Air Transport Services Group, Inc

Thank you for standing by, and welcome to the Air Transport Services Group First Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you'll need to press star 1-1 on your telephone. If you'd like to remove yourself from the queue, simply press star 1-1 again. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mr. Joe Payne, Chief Legal Officer. Please go ahead.

Good morning, and welcome to our first quarter 2023 earnings conference call. We issued our earnings release yesterday after the market closed. It's on our website, ATSGINC.com. Let me begin by advising you that during the course of this call, we will make projections and 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. Air Transport Services Group undertakes no obligation to update any forward-looking statements to reflect changes and underlying assumptions, factors, new information, or other changes. These factors include, but are not limited to, unplanned changes in the market demand for our assets and services, our operating airline's 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 and in interest rates, which may result in mark-to-market charges on certain financial instruments. The number, timing, and scheduled routes of our aircraft deployments to customers. Our ability to remain in compliance with key agreements with customers, lenders, and government agencies. The impact of current supply chain constraints, both within and outside the U.S., which may be more severe or persist longer than we currently expect. the impact of the current competitive labor market, changes in general economic and or industry-specific conditions, including inflation, the impact of geographical events or health epidemics, such as the COVID-19 pandemic, and other factors as contained from time to time in our filings with the SEC, including the Form 10-Q we will file next week. We will also refer to non-GAAP financial measures from continuing operations, including adjusted earnings, adjusted earnings per share, adjusted pre-tax earnings, adjusted EBITDA, and adjusted free cash flow. 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. we advise you to refer to the reconciliations to GAAP measures, which are included in our earnings release and on our website. And now I'll turn the call over to Rich Corrado, our president and CEO, for his opening remarks.

Thanks, Joe, and good morning, everyone. On our last call, we talked about the headwinds facing us in 2023 in our operating businesses, but mostly at our airlines. Unfortunately, The results we issued yesterday and our guidance change for the year as a whole show that reduced revenues at our passenger airline Omni and inflation-driven costs at all of our airlines are having a bigger effect than we expected. We are not alone in this regard. Inflation and a softening macroeconomy are squeezing profitability in many sectors, and especially in transport. We have limited exposure to fuel costs, but our personnel costs are rising. including for line maintenance workers and travel for flight crews shuttling between assignments. That said, we're fortunate that demand for our leased cargo aircraft remains strong. Our guidance changes were not related to CAM, which deployed two of the record 20 freighters we released this year at rates that meet our return requirements. I'll be back to share more of that perspective after Quint reviews our financial results for the first quarter. Quint?

Thanks, Rich, and welcome to everyone on the call this morning. As he just said, our first quarter results show that inflation remains a key concern, and its specific impacts on our businesses were greater than they were when we talked to you in February. Inflation is affecting all of our businesses, but the principal impact is in our ACMI services segment. The next slide in our deck summarizes the results that Rich mentioned. Our revenues grew 15 million or 3% versus a year ago to a record 501 million for the first quarter. Both of our principal segments, as well as our other businesses in total, contributed to that increase. In fact, among all of our operating businesses, only OmniAir, our passenger airline, did not grow its revenues versus a very strong first quarter last year. Our GAAP pre-tax earnings were down 39 million and basic earnings per share were $0.28 versus $0.67 in the first quarter of 2022. On an adjusted basis, pretax earnings fell $26 million to $38 million, and earnings per share was down $0.20 to $0.36. Our aircraft leasing segment, CAM, delivered all of our segment earnings for the quarter. Its pretax earnings were roughly flat with a year ago at $34 million, mostly due to higher interest expense and freighter deployment delays. Our ACMI services segment, which includes all three of our operating airlines, had a $2 million pre-tax loss on $334 million in revenues for the quarter. That loss at ACMI services is mostly attributable to Omni Air, our passenger airline, which experienced sharply higher costs and $26 million fewer revenues than it did a year ago. Airline block hours were roughly flat versus the prior year quarter, even with more aircraft in service, as scheduled flight segments were shorter this year than before. Passenger block hours were down 25%. Cargo block hours were up 4% for the quarter. Block hours for our 757 combi operations for the military were up sharply, as a Trans-Pacific route was reinstated last fall. On the next slide, you can see that versus the 12 months ended in December 2022, our adjusted EBITDA was down $20 million to $621 million for the 12 months ended in March. First quarter adjusted EBITDA was $138 million. Federal pandemic relief grants under the payroll support programs have had no effect on our results since 2021. On the next slide, you'll see that our capital spending continues to increase principally from growth investments in our lease freighter fleet. Sustaining capex, mainly for airframe and engine maintenance, technology and other equipment grew at a slower pace and includes capitalized engine maintenance services for our 767-200 lease customers. Total CapEx was $219 million for the first quarter. Growth CapEx was $165 million, up $93 million from the prior year, both to convert existing aircraft to freighters and to buy more feedstock. We deployed two newly converted 767-300 freighters during the first quarter. The next slide updates our adjusted free cash flow as measured by our operating cash flow net of our sustaining CapEx. Operating cash increased $91 million to $216 million in the first quarter, or $563 million for the trailing 12 months, net of sustaining CapEx of $205 million over 12 months. Adjusted free cash flow is up $73 million to $358 million on a 12-month basis. The cash flow gain reflects reimbursement of fuel costs from OMNI's federal government customers, which had been slower when we talked to you in February. On the next slide, you can see that available credit under our revolver facilities in the U.S. and abroad was $388 million at the end of the first quarter. with an option for additional capacity subject to bank approvals. That includes a $100 million credit facility in Ireland we established in March. Our capital allocation strategy continues to include share repurchases. We bought back approximately $1 million of our common shares in the first quarter after $2 million in repurchases during the fourth quarter. With that summary of our financial and operating results, I'll turn it back to Rich for some comments on our operations and outlook. Rich?

