Air Transport Services Group, Inc

Hey and thank you for standing by. Welcome to the Q2 2024 Air Transport Services Group Inc. Earnings Conference Call. At this time all participants are in a listen-only mode. Please be advised that today's conference is being recorded. After the speaker's presentation, there will be a question and answer session. To ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. I would now like to hand the conference over to your speaker today, Joe Payne, Chief Legal Officer.

Good morning and welcome to our second quarter 2024 earnings conference call. We issued our earnings release yesterday after the market closed. It's on our website at 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 described 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 in underlying assumptions, factors, new information, or other changes. These factors include, but are not limited to, changes in the market demand for our assets and services, including the loss of customers or reduction in the level of services we perform for customers, 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 -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, the impact of the current competitive labor market, changes in general economic and or industry-specific conditions, including inflation and regulatory changes, the impact of geopolitical tensions or conflicts and human health crises, and other factors as contained from time to time in our filings with the FCC, including the Form 10Q to be filed today. We will also refer to non-GAAP financial measures from continuing operations, including adjusted earnings, adjusted earnings per share, adjusted pretax earnings, adjusted EBITDA, free cash flow, 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 Joe Headey, our executive chairman, for his opening comments.

Joe Headey Thank you, Joe. Good morning, everyone. I want to spend just a moment on the leadership transitions we announced back in June. Mike Berger, previously our president, was appointed as CEO. Jeff Dominick, previously a board member, took over Mike's role as president while I became the executive chairman. Many of you already know Mike well from prior earnings calls and investor meetings. He's been with ATSG since 2018 and brings a wealth of knowledge and experience having worked for major express, air express companies throughout his career. With a background in investing in commercial aerospace markets, Jeff expands ATSG's financial acumen in the aircraft leasing space and we look forward to you meeting Jeff. As for me and my new role, I will still be heavily involved in the strategy development and the formulation of long-term business objectives for ATSG. I'll turn the call over now to Mike to update you on the quarter and both Jeff and I will be available during the Q&A session. Mike?

Thank you, Joe, and thank you to everyone joining the call today as well. I'm excited to be speaking to you on my first earnings conference call as CEO. I want to thank Joe Headey for his leadership and guidance as CEO after assuming the role last November and for continuing to lend us his skills and experience in his new role. I'm excited about the opportunity ahead of us here at ATSG. We have an unparalleled fleet of in-demand mid-size freighters going to market with a least plus strategy which differentiates us from our competitors. Last quarter, we communicated a key milestone, our expanded and extended flying agreement with Amazon. We will fly 10 additional aircraft they provide this year and we remain on track with prior expectations to be fully ramped up of those 10 aircraft by peak season. That will bring us to 51 767 aircraft we operate for Amazon, including 30 we lease to them. Comparisons of our financial results for the second quarter to prior year were principally affected by fewer leased 767-200 freighters as expected. Our results for the quarter did come in above our internal expectations. Also, we are encouraged to report the progress we've made on leasing available freighters. Since the end of June, we've leased four additional 767 freighters to external customers. CAM also has lease commitments for our first two converted Airbus 330 aircraft expected to deliver in the fourth quarter of the year and is optimistic about future leases of other available aircraft. All these aircraft are headed for international markets where they will facilitate global trade, further demonstrating ATSG as an enabler of e-commerce growth. Importantly, we continue to execute the plans we laid out for 2024 with a focus on safety, customer satisfaction, and cost control. I want to thank our ATSG team for their dedication and striving towards our goals. We're on track to exceed our stated goal of positive free cash flow for the year with 107 million generated through June and an expectation of additional free cash flow for the rest of the year. We are again raising our adjusted EBITDA outlook and have lowered our capital expenditure outlook for 2024. We remain focused on realizing the benefits of our business model and have the right team, the right assets, and the right strategy in place. I will now turn the call over to Quinn Turner to discuss our financial results for the second quarter. Quinn?

