Air Transport Services Group Inc (ATSG) 2018 Q3 法說會逐字稿

Welcome to the Air Transport Services Group, Inc. Conference Call. My name is Nicole, and I'll be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to Joe Hete, President and CEO of Air Transport Services Group. Mr. Hete, you may begin.

Thank you, Nicole. Good morning, and welcome to our third quarter 2018 earnings conference call. With me today are Quint Turner, our Chief Financial Officer; and Rich Corrado, our Chief Operating Officer.

We issued our earnings release yesterday after the market closed. It's on our website, atsginc.com.

We had another good quarter with more year-over-year revenue, adjusted EPS and adjusted EBITDA growth than we had in the second quarter. We also announced our agreement to acquire Omni Air International, which will contribute substantial growth and significantly broaden our revenue base in 2019.

Our revised fourth quarter guidance reflects modification delays resulting in some 767 freighters deploying later than we projected and lower margins in our MRO business in the second half than we had hoped to achieve.

But we are still on track to place five more converted 767 freighters in service this quarter, meeting our plan to deploy 10 of them during 2018, plus the one 737 we placed in April, and deliver record adjusted EBITDA and earnings per share.

Quint is standing by to summarize our overall financial results for the quarter. Rich will add some color on our other businesses, and I'll close with more on our outlook. Quint?

Thanks, Joe, and thanks to all of you joining us this morning.

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 obligation to update any forward-looking statements to reflect changes in underlying assumptions, factors, new information or other changes. These factors include, but are not limited to, changes in market demand for our assets and services; our operating airlines' ability to maintain on-time service and control costs; the cost and timing with respect to which we are able to purchase and modify aircraft to a cargo configuration; fluctuations in ATSG's traded share price, which may result in mark-to-market charges on certain financial instruments; the number, timing and scheduled routes of our aircraft deployments to customers; that one or more closing conditions to the acquisition of Omni Air International, LLC, including certain regulatory approvals, may not be satisfied or waived on a timely basis; the risk that the acquisition may not be completed on the terms or in the time frame expected by ATSG, or at all; uncertainty of the expected financial performance of the combined company following completion of the acquisition; and other factors as contained from time to time in our filings with the SEC, including the Form 10-Q we will file today.

We will also refer to non-GAAP financial measures from continuing operations, including adjusted earnings, adjusted earnings per share, adjusted pretax earnings and adjusted EBITDA. Management believes these metrics are useful to investors in assessing ATSG's financial position and results. These non-GAAP measures are not meant to be a substitute for our GAAP financials, and we advise you to refer to the reconciliations to GAAP measures, which are included in our earnings release and on our website.

We're pleased to report that our third quarter results were substantially better than the same period last year with double-digit growth in revenues and adjusted EPS and EBITDA. On a consolidated basis, third quarter revenues were $204.9 million. Under the new accounting rules, we stop recognizing revenue this year that is associated with reimbursed expenses. Subtracting $72.1 million in reimbursements from last year's third quarter revenues, our third quarter revenue growth was 13 percent, more than double the comparable 6 percent growth in the second quarter.

On a GAAP basis, we had third quarter earnings from continuing operations of $32.9 million versus a loss of $28.2 million a year ago. On a diluted basis, GAAP earnings per share for the quarter were $0.24 versus a loss of $0.48 per share a year ago.

The quarterly mark-to-market revaluation of our liability for warrants issued to Amazon resulted in a $16.8 million after-tax gain in the third quarter. The comparable mark-to-market adjustment for the warrant liability in the third quarter last year was negative $33.2 million. The related lease amortization incentive, also tied to the Amazon warrants, this quarter was $3.3 million or $0.04 a share after tax.

Our third quarter share of cost to develop a freighter version of the Airbus A321-200 with Precision was a $0.03 a share item after tax this quarter versus $0.01 a year ago. Adjusted for those items, our EPS from continuing operations was $0.31 diluted for the third quarter, $0.09 higher than a year ago.

Third quarter adjusted EBITDA was $74.3 million, up 13 percent from third quarter last year. Adjusted EBITDA grew 9 percent in the second quarter.

We ended the first 9 months of 2018 with $214 million of capital spending, slightly behind our 2017 pace. We have spent $149.2 million to buy five 767-300 feedstock aircraft and to fund freighter modification of those and others in process. We now expect a 2018 CapEx spend of about $280 million for the year.

As Joe said, we're very eager to add the great assets and capabilities of Omni Air to ATSG. We expect the acquisition to be accretive to ATSG's adjusted EPS starting in 2019.

The purchase will be funded through an expansion of our current senior credit facility, primarily through a $675 million additional term loan, along with borrowing under our existing revolving credit facility. At close, we expect our total debt to annual adjusted EBITDA ratio to be approximately 3.4 time, inclusive of Omni Air's EBITDA contribution.