Thanks, Quint. Please turn to the next slide. As I said earlier, we had hoped to begin 2023 on a path to deliver better results as measured by adjusted EBITDA than the $640 million we delivered last year. But that's clearly not where we stand today. We have reduced our 2023 adjusted EBITDA guidance by approximately $40 million and our adjusted EPS guidance by about $0.30 to levels more consistent with the results that we believe our businesses can achieve in the current environment. As Quint said, inflation is driving up costs throughout the company. Our peers are reporting the same pressures on their own margins. In our case, the most dramatic effects are on the operating costs of our airlines and higher interest expense. For airlines, line maintenance is the cost of keeping aircraft in shape during normal operating cycles. The cost of those services has been growing at double-digit rates over the past two years and above what we had budgeted at the start of the year. We also pay passenger airlines to move our crews to the next assignments. For example, Omni's costs for flight crew transport, reflecting fare increases that the traveling public is also facing, are up more than 35% per cycle in the first quarter versus a year ago. Throughout the company, our businesses are engaged in efforts to address inflation and cut costs. Line maintenance, travel, and other procurement costs, as well as right-sizing personnel requirements to business volumes, are areas of focus. Within our HDMI services segment, Omni's first quarter results were down, including lower revenues for both commercial and government customers. Those results were affected by the appetite of other passenger airlines to participate more fully in the Defense Department's CRAF program this year. Many flew missions in the first quarter that Omni had flown in earlier periods. Even if Omni's total DoD block hours do not increase significantly this year, it expects to benefit from better pricing under its DoD contract starting in October. Omni's flying also consists of charter awards from other government and commercial customers that it bids based on real-time costs. We anticipate that those assignments will cover any shortfall in craft flying. Our cargo airlines fly under long-term CMI agreements, which include annual price adjustments, some of which will occur this quarter. Controlling costs between CMI escalations has always been a focus of our airlines. Ongoing inflationary trends have only magnified their imperatives. that, along with their ability to win peak season and other limited term contracts throughout the year, are essential to our margins in that business. Please go to the next slide. We told you last time that our fleet investments will increase over the next two years based on strong demand for our freighters. Many airline customers, mainly overseas, have made commitments to lease our cargo aircraft as they complete conversion. We expect to deliver 14 767s and six A321s to customers this year. The main constraint on our ability to do so are extended conversion turnaround times at our vendors and certification of our Airbus A321 freighters. Resolving the international regulatory issues for the A321 have taken longer than expected. The USFAA has already certified the A321 based on our design. We are working directly on final remaining issues with regulators elsewhere. Pending a resolution of this issue, we intend to take a measured approach to our A321 freighter program, which could reduce our 2024 capex. That's a situation we will monitor throughout the year and make adjustments as appropriate if circumstances change. We have heard from some investors who question whether the stepped-up capital spending we will need to convert and deploy the number of freighters our customers want is the most prudent use of capital. We agree that our 2023 capital budget of $850 million, including $590 million for fleet growth, is substantially more than we have spent before. Despite the economic environment, we fully expect to earn double-digit returns on the growth capital we invest, which has long been our benchmark commitment. If freighter demand does not support our expected returns, we have the flexibility to significantly reduce our planned growth investments in 2024 and beyond and reallocate that capital in favor of debt reduction, more share repurchases, or other alternatives. It's clear to us, as well as many of you, that in our current stock price multiple, we can create additional value through share repurchases. Our decisions about capital allocation will always be driven by what creates the most value for shareholders. Please go to the next slide. Our new guidance for 2023 projects adjusted EBITDA of a range between $610 to $620 million in 2023 and adjusted EPS of $1.55 to $1.70. While we face challenges in 2023, we expect our earnings and cash flow growth to resume in 2024 and beyond from fleet investments and higher lease rates. We will continue to have a strong balance sheet, a leadership position, in the mid-size freighter leasing market with large express and e-commerce customers and the strong backing of investors in our credit facility and debt securities. Our employees are prepared to execute against all of our 2023 plans with a goal to generate long-term superior returns for our shareholders. That concludes our prepared remarks. Quint and I, along with Mike Berger, our Chief Strategy Officer, are ready to answer questions. May we have the first question operator?

Certainly. One moment for our first question. And our first question comes from the line of Jack Atkins from Stevens. Your question, please.

Okay. Great. Good morning, guys, and thanks for taking my questions. So, I guess if we could maybe start, Quinn, just to make sure everybody is kind of positioned correctly and thinking about the cadence. You know, within the framework of your guidance, I mean, how are you thinking about, you know, improvement in earnings or EBITDA sequentially? And, you know, how do you break down the EBITDA guide between sort of maybe first half, second half? Can you maybe give us some framework to think about that?

