities in the center - are the seasonal opportunities better or worse than last year?

I think from a seasonal standpoint, Helane, they're probably about the same. You know, we have our core customer DHL has some peaking but not nearly what you would see out of a call to FedEx or UPS. And, of course, we have for years supplemented the UPS network with some additional lift during the holiday season. So I'd say it would be roughly equivalent to what we had last year.

Oh, okay. So if we looked at the business - I guess then if we looked at what it was last year, assumed it was the same, and kind of backed that out we'd get what the core business was looking like? I guess. Thinking out loud there.

That would be a good way to look at.

And then my other question is I was reading in a trade magazine the other day that DB Schenker is looking at their network because I guess I've got some contracts that are up for renewal next year and they're looking at the network trying to ascertain what they intend to do. Do you still have anything outstanding with them? I know they kind of pulled down a lot of their operations. But I don't remember if there is still some stuff out there. And would you be included in that evaluation for next year?

Well as far as Schenker goes, you know, in terms of anything that was contracted directly with them, that ended at the end of 2011. They did, however, transition some of their volume to DHL which increased by a couple of aircraft the number that we had in the DHL fleet at the beginning of 2012. And certainly if they were looking for any kind of dedicated lift, we'd be right there front-and-center saying, "You know, we have some assets available." And, of course, when you look at the 767 and/or the 757, you know, it's perfect for those kind of route structures dealing with the domestic side of the equation, whether it's, you know, within the US or intra-Europe, or even intra-Asia.

Okay. All right. Great, well thanks very much for your help. I appreciate it.

Okay, thank you.

Thank you. Our next question comes from Adam Ritzer, from Pressprich. Please go ahead.

Good morning, guys. How are you?

Hey, Adam, good.

Just a couple of things. Do you have any planes coming off a lease in 2014?

From a dry lease standpoint, Adam? Or are you talking about on the ACMI side?

Either side. I just wanted to see if there's anything we need to look forward to. If anything's coming off.

On the dry lease side of the equation, no, nothing comes due in 2014. On the ACMI side, you know, contracts are generally more like one year in duration. So they're constantly rolling over. But, you know, I think we've got a pretty stable book of business right now on the ACMI side of the equation.

And another thing we noted is, you know, we've got in our remarks is that we hope to be able to get to where we can announce some additional opportunities before the year is out.

Right. It looked like you said you might have one before year-end. And maybe - would this be a good time to have Rich say something. You said he was just back from some conferences.

Yes, he's sitting right here. Rich, go ahead.

Yes, I guess Adam, just from a general market overview, I think, you know, it's pretty well publicized that the cargo market is still in a more or less stagnant mode, you know, principally because of the slow economic growth. That really hasn't changed. However, if you look at the end of the granularity of the data and also from discussing with both prospects and customers, there is a more upbeat view particularly as it relates to volumes in-and-out of Europe, both to the Middle East and back to the Americas. We've got a number of prospects and existing customers that we're talking about, particularly in the EU where they haven't added any capacity there for over two years. And even from a fleet optimization standpoint, they're looking at additional aircraft to take advantage of some economies.

So there's some good activity out of Europe. There's been real solid activity going between North and South America as well. We've got some good opportunities looking into the first quarter of 2014 that we're pretty high on. So continuing to look for the, you know, the profitable pockets of prosperity, as we like to call them, in the overall market that may be stagnant is really what we're charged with from a business development standpoint.

We've done a lot with putting multiple customers together to try to build lanes and opportunities and given that we're, you know, we do heavily leverage relationships with the integrators in certain parts, we're able to put forward as an integrator together to try to, you know, build a lane, which is simpler to do with a medium range - medium-wide body aircraft than it would do in some of the larger aircraft lanes.

Okay.

So I think the market overall - in talking with other folks in the industry, you know, people are feeling somewhat of a bit of loosening up, if you will, of some of the views towards investments in networks which is really good for us.

There had been about four straight months where the growth has not been negative. And, in fact, the August growth was over 3%. And so if you look at that and you look at some of the things that are going on in Europe, you know, I think their people are a lot closer to pulling the trigger on some things than they have been really in the past couple of years.

Okay, that sounds a little better. And maybe if - maybe Quint, can you talk about, you know, you have a current portion of debt of a little over $23 million. Is that what you expect over the next 12 months, or is there anything additional that you have to pay down on your credit lines?

No, that Adam, that would be the next 12 months. And mostly the programmed principal payments, you know, on the term loan, the asset back loans, and so on.

Okay, so we have that. And what do you think maintenance CapEx is going to be next year?

Probably about $30, 35 million.

Okay, 30, 35. Okay and it really - with a 2.5% rate on your debt, is there any reason to pay down more than that, you know, $23 million, $24 million the way you look at it?

Well it just, you know, it again depends on, I guess, what - you certainly, compared to what you get with cash in the bank if you're not doing anything with it except storing in the bank, you know, there is a little bit of upside. But it's a pretty low rate. And also it allows you to reduce the debt to EBITDA leverage tranches. We're priced - our debt is priced based on, you know, our leverage. And so when you pay down your revolver and you get your total debt into a lower tranche, you pick up, you know, pricing leverage on the full data amount, which can be, you know, pretty significant.

And keep in mind, Adam, the bulk of our debt is in the revolver side. So if you pay it down, it's still down if you need to pull it back at another point in time later. So it's not like the fixed portion, where you pay it down and can't redraw it.

Okay. I appreciate it. That's all I had. Thanks a lot.

Yes.

Thank you. I would now like to turn the call back to Mr. Hete for closing comments.

The progress we made in the third quarter in our ACMI services business put us on a much more positive trend heading into the fourth. As you recalibrate your models for the rest of the year and 2014, I'm sure you'll want to factor into the continuing benefits of our ongoing cost reductions and the upside potential that our available aircraft represent to an already positive cash flow outlook.

I'm sure I'll be seeing some of you as we go on the road between now and our fourth quarter call. But until then, I want to thank you for your continued confidence in ATSG.

Have a quality day.

(Operator's instructions). Thank you. And thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.