Joe will have more to say shortly about the significant adjusted EBITDA our existing businesses and Omni are expected to produce next year. The strong cash flows from those combined businesses and air fleets in 2019 will provide us with ample liquidity to continue to invest in attractive growth opportunities.

That's the summary of our overall financial results for the quarter. Rich is ready to discuss our segment results and market perspective. Rich?

Thanks, Quint. The third quarter was challenging on an operating basis, but we still delivered revenue growth across each of our segments and achieved a $1.5 million gain in pretax earnings overall on an adjusted basis versus 2017.

Our airlines again achieved improved revenues and positive earnings, even with the same number of aircraft they operated last year. In the fourth quarter, ATI will be operating 2 more 767-300s on an ACMI basis during peak and continuing well into 2019. As we told you last quarter, ATI's pilots received pay increases last March that have increased expenses by $2.2 million per quarter. We continue to negotiate for an amended labor agreement with our ABX pilots as well.

Block hours increased to just 2 percent overall in the July to September period preceding peak. Service performance was strong and continues into the fourth quarter. CAM, our leasing company, had seven more aircraft in service at September 30 than a year ago.

Pretax earnings were $19 million, down marginally from a year ago. Earnings from a larger leased fleet were again offset by increases in the lease incentives to Amazon and lower maintenance support revenues.

We had expected to place two 767-300s in service during the third quarter and three in the fourth. Conversion process delays instead pushed lease and certification arrangements for those two aircraft into the fourth quarter.

We still expect to complete deployment of five 767-300s this quarter, for a total of 10 newly converted 767s. We sold one for a net of nine 767s, but added 1 more 737 freighter. 2 of the added 300s are already in service as dry leases. We will dry lease one more and lease the other two to ATI for ACMI Service during peak and beyond.

CAM remains in the market for more 767 passenger feedstock to meet 2019 demand. We have secured rights to five 300s for 2019 deployment, and that number is likely to increase in the coming months.

MRO Services, which includes the results of our aircraft maintenance and conversion businesses, had earnings of $2.3 million for the quarter, down slightly from a year ago. The results were not as strong as we had expected, however, due to a higher mix of maintenance services for CAM's expanding portfolio of external dry leases versus work for outside customers and delays in completing some scheduled maintenance. Specifically, two 767-200s were put into AMES to transition from internal to external dry lease deployment in the fourth quarter. These dry lease preparations took MRO slots that could have been utilized for external customer revenue and profit. The short-term impact of MRO performance creates a benefit for CAM and ATSG through the long-term external dry leases of these assets.

Pretax earnings from other activities increased to $3.1 million. The gain is attributable to better results from our minority interest in West Atlantic and improvement in our postal and gateway operations. As we noted in our release, our contracts to manage sort operations at five regional U.S. Postal Service centers expired in September. Pretax earnings for that business were $2 million in the third quarter.

From an operating margin perspective, I'm looking forward to bringing Omni Air's aircraft assets and capabilities into the ATSG family of businesses. We regard their strengths as very complementary to ours, including a broader base of government and commercial customers, along with the addition of the Boeing 777 platform. We will have more to say about Omni Air and the opportunities it brings after we complete the purchase this month.

With that, I'll turn it over to Joe.

Thanks, Rich. While the third quarter was a good one overall, we fell short in a few areas that we were counting on to achieve our adjusted EBITDA target for the year. The principal issues were delays in getting newly converted and current 767s deployed or redeployed, plus lower returns from our MRO segment, stemming from a change in the mix of internal and external volume.

Those factors, plus the expiration in September of our sorting operations for the U.S. Postal Service, are the principal reasons we lowered our adjusted EBITDA for 2018. We are now targeting adjusted EBITDA of $80 million to $85 million for the fourth quarter, which will likely be a quarterly record for ATSG.

Delays in aircraft placements won't affect our momentum entering 2019, with 78 ATSG cargo aircraft in service, plus 13 passenger aircraft that will come to us with Omni Air.

On a preliminary basis, we expect to deliver more than $440 million in adjusted EBITDA next year, including from those 91 ATSG and Omni aircraft, plus our existing businesses. That does not include contributions from the eight to 10 more 767-300s we expect to deploy next year. And we have identified lessees for most of those additional 300s. We will issue a complete picture of our adjusted EBITDA outlook for 2019 when we release our fourth quarter results in late February.

We feel fortunate to have been the successful bidder last month for Omni Air, a leading provider of contracted passenger airlift services to the Department of Defense and other federal agencies. Our conversation with Omni Air's management since the deal was announced in early October give us even more confidence that we are making the right move for ATSG shareholders with this transaction. We hope to close within the next several weeks.

We are also pursuing opportunities that would secure more ATSG growth and cash returns well beyond 2019. By the time we hold our fourth quarter call in late February, I'm sure we will have more to report about how the long-term shareholders of ATSG will be rewarded for their confidence in our ability to deliver superior results over time.