Sure, Jack. Thanks. You know, it is second half weighted is the way we're projecting right now. And in terms of You know, thinking about the segments, you know, the second half improvement, a lot of that is driven in the ACMI services segment. You know, CAM is, you know, more of a sort of a steady, fairly steady EBITDA contribution, you know, with growth as we move through the year. But ACMI services, I believe the second quarter will be – you know, some modest improvement, but more of the improvement is in the second half. If you think about Omni, you know, Omni, you know, its busiest time is sort of June through October, typically. And that drives some of that. And, of course, the cargo carriers, you know, as they head into peak season and as additional aircraft are added, you know, we've got some customer aircraft coming on, for example, in the ATI fleet. That's the drivers in that balance. EBITDI-wise, we're looking at some improvements certainly in the second quarter and then the third and fourth, more of that as we finish off the year.

Got it. But, I mean, if you did $138 billion in the first quarter in EBITDA, you know, the guide at the midpoint, $615, you said second-half improvement. You know, just kind of roughly speaking, like what percentage of the EBITDA, full-year EBITDA, would you expect in the second half of the year, just so we can kind of think about that?

I would say, let me see. We'll run that for you here quickly.

Okay. I can move on, and then we can come back to that if that's okay. So I guess, you know, Richard, Mike, as you sort of think about the pipeline of demand for the core part of the business here, which is midsize freighter leasing, whether it's the 767, 300, A330, have you seen any sort of change in customer demand in the last few months with with everything that's been going on in the economy? Anything that would make you think that folks are getting a little bit less confident in their forward expectations around demand?

Jack, we haven't seen any erosion to the order book at all in 2023, inclusive of 24. And if you look out at our 330s that we've talked about now for several quarters, You know, we still have, you know, over 20, you know, commitments with deposits on those, and we start inducting those later this year. Our first couple will go into induction. So when we look at the 24, 5, and 6 specifically, with those new aircraft coming in, you know, we still see a very, very solid and bullish market. And, you know, when we look at the industry forecast as a whole, you know, the big Boeing forecast and the CargoFax forecast, When you look at it even further, a much broader view, 10, 20 years or so, those continue to be very, very strong in regards to the medium wide-body needs for the industry, close to 900 over the next 20 years or so. So short-term, to answer your question specifically, still very solid, no erosion. And from an industry broader view, still very, very bullish. Jack, this is Rich. Just a couple other points to add on to Mike. Interesting data from Syrian involving freighters that during the pandemic, during a normal course of a normal year, there's about 70 freighters that are retired each year. During the pandemic, that was only about 15. And so you're looking at 165 airplanes over that three-year period that may have would have been retired of different sizes, right? And so there's been a pent-up demand for right-sizing aircraft and for replacing older airframes with newer airframes going forward, on top of the fact that e-commerce growth is better outside this country than certainly it's growing inside this country. If you look at the order book, just quickly on the 767 side, that has an example. for 2023, 11 of the 14 aircraft that we'll deliver this year, they're to existing customers that already lease airplanes from us. So we've got ongoing regular dialogue with these folks, and we're real confident in the order book for 2023.

Hey, Jack, just circling back on your question on the cadence on the EBITDA. The second half is about 54% of the total. So sort of a... two halves.

Okay. Okay. I appreciate that, Quint, and I appreciate the sort of the thoughts on the outlook. So I guess when you put it all together, I mean, the stock is down about, you know, 40%, 45% so far this year. If you go back and kind of benchmark the reduction in EBITDA at the bottom of your guidance versus where the history was before for 23, I think it's about a 13% reduction. So, you know, pretty aggressive move down here. The stock is not a vote of confidence, I guess, in the CapEx plans, as you sort of think about both this year and next year. So I guess, you know, Rich, you don't want to make a knee-jerk reaction to sort of how the stock's trading, but you've got a $1.1 billion market cap, and you're spending $600 million or so on growth CapEx. I mean, at what point do you think about you know, sort of other alternatives for your capital to sort of, you know, better align your cash flows with, you know, supporting the stock here? We haven't seen it this cheap since 2016.

Well, first off, you know, prior to this quarter, we thought, you know, just for the guidance that there was an overreaction to the stock. and that it should have been higher before we got to this quarter's results. And, look, we do have flexibility going forward. In terms of dialing back on CapEx for 2024, we've got different scenarios and everything. We do have customer commitments for just about all the freighters that are coming out in 2024 as well. And so in backing off on any of that, it would be a significant decision. We believe that if you look at the book of freighters that we're going to put on in 2023, they will deliver a little over $70 million in revenue in 2024. And we have a high conversion of adjusted EBITDA to revenue on the leasing business. You know, we feel that this is a good use of capital. The lease rates are something that we're focused on right now, particularly for 2024, to make sure that we have the right returns for those airplanes. And, you know, we think we're staying the course at this point in time. But, again, we do have flexibility should we need to adjust.

And, Jack, the adjustment in the guide is strictly related to ACMI services. I mean, the CAM – you know, the CAM – investments are generating the returns that we expect. And if that doesn't, somehow that were to change, as Rich says, we do have some flexibility to reduce our capex spending. And at the same time, we understand how attractive our own stock is as an investment at these prices. And so that isn't lost on us. So the capital allocation is always going to be done with an eye towards what generates the best value. And we think there's value creation through directing capital to both share repurchase and growth. The headwinds we've faced this quarter have been strictly limited to the ACMI services segment. And at least on the revenue side this quarter, it's more related to our passenger flying, which we referenced in the release. We do think that that is going to improve as we move through the year. We also mentioned the inflation, which continues to be an issue for us. But there are adjustments in the contract that our airlines have that should help that as well as the cost control measures that all of our subsidiaries are undertaking right now.