Thanks, Mike, and welcome to everyone joining us this morning. I'll start on slide four, which summarizes our financial results for the quarter. Revenues were down 41 million or 8% versus a year ago to 488 million. This was driven by reductions in both our CAM and the ACMI services segments. In the second quarter, we saw a gap pre-tax earnings of 10.7 million down from pre-tax earnings of 49.7 million in the prior year period. This resulted in a diluted earnings per share of 11 cents versus diluted earnings per share of 49 cents in the second quarter of 2023. On an adjusted basis, pre-tax earnings fell 41 million to 17 million and EPS was down by 38 cents to 19 cents. Adjusted EPS did improve sequentially by three cents from the first quarter. In our aircraft leasing segment, revenues decreased 7% as CAM's fleet of externally leased aircraft expanded by one since June 2023. That includes 14 incremental new leases, less than 13 aircraft that came off lease over the last 12 months, and their related engine PBC revenues. At the end of the quarter, 87 CAM-owned aircraft were leased to external customers. CAM's pre-tax earnings were down 16 million for the quarter, reflecting 9 million more in depreciation, a 6 million revenue decline from fewer 767-200 engine cycles, and $4 million more interest expense versus the prior year. In our ACMI services segment, we reported a pre-tax loss of 7 million compared to the gain of 24 million in the second quarter of last year. Total block hours flown by our three airlines were down 10% versus the prior year quarter. Our cargo airlines flew 11% fewer hours across our customers' delivery networks. ACMI services results were also affected by a $3 million increase in non-cash amortization expense for the Amazon warrants. ACMI services also experienced increased expenses for maintenance, travel, and ground service rates as the average flight segment was shorter than a year ago. As a reminder, we executed an expanded agreement with Amazon announced in May to begin flying 10 additional aircraft at ABX Air in the second half of the year. Three of these are flying now, and we expect to have all of them flying in time for peak season in the fourth quarter, when additional pilot training and transition costs will be largely behind us. The fourth quarter will also include benefits of seasonal peak flying opportunities and separately, scheduled pricing increases under certain flying contracts. Turning to the next slide, our second quarter adjusted EBITDA was $130 million, down $27 million from the prior year period. CAMHS adjusted EBITDA decreased by $4 million, and ACMI services and other decreased by $23 million. CAMHS decline was again driven by 767-200 lease returns and fewer engine cycles operated by the 200s remaining in service, resulting in lower powered by cycle engine revenues. The decrease in ACMI services and other was driven by fewer block hours as well as increased expenses for maintenance, travel, and ground services. Slide six details our capital spending on a trailing 12-month basis. Total capex for the quarter was $70 million, consisting of $43 million in growth and $27 million in sustaining capex. Our capex spending is down 64% year over year for the second quarter, and for the full year, 2024, we projected a decline of more than $400 million in capital expenditures compared to 2023. The next slide updates adjusted free cash flow as measured by our operating cash flow net of sustaining capex. Operating cash flow was $137 million in the second quarter this year, while that was down $55 million versus the prior year period, we still generated $110 million of adjusted free cash flow. Furthermore, as a result of the reduced growth spending as well as $25 million in asset sale proceeds, we generated $92 million of free cash flow in the quarter. This brings the -to-day total to $107 million. On slide eight, you can see that available credit our bank revolver in the US and abroad was $489 million at the end of the second quarter, as we reduced total debt by $131 million since the beginning of the year. Our plan now calls for us to reduce our adjusted EBITDA leverage ratio to around 2.9 times by the end of this year, compared with 3.2 times at the end of last year. We continue to maintain healthy liquidity with unencumbered aircraft assets of $1.4 billion. Now I'll turn the call back over to Mike to discuss our updated outlook.

Mike? Thanks, Quinn. Turning to the next slide, I'd like to spend some time discussing our outlook and assumptions for 2024, including the additional leases we signed since June. ATSG now expects adjusted EBITDA for approximately $526 million in 2024, an increase of $10 million from the outlook we provided in May, with the increase concentrated in the fourth quarter. The contribution from these leases was included in our original $30 million of potential, but uncommitted additional adjusted EBITDA we laid out in February. We expect the quarter adjusted EBITDA to be similar to the second quarter, with a marked improvement in the fourth quarter. As a reminder, this forecast also excludes any contribution from additional leases not currently under contract, which could generate additional adjusted EBITDA. We continue to see more interest in our newly converted freighters, while maximizing value from 767-200 aircraft that finished their lease terms. This includes utilizing three as spares to support additional Amazon flying. As mentioned, we are reducing our total capital spending target to $390 million versus $410 million we projected in May. This includes $165 million for sustaining CAPEX and $225 million for growth. The growth spending outlook includes the completion of 17 aircraft that were in the process of conversion at the start of the year and seven feedstock purchases, including one additional Airbus A330 later this year. As I mentioned earlier, we generated $107 million in free cash flow through June, and we expect continued improvement during the rest of the year. This improvement stems largely from the $400 million reduction in our CAPEX spending versus a year ago. We continue to believe our mid-size freighter assets will remain in high demand, and our unique Lease Plus strategy positions us for more freighter leases and superior customer satisfaction. We are focused on safe, efficient operations as we deliver our 2024 goals and look forward to an even better 2025. That concludes our prepared remarks. Jill, Quint, and I, along with Jeff Dominick, our president, are ready to answer questions. May we have the first question?

Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. One moment for questions. Our first question comes from Frank Galanti with Stiefel. You may proceed.

Yeah, great. I appreciate you taking my question. I wanted to ask sort of about demand for the mid-size freighters, what you're seeing, right? Obviously, you had more lease than you anticipated at the beginning, but given how many of the older planes are coming out of service, how do you see the supply-demand balance for that freighter class?