That concludes our prepared remarks in the call. We're ready for the first question.

(Operator Instructions) Our first question comes from the line of Kevin Sterling of Seaport Global Securities.

Let me -- just on the MRO work, you talked about you had a higher level of internal versus external. Was this -- what drove this? Was it just a higher use of aircraft with the internal network? Was it unscheduled maintenance? You may have touched on it in your prepared remarks. And if you did, I'm sorry. But just kind of curious as to what drove that level of higher internal work.

Kevin, thanks for the question. The principal reason was a transition of aircraft from internal operation to external lessee. And there were four aircraft involved in that. two of them were actually on ABX's certificate and leased to DHL in the U.S. And DHL made a decision to move those aircraft to the Middle East, so we had to take those out of service, put them in the hangar. And generally, what you do is you have to upgrade the navigation equipment for that area of the world. And you have to go through a number of things between the records and the repairs on the fuselage that have been done over time and make sure that you've got a clear picture what the records look like for the aviation authority in that region of the world to review the aircraft and accept it on their certificate.

So we had those two aircraft. And then we had two other lessees, one in Poland and then one for West Atlantic that will be delivered this month, both aircraft. Those also went into AMES. And the same issue, those are going into EASA both in Europe, and we had to upgrade the navigation equipment for the aircraft and we had to go through a thorough records review.

The records review, generally, some of the things you find in that is, if you don't have back-to-birth records for some of the repairs, you may actually have to remove the repair and put it back on the aircraft, believe it or not. And so you generally don't know until you review the records how long or what the extent of the work that's going to be required on those aircraft.

So if you look at the four slots that were available, if you could have put C checks in there, as an example, then you would have driven more revenue into AMES on top line and you would have driven more profit that would not have been eliminated due to the external.

A lot of that work, Kevin, goes on the balance sheet than to the P&L, and then it gets amortized over the portion of the lease until its next heavy check, for example, and that's why it doesn't hit the profitability line as well.

The good news on that, if you will, is that we've now secured a 5-year lease on one 200 external lease, a 7-year lease on another 200. The one is going into Europe. And then we're getting -- we're working right now with DHL on lease extensions for those aircraft that are going into the Middle East. So although we've got the short-term dip in the MRO performance, it's good for CAM and it's good for ATSG to lock those assets up for a long period of time.

Yes. So Rich, it sounds like you have kind of maybe some short-term pain, if you will, right now for kind of the long-term gain. Is that fair?

That's exactly right, Kevin.

Okay. And I just want to make sure, Rich and Joe, too, that I got this right. I think last quarter, you said you could place six to 10 767-300s in 2019. And now you believe it's eight to ten. So it looks like you upped the bottom end of that range. Am I reading that right or did I hear that right?

No, you heard it right. And as we said in our remarks that the majority of those aircraft are pretty much identified as to where they're going. Obviously, we don't talk about who customers are until we got final contracts inked. But we're pretty confident in terms of being able to place eight to ten airplanes in 2019.

Okay. And then let me piggyback on that, Joe, if you don't mind because I think in your prepared remarks and Rich's, you talked about really strong demand and customer indications of some leased aircraft. Is it a matter of just finding feedstock for you guys to satisfy this demand? Are you still turning away business? How should we think about that? Because it sounds like you've got a lot of opportunity, customers knocking on your door, customers calling you, looking for aircraft. So is it just a matter of getting your hands on additional feedstock? Am I thinking about that right?

Yes, in terms of feedstock, it's still pretty tight. Again, you can always find an airplane, it's just a matter of whether it hits your into-service price point. That's always a key driver for us. And as far as turning customers away, it's not necessarily a function of turning them away as much as just scheduling out in the process in terms of when an aircraft would be available. So as I said, if we're talking eight to ten airplanes, we don't have them all placed at this point in time with identified customers per se. But -- so we do have a couple that are potentially available. It's just a matter of priorities.

Okay. And then last question from me. You guys kind of indicated as we think about EBITDA for 2019 with no growth of $440 million. And let me ask a CapEx question, if you don't mind, for 2019, at least directionally. I think you talked about a CapEx in 2018 of $280 million. Can you give us a guide for how we should think about 2019 CapEx? Is it similar to 2018, up or down? I'm not asking anything specific, but maybe just directionally how should we think about 2019 CapEx, if you don't mind?

Yes, of course. We'll have Omni, Kevin, on board next year. So if you think about sort of maintenance CapEx, our business not -- without Omni, historically, we've kind of said, hey, we're sort of in the $60 million to $70 million annual range for maintenance CapEx. And I think Omni, if you look at them, they're more like $20 million of maintenance CapEx. They have a fleet, an existing fleet, which, depending upon growth opportunities, we would look at potentially adding to that. And we do think there is some growth opportunities for it. But their existing fleet has that maintenance CapEx level, so figure $80 million of maintenance CapEx. And we talked about eight to ten airplanes. And you know what our sort of all-in cost that we target is sort of that $23 million to $25 million range for the 300. So depending upon where we land on that eight to ten, you get a pretty good sense of where the CapEx might go next year. It could be up from this year a bit, but I think that reflects the growth opportunities we're seeing in the market.