Okay. Maybe one other final quick question, and I'll hand it over. I don't want to hog all the questions. But I guess, you know, as you sort of think about the valuation of the company today on an enterprise value basis, you know, relative to your asset value and the value of the cash flow of the company, you know, at what point does it make sense to maybe think about private market valuations and what an infrastructure fund or somebody like that would be willing to value ATSG at if the public equity holders won't value the company appropriately?

Well, Jack, this is Quint. We certainly understand the question, and we have looked at our valuation, our public valuation, and when you look at what the company produces in terms of the cash flows, the the adjusted EBITDA, you know, kind of the way we believe, you know, that somebody from the outside would look at it is when you think about our leasing EBITDA, which is the majority of the company's EBITDA, you know, it's, you know, four and a half, you know, over 400, you know, 400 to 500 million dollars of EBITDA And you put a multiple on that, you know, as PE firms often do. Now, leasing multiples tend to be higher, you know, eight plus. But, you know, if you put something even lower than that on there, which could be very conservative. And do the same with our ACMI services EBITDA, which last year was, I think, over $200 million. This year, obviously, it's going to be down. And ACMI services and airline multiples tend to be lower. And so, again, put a conservative multiple on that, as well as the other businesses, the MRO and logistic businesses. And then, of course, reduce the debt. But I think what gets lost is we have $500-plus million of assets in process, you know, the assets we have in conversion. So it's 27 aircraft. as Rich described, have customer contracts waiting on them. And if you just simply assume that at cost, that what our invested dollars are, you know, again, take out the debt, take out something for Amazon warrants, you know, that's kind of how we think of it. And when we look at it that way and spread it over a per share value, you know, we get a valuation that's conservatively closer to 30 than it is 20. And certainly, you know, We're even below that as we speak here. To us, it appears your point is well taken that the public valuation doesn't seem to be giving credit for the assets that are in process. Those 27 aircraft and even at a conservative multiple on our EBITDA, which for our leasing entity, we've got a lot of long-term leases and cash flows that we can we can look at, as well as contracts for the assets in process, it seems to be a very attractive valuation, to say the least, at our current public valuation. And, you know, we have looked at it in that fashion.

Okay. All right. Well, thank you for going through that, Gwen. I appreciate it. Thanks, guys. Thank you.

Thank you. One moment for our next question. And our next question comes from the line of Helen Becker from TD Cowan. Your question, please.

Thanks very much. Hi, guys. So just a question on the ATI pilots. That contract is open, and they've been very aggressive and very vocal about wanting more money. They've talked about... service issues and attrition rates. And I'm wondering if you could just give us an update on what's happening with that and how you're thinking about covering the cost of a potential increase.

Sure. Helena, this is Rich. Thanks for the question. It's not unusual for labor unions to put out press releases in regard, you know, particularly around, you know, benchmark earnings calls and and play out labor relations in the media. We don't think that's fruitful on our part. I can comment on the service quality of ATI, which is outstanding. And as an example, we get paid a bonus for making service with our customers, and they made the bonus two months out of this year so far. So we're in pretty good shape. We're in really good shape in May so far as far as service goes. There has been crew attrition. We've talked about crew attrition on other earnings calls. It's prevalent in the industry. It's common between our three airlines. It's a situation that we're managing. We're still able to attract crews with a good amount of experience and a good amount of flying hours, well over the minimum, and train them and get them into the network to be productive. So we're in good shape as it relates to moving forward with crews, but it has raised our costs, and it's one of the inflationary cost pressures that we have. When you're training pilots to replace pilots at a trip, you know, you've got an unproductive resource while you're going through that training period, which is anywhere from 70 to 90 days. So it has impacted our cost situation. As far as the union agreement goes and the costs going forward, Negotiation is now in mediation, both parties agreed they had taken it in terms of ALPA and in terms of ATI, had taken the negotiation as far as they could take it by themselves, and it's now in mediation, so they'll be going through and iterating contract issues, et cetera. As it relates to the cost side of that, we have always maintained in the past when we've negotiated union agreements and for this union agreement as well, that we need pricing or contract rates and benefits that allow us to attract the best pilots we possibly can, while also focusing on the fact that we need to be competitive and we need to be able to compete for business in the HDMI segment of flying. Those two parameters still guide our decision processes in this fashion. I can't really comment on the amount of increase or that going forward, but But like I said, it will play out over the course of probably at least the rest of this year, given that the contract is in mediation.

Okay. Are there any accruals in the guidance for any increases? I don't remember how you guys normally do that.

Yeah, we don't. I mean, the contract or the amendment resolutions are a ways off. And it's, you know, that's nothing we ever, you know, comment on. But typically, we're not expecting a contract resolution for a while yet. Just based on past history, it usually takes longer to work through a mediated process. And so, you know, as we get closer and we see what's going, you know, how things are shaking out, you know, we'll appropriately, you know,

record whatever we need to, but... Yeah, no, I mean, Quint, that's pretty standard. Some airlines will not accrue until they have a better sense of what the contract's going to look like, and some accrue a little amount. So I just didn't remember how you guys did it. I wanted to ask about the 12 767s that were due to come up for renewal this year. I know four were released. Three were not going to be because you were going to use those aircraft because there's time on the engine so you could use them for other customers. What's the status of the other five? Do we know that? Did I miss something there?

Yeah, I mean, what we said, you know, previously still goes, Elaine, we would look to release or sell the other five.

Okay. Has anything happened with those yet?

Well, right now there's still

Right now there's still an operation, but we've got commitments to sell four of the returns as we progress through the end of the year.

Okay. Is the proceeds or the timing, the proceeds included in the guidance and is the timing, do we, do you know, I mean, you must know the timing.

Yeah, it would be in the second half, right, it would be in the, what, third and fourth quarter, sort of split between those quarters, and it is in the guidance.

Okay. That's very helpful. Thank you, I guess. Thank you.

Thank you. One moment for our next question. And our next question comes from the line of Frank Galanti from Stifel. Your question, please.

Yeah, great. Thanks for taking my question. I wanted to follow up on thinking about the business as two separate entities, right? You've got CAM, the leasing long-term contracts, much more stable, right? Your public peers, although not in the cargo, right, are trading at nine, ten times their lease, their cap. And even if you look at the Atlas Air takeout, doing that kind of split, you had about eight, maybe eight and a half times on the leasing side. And then the question really gets down to two parts. One, is it reasonable to think about the company as two entities like that, right? It seems to me that they're inherently intertwined as the main reason the leasing business is so large is the value-added services through the ACMI business. And then a second part of that is long-term ACMI margins. And so we saw in the pandemic, those margins jumped 4%, 5%, 6%. But if you look through the history, those were just breaking even and negative for a couple of years. Can you sort of talk about those two components? Is it reasonable to think about the businesses separate and then ACMI margins on a long-term basis? What gives you confidence that those shouldn't go back to zero, that they should stay at the 4%, 5%, 6%? Or where do you envision that in the medium term?

Thanks, Frank. I'll start here, and I think Rich will join in here. But, you know, Historically, on the ACMI services segment, and first of all, we do bifurcate. That's why we report them separately as segments, right? So we think of the businesses, the leasing business, separate from the airline ACMI piece. And the ACMI services piece tends to be more asset-like. Obviously, the CapEx side of our business is the leasing business, buying the feedstock, converting the aircraft, et cetera. you know, the margins that we had historically looked to achieve, you know, on the ACMI services piece as a whole, and it varies between, you know, sort of the passenger, you know, and Omnicare is a little different than the other two. But generally speaking, it had been in that, you know, 5% to 10% range. And you're right that during the pandemic, there were, you know, there were some opportunities certainly that you were available due to shortage of capacity, or in the case of Omni, sometimes world events that drove some of the demand that allowed for improvement over those traditional margins. But we do think that that asset-like business over the long term can produce attractive contributions to our overall cash flows and margins. It doesn't drive a lot of capex. And you're right that some of our large leasing customers, you know, Amazon and DHL, also lean on the experience and the capabilities of our cargo airlines. And that does make our business model unique. But I don't, you know, when you say intertwined, I think regardless, you know, customers who need the midsize freighter to handle the e-commerce growth and express growth, they're going to need that you know, that converted midsize freighter capacity, and that would be required anyway. Having the capability, though, to, you know, also use our operating services and our MRO services, we think is a value add for them, and it's a value add to our cash flows. Now, there is more volatility with the ACMI services segment, and I think the Omni piece is probably, you know, more – less visible what the future demand is sometimes for obvious reasons. You know, their large customers are, the largest customer is the government and the DOD, and that can be difficult sometimes to project. Now, that has been, you know, worked well for us for several years, really, since we bought them. And this quarter, you know, we did see some reduction in that flying, and You're right that cost pressures, inflation pressures can affect ACMI services more. But over time, we expect, you know, to see inflation worked into our revenue streams through our contracts. And we do have long-term contracts. You know, the Omni contract structure, you know, has escalation points built into it. But in the short run, there can be dislocation. You know, when costs rise rapidly and you don't get it, adjustments until contract anniversaries and things like that, your margins suffer in that interim period. But over the long pull, we expect those to adjust and we should be able to achieve targeted margins on our HDMI services segment over the long run. And it will contribute to our overall ATSG cash flows on top of those leasing streams.

I think the only thing I'd add to that, Frank, is that We're the largest dry lessor to Amazon. We're the largest dry lessor to DHL. We also fly a lot of the airplanes that we lease. Well, all the airplanes we lease to Amazon and most of the airplanes that we lease to DHL. It's a unique strategic advantage that we have to be able to pair the flying with the leasing and augment the returns on top of the lease with the flying piece of it. And so that strategy has played out well for us in the past. Now, what we've done in the last couple of years is really focused on the dry leasing business and a global growth plan. And so a lot of what's coming in 2023 and 2024 are leases of aircraft that are going outside the country where we won't have necessarily an operating role in those airplanes. And so it's like a diversification, if you will, of the strategy so that we're leasing these aircraft to other operators. Now, a lot of these operators happen to fly for DHL, UPS, or FedEx, or Amazon in other parts of the world. So they're still augmented and supported by strong customers that are paying for the airplane. So We think it's a good strategy, and it's allowed us to diversify into a situation. At the same token, I will also say a big growth spurt for us during the pandemic was flying just in a CMI, asset light only basis, for airplanes that our customers have given to us. And I think the count's up over 15 now. I think it's 17 between our two large network providers in the U.S., So that's an area where obviously we wouldn't be flying those airplanes if we weren't confident in our ability to be profitable with that business. And so we look at the cost pressures that are going on right now as something that we will cycle through and address.