Our next question comes from the line of Jack Atkins at Stephens.

So just to piggyback a bit on some of Kevin's questions there. Rich, I guess, if I could direct this towards you for a minute. I mean, I guess, we're seeing some concern in the market overall around just the direction of the macros going to maybe 2019. Obviously, trade concerns are top of mind for folks. But your prepared comments would indicate that your customers are pretty confident about the direction of their businesses.

So could you maybe comment just around, in general terms, obviously, sort of what you're hearing from customers in terms of their outlook for their businesses going into next year? And how do you think demand for your asset base trends over the next 12 months?

Thanks for the question, Jack. Now we're just as bullish on demand for the assets in 2019 as we were in 2017 and 2018. The market is very strong for this asset class. And again, this asset class-wise, network operations for integrators, express carriers and for e-commerce service providers. And that market, you look at some of the macro news in terms of the China-U. S. trade situation, et cetera, I mean, those are lanes that we don't compete in. And the e-commerce business is still growing significantly, and the conversion of retail into e-tail is still something that's a growing venture. And if you look now, I think nine percent of the global retail spend is in e-commerce. So there's a lot of room for growth in that to continue.

So when you look at that macro number as it relates to e-commerce, which is driving both the integrators and folks like Amazon and the demand for assets that we're hearing across the board is very strong, I mean, the deployments that we've done this year, if you look at them, one was in Asia. We're moving some aircraft into the Middle East. We put -- we're going to put three more into Europe. And then we put, I think, eight into the U.S. And so the demand right across the board is very strong. And the demand that we're seeing going into 2019 is again strong in all areas of the world.

Okay. That's really encouraging to hear. And then, I guess, along those same lines, but just sort of thinking about it conceptually, I mean, you've got quite a number of your assets that are under long-term lease, and it sounds like that, that mix is growing. And then with the addition of Omni, that is principally a government-driven business there, so I would think that would not be as macro-sensitive.

So I would just be curious to hear you guys kind of talk about the level of cyclicality that you see in your business. I would think that the way you guys have structured things here, if things were to soften up from a macro perspective, you may not see it in your business.

Yes, no, that's a good point, Jack. If you look, I mean, we have -- it's been our strategy to focus on the dry leasing portion of the business and look at all the other things we do in terms of whether we're flying or whether we're maintaining aircraft, there's value-added services on top of the lease to increase the returns we get. So from that perspective, we've -- I think we'll have over 85 percent of our assets, the 767 assets dry leased. And then a number of those, of course, are subleased back to us and we also fly. So that's been the strategy that we've gone through.

But even more than that, if you look at the customers that we dry lease to and also the aircraft that we fly, again, it's for the integrators and for network operations, those are the ones that are a lot less sensitive to cyclical demand because when you're servicing a network, you have to service all those points in the network. You can't all of a sudden not service Boise, Billings or Butte. You have to go to those -- you have to provide service to those areas as part of your network. And so the -- for express carriers to downsize their network, it would have to be a significantly long-term impact of the economy that would impact the demand for those services.

And Jack, keep in mind, on those aircraft, like said, over 80 percent of our 767 fleet will be on long-term dry leases by the time we close out the year. If you look at the Omni acquisition, 70percent of it is DOD business, another 15percent is government business, and then 15percent is in play from a commercial perspective. So if you look across the board in terms of macroeconomic impact, we've immunized the lion's share of our book of business.

Yes, that's definitely the way it seems, so that's great to hear. Last question, and I'll turn it over. But would just be curious to get an update on the A321 conversion joint venture, so where does that stand? And are we still targeting the first plane into modification maybe late 2019? Or I guess, the certification of the modification process in early, please?

Yes, the first airplane, I believe we've already cut metal on the first aircraft. And so, now as you start the whole process of putting the pieces back together, it's a complex issue to deal with. And of course, one of the things you run into as well is getting past the FAA. And so what the FAA looks at as you're going through the certification process is what new things are they looking down the road at. And since your opening the airplane up, they want you to embody some of those things in there, like in the past, we never had to deal with 16-g seats in freighters, for example. But since they're putting those in passenger aircraft, they want us to do that for the supernumeraries, for example, in the aircraft. But all that said, we're still targeting the end of 2019 for certification of the first aircraft and going into production in 2020.

Our next question comes from the line of Helane Becker of Cowen.

Question, just a follow-up on the last question. Your -- how many aircraft will you be able to manufacture or convert once the whole process of Precision is up and running, let's say, a 2021 or 2022 run rate?

Yes. So basically, it's a matter of how many facilities we can make available for setting up production lines. And of course, a big part of that is going to be driven by what the demand is. But if you think about it in terms of from a turn-time perspective when we haven't nailed that down yet.