That's super helpful. I really appreciate that. I wanted to dig in to the second question on maintenance costs. So I think some of the negative reaction in the stock and the investors I talked to is around the large jump in sustaining cash flows. I know that's sort of not the focus of this call. It was sort of the last call. But I wanted to think through that from a, like, when I look at the, I don't know, just sustaining CapEx on a trailing 12 basis relative to assets, and I know we've only had this for a year, so it's kind of hard to look back historically, but it's been about 8% in 22, and on the 260 number on a go-forward basis, that's a 10%. Is that, like, is this an outsized year? Is the way to think about sustaining CapEx is basically all CapEx minus growth to CapEx is sustaining CapEx? And so that it's sort of, It's going to be lumpy, but if you looked at it, you'd say, oh, 9% of assets is really the normalized number. Yeah, we're going to have bigger maintenance events because of engine, right? We didn't do engine overhauls last year, but we're going to do engine overhauls this year. And then next year, there's going to be sort of a little bit of reprieve. It's sort of 9% of assets, the normalized number. Because there's a difference between sustaining CapEx, the way you report it, and a normalized maintenance CapEx number. Can you sort of talk about that difference and what that number would be on a go-forward basis?

Yeah, Frank, I'll take a shot at it here. The spike in 2023 sustained CapEx is associated with the timing of some engine overhauls, you know, for the – GE88 engines that are part of the pool that we offer to less ores. And, you know, those came out of a power-by-cycle agreement with Delta a while back, and we established this pool. But there was a sort of a larger number of engines that was going to require overhaul, and, you know, this is that timing. So I do not anticipate the 260 to be the norm. You know, we've talked about more like 200. And you can see, you know, over the longer pull, and you can see looking back, it's been under $200 million on a 12-month look back. What really drives our sustaining CapEx to increase would be if, you know, we had more aircraft that we were responsible for the maintenance on. And in our business model, you know, the growth is going to be leased to external lessees, and they're responsible for that maintenance. So as CAM grows its fleet, you know, we do not anticipate significant growth in sustaining CapEx. You know, the airlines do themselves have some, you know, spare capability for aircraft that they have for their CMI agreements. and they are responsible for the maintenance for those aircraft, but that doesn't increase significantly as does our lease fleet, externally lease fleet that we have no maintenance responsibility for. We don't expect Suspended CapEx to really grow much over time. There may be some growth due to inflation, et cetera, There's nothing really driving it fundamentally. And the growth capex that we report is strictly feedstock plus conversion cost. So you are right that everything else we're putting in that sustaining line. And that does include some smaller items that our subsidiaries may have to do repairs and maintenance that they have to do. on large items, hanger mates, things like that that may fall into that category and some smaller pieces of equipment. But generally speaking, we don't expect that to go up significantly over time as we grow.

Perfect. Very helpful. Thank you very much.

Thank you. One moment for our next question. And our next question comes from the line. of Christopher Staphalopoulos from Seshquahana Financial. Your question, please.

Okay, good morning, everyone. Quint, I just want to understand here exactly what's included in this revised EBITDA guide for this year and trying to get a handle on what potential downside risk there could be to this guide. So if you could kind of walk, if you could walk us through, you know, how we should think about ACMI block hours. through the balance of the year, and particularly Omni, and then remind us with Amazon, how much visibility do you have into their flight schedules? Is it sort of month by month, or do you already know what you're going to be flying in the second half and by extension peak? Two, what's the assumption in terms of CAM placement renewals? Three, it sounds like there's some provision for there in asset sales, and then It doesn't sound like there's anything in there for pilot accruals. So just want to understand sort of the building blocks as we think about this revised EBITDA guide for this year. Thanks.

Thanks, Chris. Yeah, you know, obviously there's, you know, a lot of detail in our projections. But, you know, just sort of in terms of a little bit like Jack Atkins' question to start off in terms of sort of the cadence of – of what we anticipate, the hours in the ACMI services segment, more of the variability is associated probably with OMNI in those, just because they have more of a seasonal pattern with flying, with things like troop rotations and so forth. A lot of those taking place starting in the summer months and then extending into the fall. you know, for their hours, you know, we have assumed some, you know, some growth through that period. And then, you know, their fourth quarter after, you know, sort of the latter part of the fourth quarter, it drops off again. And then on the cargo carriers, you know, typically their hours, you know, are going to grow as we progress through the year based upon, you know, the normal sort of peak seasons that you have for shipping and the the various customer days that customers have. But in terms of the number of aircraft that they're going to be operating, it's pretty stable year over year. We are going to get some customer aircraft, but there may be a few aircraft that come out. We talked about some of the retirements and so forth. So that part is pretty stable. As far as the CAM segment, we expect, I believe, eight We put two aircraft, we leased two aircraft in the first quarter. I think we expect six in the second quarter. Two of those are already leased. Yeah, two of those we did in April. And then we have the other 12 aircraft that we project to lease to external customers in the second half, fairly evenly split. I think third quarter might have a little bit more than four. And so that's some of the cadence, I guess, in terms of how we're looking at the drivers as we move through the year.

I'm sorry, with Helene's question on the 767s, the older 200s with Amazon, is that included in the guidance, whether those are renewed or sold?

Yeah, I mean, that's, you know, it's not, I mean, that's in the second half. I mean, you know, the aircraft will either be sold or released, those five as they come out, but it'll be pretty late in the year. And, you know, the aircraft, it's not a huge number either way. It's not like it's a, you know, significant driver.

Okay.

And then Amazon's adding three aircraft, we believe, you know, that they will... Okay, Mike, go ahead.

Yeah, we've talked about the extensions. You know, we talked about what we're going to do with the 200s as a whole, you know, and the retirements and the sale piece of it. You know, and as Quint and Rich mentioned, those are in the forecast already.

Okay. So my follow-up in the prepared remarks, which you talk about growing earnings and free cash flow next year, I just want to understand the assumptions there, because we have uncertainty around the approval of these new Airbus aircraft, growing odds of recession. We have two open pilot contracts. We have elevated attrition levels. You know, maybe it's a way to think about it if, you know, we have, you've given us a lot of detail on your order book through mid-decade, and so if anyone wants to think about, you know, building out an EBITDA bridge or discounted cash flows. The way to think about this, really just taking your pandemic peak EBITDA per aircraft, discounting, you know, rate accordingly to where we see lease rates are, and then adjusting at the margin for contracts and inflation. I just want to better understand the assumptions in this kind of what sounds like

um growth for for next year given all the pressures you're seeing in the business and and macro uncertainty thank you well well the biggest driver is what we talked about with the lease order book through 2024 um you know again i kristen we don't want to get into the you know trying to uh go through the uh in great detail the model on this call but but um that is going to drive, as it always does with CAM being the biggest part of our EBITDA, that's going to drive the overall growth in EBITDA. We do believe on the ACMI services front, as we said, that we will see some rate increases that will help offset some of the cost inflation that we've seen. And there's other steps that we're taking subsidiaries in particular to adjust for cost, but there's always uncertainties in every business. We have been through a period here where we've had more inflation, higher interest rates as a factor. We haven't talked about that, but certainly that's been something that has escalated in the last 18 months. pretty significantly, right? So those are things you always have to take into account.

Just for clarity on the 321 side, just so we're all clear and aligned, the 321s that we have for delivery this year are not facing any regulatory issues. They'll all be leased to customers that follow the FAA certification. So that's no issue for 2023. And in fact, the ones that we have scheduled in 2024 are also aligned to the same. So we don't have any regulatory issues on the 321s that we have planned for delivery right now in 2023 and 2024.

And Chris, as we said in our release, just the annualized revenue from the 20 aircraft that we'll put on this year, next year will generate in excess of $70 million. You know, the EBITDA margin on that is quite high. You know, it's probably 90 plus percent.

And the confidence level on that is really strong. I mean, we've seen a lot of stability in our conversion houses. You've heard us talk about increasing the conversion sites with our Boeing locations as well. So the throughput in order to deliver on those 20 aircraft is very solid, not only from a conversion standpoint, but as we've mentioned, from a customer standpoint as well.

Okay. If I could just squeeze in one more. Just remind us of the orders that you have out there through mid-decade. How many of those are spoken for? And do you have also – the feedstock that you need, because what we're hearing is airlines holding on to older aircraft longer than they typically would be production issues with the OEM. So curious, how much of your book is spoken for through mid-decade, and do you have all the feedstock that you need to have to execute on the plans you have in place through that point? Thank you.

Yeah, I think if we break this down by each aircraft type, So if you look at the 767-300, you know, Quinn had mentioned earlier the 27 airplanes that we've got as work in process. That includes A321s as well. You know, we buy feedstock. The 767 was a feedstock airplane that was scarce and remains scarce. And look, when you're looking for feedstock airplanes and you find a good airplane at the right price, We've been acquiring those because if you let that go, you don't know if you're going to get an airplane closer to when you're going to induct it. We always try to match as close as we can the same year of induction to when we acquire the airframe. We're required for most converters to have an MSN number, a serial number, for an aircraft six months prior to induction, so there's a lag there. So out of those 767, you know, I look out right now, 34 slots through the end of 2024. And we've got, you know, customers for all but three of those slots right now. And then if I look at the A321, keep in mind, you know, we own the – we're involved in a joint venture for the STC, but we also own a main conversion house for that. our PEMCO conversions, which is part of AIMS in Tampa. And so we've got 11 aircraft in queue right now, and we own the slots. And as we spoke earlier, we'll look to make a decision about expanding or retracting further on the A321, depending on how these regulatory issues get worked out. What the issue is there is the ASA approval. And so there's a lot of aviation authorities that follow EASA, and there's a lot that follow the FAA. When Mike says that we're okay with the ones we've got, it's because they're going into regulatory environments where the FAA is the common benchmark that they follow. EASA, we're down to one issue, and it's an issue that in working with EASA, they've given us a pathway to get it approved. It's just about doing the work, and then what the unknown is how long it takes them to evaluate and approve that. So we'll wait to see how that goes before we articulate any more future slots and aircraft. On the A330s, out through 2028, we've got 30 slots. The first 20 all have customer assignments. We've identified some feedstock. I think we're in the process of acquiring the first one, which is going to go into conversion in the fourth quarter. So, again, real strong demand for that, going out quite a ways in terms of the order book. I hope I answered your question. Yeah, just maybe a drop more on the 330 since, you know, it's going to be a huge part of our future, you know, starting next year from a delivery standpoint. You know, based on the 30 slots, the timing that we have with them over the next few years, You know, we estimate that we're going to have about 65% of all the A330s that are converted from a market standpoint will be our conversion slots. I talked about just the breadth and depth of the industry as it looks out over the next several years in terms of the freighter demand. So if you think about, you know, that as the natural replacement in the future of the 767 and controlling that majority of the conversion slots, You can see that our order book is already filling up 20 plus. So the future in terms of the expansion into 24, 5, 6, 7, where these slots start producing converted freighters, you know, is the reason why we're so bullish and optimistic about the future in the coming years.