But if you look at a 767, for example, the turn time on the conversion for one of those is 120 days. So you'd figure, worst-case scenario, you're going to do three or four aircraft with one line and probably better than that at the end of the day because you don't have quite as much floor structure to replace on the 321. And then it's just a matter of how many different lines do you want to open up.

Certainly, from our perspective, we're looking out to say, okay, what can we fit, if anything, in our existing facilities? PEMCO does the 737 conversion process. They most recently flew the 737-700 for the first time. It's in paint now, will be heading over to the Bahrain Airshow and then come back for its final certification flights.

So we've always got at least one or two base in Tampa that we can utilize, whether it's on the 737 bases or the 321. And if you remember, when we did the PEMCO acquisition, one of the reasons we did that was because they were well-versed in the Airbus products, which we didn't have a whole lot of experience with here in Wilmington. So if you think on a conservative basis, we could probably produce, when we're up to full speed, 10 to 15 airplanes a year.

Okay, great. And then just on the Postal Service contract, I guess I missed that you -- I don't know, it's probably in last quarter's 10-Q, and I just missed the contract, when it'd be renewed. So that's $2 million of pretax earnings per quarter that you're going to be not having? Is that the way to understand that?

Yes, Helane, it's Quint.

The fourth quarter was probably the largest quarter in terms of the postal operation. I mean, if you look at it, the -- and I went back and look, of course, we've had these contracts for a number of years. And I think in the last few 10-Qs, we've pointed out, hey, these contracts terminate in September, unless renewed. We hadn't expected to get renewal. And instead, they -- I think they went to sort of a new operator in terms of managing these facilities.

The EBITDA production that we have gotten out of the postal operations, about the best year we have had over the last several was about $5 million annually. Now in the fourth quarter, typically, you saw -- in third quarter, you saw a little better production from that. Most of that occurred in those quarters. So in terms of scoping this as far as our EBITDA impact, probably about $5 million annually was associated with the postal.

Okay. And then on Omni, so I thought I saw earlier this week that you received clearance to regulatory approval to do the acquisition. And what's left?

We did receive the Hart-Scott-Rodino approval, which is the antitrust piece. We have not received the Department of Transportation go forward -- approval to go forward at this point in time. We expect to get that within the coming week and right now targeting, if everything goes according to schedule, closing this thing out by the end of next week.

Okay. So the way we should think about it is, what, about eight weeks? What is that, seven-weeks-ish of revenue from...

Yes, six to seven weeks.

Right, of this -- for this year and then full on next year?

Yes, ma'am.

Our next question comes from the line of David Ross with Stifel.

I guess, with Omni, real quick. You mentioned being maybe a little bit more encouraged or incrementally positive after conversations with management. Can you elaborate on anything new that you've learned since announcing the deal? And what made you positive after having those conversations?

Well, I think talking to the folks at Omni, obviously, since they were in the sales process, they were a little bit hamstrung in terms of being able to add assets into the mix. Right now, they're saying that there's additional opportunities that they've had to pass on from a commercial perspective just because of shortage of assets.

Now remember, part of the rationale for buying them was synergies. And one of the key synergies in there was related to the fact that they operate the 767, and it provides a natural feedstock pipeline potentially, i.e., buying newer aircraft that don't fit our price target for conversion, running them through Omni, heading out at the point -- at some point in time later when the value has been depreciated somewhat, putting them into the conversion process.

So it's really a function of their commercial opportunities that they believe are going unfilled. Obviously, feedstock, as mentioned earlier in one of Kevin's questions, is it's still a little bit tight from our normal conversion price point. But it doesn't preclude us from looking at an asset that normally wouldn't fit that cost profile to be able to run it in through Omni and allow them to operate it from a commercial perspective and a passenger perspective.

And those additional commercial opportunities would be on the passenger side, not the cargo side?

Yes. Yes, passenger side.

Okay. And then can you talk about the delays in some of the conversions in the 767 schedule back after this year? When you're doing a conversion for a customer and it's getting delayed, what do they do? If the plan was to put something into service in October and it doesn't come until December, do they just have to wait? Do they charter a plane for a couple of months? Do you guys do anything for them in terms of providing aircraft?

Yes, this is Rich.

It's kind of a mixed bag. So some of the customers that are waiting for aircraft, they have other aircraft that they have spares for maintenance coverage that they may be able to just use those to cover those routes or what have you. Sometimes, folks are timing a new aircraft delivery because of their maintenance schedule, and they can extend their maintenance schedule a little bit and wait for the aircraft.

We do some swapping around sometimes where, if a delivery is late and the customers can move it to another quarter, we can get back on queue with the other customers. And so we try to minimize the impact to customers. But it's really variable depending on what they need it for.

In a wet-to-dry scenario where we start an aircraft and we fly wet until the customer wants to take a dry lease, Northern Air Cargo is a great example of that. They took three aircraft from us between the fourth quarter last year and this year. We're still flying a route for them today as they get their crew component up to speed. And so that's another scenario where we would continue to fly and put up an asset to support a customer in the event that they're waiting for aircraft.

And when you think about the fleet and the 767-200s that are left in there, how much life do you think they have? And how close are we getting to scrapping some of them altogether?

Well, we took one aircraft out of service in midyear of 2018. And we will begin the part-out process at this point in time. Right now, based on a 50,000-cycle limit before you got to go into a new maintenance program on the aircraft, we have a second aircraft that's coming up against that 50,000-cycle limit, it will be in the second quarter of 2019. So we would end up by the end of the second quarter of 2019 with two of the 200s that are out of service at that point.

Our next question comes from the line of Steve O'Hara of Sidoti.

I'm just curious, were there costs around the Omni acquisition in the quarter that were called out? I didn't -- maybe I missed it, but I don't know if there was anything in there.

No, not significantly, Steve. I think in the fourth quarter, certainly, we'll have costs, and we will segregate those as we report. But we'll have some significant transaction fees in the fourth quarter that will spike out.

Okay, okay. And then just if you look at CAM, I guess I'm just -- I know there are some delays and some, I think, maintenance within the quarter. But I guess, with seven more aircraft, and I guess I'm just a little surprised that the pretax wasn't up a little more or maybe that the revenue wasn't a little higher. And I'm just wondering, I mean, is that going to -- I mean, maybe the aircraft added late in the quarter -- I mean, you did note that kind of operationally it was a tough quarter, but I would think that would be more on the ACMI side.

I guess, when do you start to see maybe better pretax income growth and relative to aircraft divisions? And then looking at ACMI, how far away from the typical range that you've given in the past are we now from that given the higher pilot costs with ATI? And then is that just something that corrects over time where new contracts are kind of included -- including higher maintenance -- higher pilot costs? And as those contracts come up for renewal, the industry is going up, you guys are going up, and that kind of corrects itself. Can you just go through that?

Sure. Steve, of course, as we mentioned, in terms of the third quarter, we have anticipated, I think, three leases starting during the quarter, and those pushed into the fourth quarter. So as far as CAM and growth in the CAM results, revenues and margins, those will occur as we add aircraft into the mix, which we'll have five online, new ones, by the end of the fourth quarter. And then, of course, we've given some guidance about eight to ten additional tails next year.

CAM is also impacted by these lease transitions that Rich mentioned, where you have to interrupt CAM's revenue flow to pull an aircraft out and ready it for delivery to a lessee, external lessee under a long-term lease. He mentioned, I think, that we've got a couple of aircraft that are going to be placed, I think, one for five years, another for seven years with external lessees. But to do that, we pull those out, we have to send those to the MRO, and it's that short-term pain and long-term gain.

I mean, we get very -- we get attractive returns, and we get the certainty of these multiyear deployments by doing that. And that can, in a given quarter, that can impact how CAM's results look. But again it's a, long term, a better scenario. We're still targeting the same kind of returns on our deployments that we always have. And I think you're familiar with that in terms of our ROIC that we target for those on an unlevered basis. And so I would continue to expect that as we go forward.

And Steve, on the ACMI front, yes, obviously, as we noted, after we got an agreement with the ATI pilots, it's about a $2.2 million a quarter impact this year. The contracts under which the ATI guys fly today essentially didn't have escalators in there that would allow us to recoup those costs. And so until such time that you get to where you can rebid the contract to cover those additional costs, it's something we're going to have -- it's going to come off of our bottom line that we're going to have to deal with. So when you look at the ACMI results, obviously, on a year-to-year comparison, much better this year than they were last year, in spite of the fact that we do have that additional cost in our cost structure for the ATI pilots at this point in time. And of course, as we go forward, we'll be looking to try to recoup those costs from our customers when we go through to a rebid process.

Okay. And then maybe just on the pilot situation and the kind of, I guess, indexing contract. I mean, is there more -- if it is to do that on your side today, then maybe it -- there was maybe five to ten years ago given concerns about pilot shortages and things like that.

It seems like the pilot shortage is likely a real thing. And eventually, it comes home. And I think attracting pilots is obviously important to you guys. I think you do a good job of attracting them and keeping them. But it would seem like pilot costs are bound to go up over time. And I'm wondering if there's more pressure on you guys or you guys are putting more pressure on customers to kind of create a contract where you don't have this lag between rising costs on the pilot side and then getting the benefit back in the contract.

Yes, in an ideal world, you would certainly like to see something like that, Steve. But from a customer perspective, obviously, their pushback is going to be -- it's something -- want something that's more well-defined and known going forward because they have to price their business to their customers in the end. So from the standpoint of at least on the ATI side, we know where our cost structures needs to be as we go through rebid processes for the next four years.