Okay. And the IASU approval is what I was referring to. But it sounds like that at this point, There's a good portion of that book through mid-decade that's spoken for or has pretty solid plans in place.

Just for clarity, the ASA only relates to the A321. It has nothing to do with the 330. That already has the ASA approval, just for clarity.

Okay. Got it. All right. Thanks for the time. Thanks, Chris.

Thank you. One moment for our next question. And our final question for today comes from the line of Michael Charmalee from Truist. Your question, please.

Hey, good morning, guys. Thanks for taking the question. I guess I'm still just trying to figure out here, you know, a lot of these headwinds, you know, rising maintenance costs, inflation, interest rates. I mean, these aren't new. So the pressure on ECMI, I mean, you gave the guidance, you know, in late February that I think you were talking about Omni being down less than 5% for the year in terms of hours. I think you called out down 25% in the first quarter. I guess, what changed so rapidly to drive that erosion in profit that that wasn't already known?

Yeah, I think in the first quarter, Michael, the bigger impact was on Omni block hours reductions, although the cost pressures have been more than what we had projected in terms of what we're saying. You know, we've seen some of the costs like return maintenance, you know, up on a per cycle basis, you know, over 20% travel, you know, to position flight crews, flight attendants, increased significantly. But for the guidance change, a big piece of it is on the revenue side, and particularly at Omni. We knew and we said on the last call that we expected some of the other government flyers to fly more of their eligible entitlement than what we had seen previously because the macro environment wasn't presenting as attractive opportunities for them to take their pilots and fly them, for example, for cargo or commercial customers. We've actually seen more of that even than we had anticipated, and that affects Omni quite significantly. Omni has been the go-to carrier and flown a lot of the excess you know, in excess of their entitlement additionally, you know, taking some of the missions that others passed on. So that is, you know, a very large driver of this. But the cost side and the cost pressures are also, you know, I would say that they're higher than what we had projected.

Right. There's a couple of other things, Michael, that were prevalent in the first quarter. First one is the type of flying that they got resulted in a drop in their hour-to-cycle ratio by about an hour. So to put that in other terms, versus their plan, their cycles were up 200, but their block hours were down. So what that means is they've got 200 more stops that involve maintenance, and catering, and all the things that go along with that, you know, when you have a cycle, it drives your maintenance costs. And so it was just an unusual situation that they, Omni believes that going forward, the hour-to-cycle ratio will return back to a normal thing. They did handle a type of flying that is not going to be prevalent moving forward. The other thing is, you know, As a passenger charter ACMI airline, the way Omni had staffed, and keep in mind they had a very good year in 2022, and they were never at full staff. Well, they achieved full staffing at the end of 2022, where they had the right amount of pilots and the right amount of flight attendants for their fleet. And then when the flying dropped in the first quarter and you're at full staff, it's where you see that erosion. Now, part of their go-forward plan is to fix that, and they've already gotten pretty far along in doing that in terms of right-sizing the staff across the operating side to the type of flying that they're going to be doing and projecting going forward. So that's one of the cost benefits we think we'll begin to see in the second quarter.

Got it. Okay. And then just the capital spending plans for the remainder of the year. You know, you've got $89 million in cash on the balance sheet. I mean, are you planning on exhausting the revolver by year end? Or how should we think about the, you know, maybe the cap structure exiting this year?

Well, we, you know, we're, we have about, I think, on the current, You know, we have access to about 390 million or so. And, you know, that in and of itself, I think, would get us, you know, this year, which would take care of this year's needs. But we also have access, you know, to additional, should we need it, you know, through an accordion feature, et cetera. And so, you know, our leverage ratio is still, you know, expected to remain. we finish the year. So we're not highly levered. And so that isn't, you know, access to liquidity isn't a problem for us.

Okay. Okay. And then just, Quint, can you remind us how much of the debt is floating? Presumably the revolver and I'm assuming drawing down or drawing on that line.

Yeah, it's about 40% of it, Michael, about 60% of it is fixed. Okay. Okay.

Perfect. All right. Thanks, guys.

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Rich Corrado for any further remarks.

Thanks, Jonathan. For more than a decade, freighter leasing has been the foundation of our strategy. All of our other businesses serve to extend our core leasing relationships with services that add value and supplement our overall returns. That strategy has been successful and will remain our strategy for the future. It's paid off over time in significant returns of this Boeing 767 freighters that remain the core of our fleet. Because our airlines operate on an ACMI or CMI basis, their returns do not depend on ticket sales or stable fuel prices, but they are vulnerable to inflation in the short term and to customer decisions about how and when and how far they fly. Sometimes, as is happening in our passenger airline business, both factors converge in a way that affects our results. Our leasing returns are both stable and growing. The 20 aircraft that we are scheduled to deliver in 2023 will contribute over $70 million in increased revenue next year with a high adjusted EBITDA conversion. Our customers indicate that volumes will improve in the second half. We look forward to finishing the year strong. While continuing to keep our freighter investments consistent with the shareholder's with the returns our shareholders have come to expect from their investment in ATSG. Thank you for your participation in today's call, and stay safe.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.