The ABX contract is still in negotiation. Where that falls out when we finally get a contract certainly is not going to be before the end of 2018, and so we will look for 2019 to get there. But it's just one of those things that you have to deal with in the business, and we're not alone in that respect. Our competitors out there either have contracts and have to swallow some of the same costs as we do and/or they haven't got a collective bargaining agreement yet and will have to deal with that increased cost when it comes.

Our next question comes from the line of Howard Rosencrans of Value Analysis.

Just a sort of question or a sort of bigger-picture question in terms of your business and, I guess, what I perceive and I'm curious how you perceive the connect between the market and your business and prospects. Your stock, as you're probably aware, is hovering at a new 52-week low. Yes, the market was a little sloppy in October, but it seems to me you guys sort of get grouped into a very cyclical sort of business, number one; and number two, possibly tainted with some trade concerns as you generally trade with what is viewed to be you're comparable as Atlas. And I just want to know sort of generally how you feel about that. But putting it in a little bigger context, with $455 million in EBITDA if we include the eight to ten planes that you're incorporating into the incremental mix next year, looks to me like you've got possibly $300 million in free cash flow before, I guess, the add of those planes sort of on just utilizing maintenance CapEx. So it's foreign change, $5 per share in free cash flow. Do you envision redirect? Or is it -- do you think, at some point, you get more -- you get aggressive and you reposition yourself to more so focus on the stock and the shareholder return that would provide?

Thanks, Howard. It's Quint.

Certainly, we are excited about, with the addition of Omni, what the cash flow production looks like for next year. And I think Rich and Joe talked about not only the five aircraft coming out in the fourth quarter, but that the eight to ten next year, other than I think Joe mentioned there's a couple that are still available as we always try to have a couple that we can fill our customers' quick need for, we have a very high confidence level about where those placements are going next year.

And so we think that things look very bright in terms of what we can produce. And I think the Omni acquisition, as has been discussed, is something that, in terms of adding a nice stable cash flow contributor into the mix and diversifying the revenue stream, is also seen as a really good thing.

In terms of how we think about capital allocation, you mentioned we get lumped in with other things. And certainly, the tariff discussion, we do get that question a lot. And I think you and I talked about that before. We don't feel that there's an impact with where our assets go that is significant at all for the tariff piece or the trade talks. As you know, our mid-sized assets go into the e-commerce-driven regional network structure, and now many are deployed or will be deployed with the DOD. So we feel really good about that and don't feel that, that will be a real problem for us.

As far as capital allocation towards looking at our stock, we are going to, of course, close the transaction with Omni here shortly. And for a time, as one of our bank provisions, there will be some limitation. Our leverage ratio at close is estimated to be around 3.4 times, inclusive of Omni's EBITDA contribution. And I think we have to be under 3 times after giving effect to any stock buyback or dividend-type capital distribution before we would be free to do that under our current bank deal. So it would probably be sometime later in 2019 before that would be an available option.

But certainly, as we always do, we look at what brings the most value to our shareholders. And depending upon where our stock is trading, absolutely, that's a viable option for us in the mix along with our growth opportunities.

Great. I appreciate that. I hope you'll look at that more aggressively. But the follow-on question I had concerns the -- to your smaller businesses. And you and I have spoken offline about sort of the ACMI not being part of the CAM business. I always feel like it's a semi-loss leader. And you all suggest, no, it's really a standalone. But I'd like to discuss the potential briefly, just if you could provide some color on both the ACMI. And I did not hear the answer to Helane's question or maybe that was the lead-in. But could you give us some color on what sort of the potential is for MRO when you get the approval to start dealing with the Airbus fleet and where that can go?

From a margin business perspective, both the businesses, ACMI and MRO, are probably single-digit-type margins. But the businesses themselves complement the leasing piece very strongly. I mean, our two largest lease customers, DHL and Amazon, also avail themselves of the operating capabilities of our airlines. And of course, our airlines are very -- really have grown up serving the very business that those guys concentrate on, which is that expedited delivery piece.

And so that is something that has been -- worked really well for us. It also gives us the capability most pure leasing companies don't have, and that's to take an asset that would otherwise be idle and generate cash flow through having our own affiliate airline operated on an ACMI basis. So we -- from a cash flow perspective, they've certainly been contributors. And on a margin basis, you're looking at a single-digit-type margin that we look for in the ACMI piece. On the MRO piece, it's very similar. Lease transitions that Rich mentioned earlier can be handled seamlessly. And both of our largest customers also use our MRO to take care of the assets they lease in terms of their heavy maintenance. So it's really a value-added service that just fits well with our leasing business.

Yes. And Howard...

I'm not asking you to quantify it. I'm just trying to get any sort of sense as to what your investment is, what your return can be, where these -- where in particular the MRO can go when you get Airbus approval. I'd like to think that there could be -- I understand they're single-digit margins, but I don't understand the associated top line that you're -- that one could get with, let's just say, the MRO in particular when you have Airbus, even if it's 2021 or something.

Yes. Howard, as far as the Airbus goes, we don't have a finished product yet. So I mean, first and foremost, it's going to be, what does the finished product look like, right? How much of that is going to be installation labor, which is where the MRO would come in versus the materials that it takes to complete the modification, the cargo door and things of that nature.

We're not far enough along the track to be able to give you any kind of number in that regard. And keep in mind, at the same time, we're limited by the capacity in our hangers. So it's not like you can just stuff a whole bunch of airplanes in there and generate more bottom line dollars because the floor space is limited to a degree.

So the MRO piece, unless you go out and start investing or leasing new facilities, you're not going to see it as a growth vehicle. But certainly, it's critical to the support of our leasing business, as Quint mentioned. And there are opportunities in the future, both from a conversion standpoint, which is nice to have because it's cookie-cutter, you roll an airplane in, it's the same work, you don't run into any unexpected things.

But at the end of the day, it's not that the MRO business is not capital-intensive. It's basically a people-oriented business, just like anything from a logistics perspective. So when you talk about returns, anything you get is a good return because the initial investment is pretty de minimis.

Our next question comes from the line of Chris S. of Susquehanna Financial.

So just if you could walk us through the procurement process here for the planes. So you've secured the rights for -- and that was an eight to ten now once you've taken up the low end there. So does this mean that there's an economic liability for ATSG attached to these? Or do you wait to put a deposit, if you will, once you have a formal contract in place with customers?

Yes, there's -- Chris, I think we've got in our release here with that fleet summary, five aircraft, so that will be in process and are awaiting conversion at the end of 2018. So that -- think of that as five of the eight to ten. So that would, say, there will be three to five others that we would need to find to round out next year's, what we talked about, as fleet additions. Typically, until you accept the airplane, there isn't a whole lot of capital that's expended. You may have -- you may put down a small deposit just to secure the airplane, but any liability or significant outlay of cash doesn't occur until such time as you actually accept the physical airplane.

Okay. And of the five you mentioned here, you have formal agreements with customers where you're closed?

We're closed.

You're closed. Okay. And then on the Omni call, was it a few weeks back, you've spoken about the sort of the shift in revenue where DHL and Amazon were around, I think, around 57 percent of revenue or around 29 percent each, and now they're 18 percent, 19 percent, and you said for now. And then in your opening remarks, you spoke about giving additional color on ways to enhance shareholder value back in January.

So given where we are with the higher leverage constraints, which Quint alluded to before, how should we think about capital allocation going forward? Is it -- are you suggesting that we could go back to kind of looking at more e-commerce levered opportunities? Or are you considering a step-up in buybacks?

Well, I think, Chris, we spoke to buybacks earlier. And I think what we said was, of course, the board has approved a buyback program. And while that can be temporarily affected by our covenants in the bank agreement after the Omni acquisition, that's always a viable option for us, depending upon what the full range of growth opportunities look like. If growth opportunities are out there, I mean, we typically do lean that way because if we don't move on them, then you lose that opportunity perhaps forever because someone else will take that.

You spoke about the Omni impact on our revenue mix. And as you pointed out, it does -- and I think when we announced the deal in early October, we had a slide that went with that announcement where we gave a first half '18 revenue mix and a pro forma first half revenue mix. And it does have significant diversification impact on us. For example, I think in the first half of the year, Amazon was 29 percent of the revenue, DHL was 28percent. On a pro forma basis, those numbers would go to 19 percent for Amazon and 18 percent for DHL, with the DOD becoming the largest single piece, along with our current 757 combis to be about third of our overall revenue. So it does do a nice job of diversifying the revenue stream.

Okay. And a follow-up, if the -- and apologies if you mentioned this before, but could you give an update on labor with ABX and if that's any type of markup is included in the preliminary 2019 guidance?

As far as ABX goes, we're still under the auspices of the National Mediation Board. There were meetings held Wednesday and Thursday of this week with the union to discuss further moving the ball down the field. As far as the contract goes, no, we have not, in terms of talking about the $440 million, have not put in, factored in anything specifically related to the pilot side of the equation. Obviously, there will be a lot of fine-tuning in terms of what our guidance will be for 2019, which we'll elaborate fully on come the year-end results announcement, which will be at the end of February.

Our next question comes from the line of David Ross with Stifel.

I'm all good. Questions asked. Thanks.

Thank you. I'm sure those are all the questions we have for today. Let me hand the call back over to Joe Hete for any closing remarks.

Thanks, Nicole. This year's third quarter was our best ever even if it fell short of our goals. We have redoubled our efforts to make the fourth quarter a strong one as we complete our Omni Air acquisition and meet our 767 deployment targets. Thanks to everyone for joining us on the call. Have a quality day, and don't forget to vote next Tuesday.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect. Everyone, have a great day.