Yeah, Frank, it's like we still see solid demand for the mid-widebody aircraft. We've delivered 14 aircraft in the last 12-month period, as we've announced. We've delivered eight so far this year. As I said, we know we're going to deliver the two A330s as we talked about. We fully expect to deliver double-digit aircraft by the end of this year and hope to carry that continuous momentum into 2025.

Okay, that's helpful. And then switching gears a little bit to the ACMI business, it looked like there were negative pre-tax earnings on the segment, which is worse than I thought. Can you sort of talk about the flips and takes in the quarter between lower block hours or more Amazon capex to get the trained up? And then relative to what do you expect on a go-forward basis?

Yeah, Frank, it's Quint. Thanks for the question. Yeah, and the biggest impact in terms of the second quarter ACMI was just block hours. And block hours were down. As you know, we had the smaller 7.62s that we talked about last year that were coming back from Amazon. We got all those right at the beginning of the quarter, the second quarter. And so we had a reduced block hours flown in their network. Of course, as Mike said, we're going to begin adding aircraft. The larger 300s went three on and another seven expected to come on the second half of this year. And then on these block hours, our passenger block hours were also down, of course, versus the prior year. And so those are the biggest impact. And we also had, in terms of that, we had some warrant amortization with respect to the new Amazon arrangement. We had extended some of the warrants that had been previously granted to Amazon. And the amortization of those is driving about a $3 million impact for that. Now that said, in terms of what were our expectations for the balance of the year, we do expect ACMI services as a segment to be profitable for the year. And again, you saw some commentary in the release. It's weighted to the fourth quarter. And there's a few reasons for that. Of course, there's always peak. There's the timing of some scheduled contractual price increases that are coming there. There's some seasonal charter opportunities, peak season opportunities. And so we do expect that for the full year, ACMI services, which is down for the first half in the loss position by about $10.6 million to end up profitable for the full year. And I think they'll carry some momentum into 25 with a larger fleet and some improved margins.

This is Joe Frank. On top of that, you got the elimination by the time we get to 4Q of all the gear up costs for the Amazon business, as you mentioned, in terms of pilot training, getting maintenance technicians trained up, et cetera. So that will be behind us by the time we get to the called November timeframe.

Perfect. Really appreciate it. Thank you. Thanks, Frank.

Thank you. Our next question comes from Christopher Stathalopoulos with SIG. You may proceed.

Just to follow up on this last point here on the pre-tax contribution for ACMI. So Quint, profitable in 4Q, you know, just to better understand if you can contextualize that, is that slightly above breakeven? And as we think about, I know there's a lot of these one-time costs going off, but just looking at 23, you did around 32 million 2019 pre-pandemic, around 32. How should we think about pre-tax earnings and ACMI as a percentage of your EBITDA mix for 25, given the expanded TSA with Amazon and all these other additional aircraft that are being placed? Thanks.

Well, it might be a tad early for specific 25 guidance, but in terms of the remainder of this year, Chris, it's really, again, the fourth quarter where you're going to see, I think, ACMI service, you know, improving its profitability and getting positive for the full year. I think the third quarter is going to, because we're still onboarding the aircraft from Amazon and we've got those transitional costs that Joe mentioned in the third quarter, and that's going to be a factor. And the fourth quarter, is when we expect to have them all on board. And that combined with just the timing of sort of some annual adjustments that will take place on some of these contracts, I think will really provide a nice tailwind for ACMI services in the fourth quarter. I mean, as far as next year, of course, we'll be speaking to that guidance more on the next quarterly call for the full year. But, you know, I think ACMI services is going to make headway next year, assuming contracts and business volumes remain in place as they are today, we would expect it to improve. As you know, they've had to absorb some aircraft coming back with the 767-200s, and those are all back now on those CMI contracts. So I think, you know, they're set to make progress on a go-forward basis.

We think about and come up with our own bottoms-up analysis using all the fleet stats that you've given here for our 25 enterprise EBITDA. Is it fair to say that ACMI as a percentage of enterprise could fall somewhere between, call it 25 and 30 percent of adjusted total EBITDA for next year?

Yes. Yeah, I think so. Yeah, absolutely.

Okay. And as a follow-up here with the outlook here for lower interest rates, you know, how should we think about, I guess, lease rates or if you want to speak to, I guess, lease factors into 2025? Thank you. Or lease rate factors.

Yeah, thank you. In regards to the rates, as I've mentioned on a number of calls, you know, we've seen, for the 767 specifically, lease rates be very, very stable over the last several years. We haven't seen much fluctuation at all through the different cycles that we've undertaken over the last few years. In terms of the lease rate factors, you know, that can vary a little bit based on the feedstock costs, you know, depending on different aircraft types as we go. Aircraft availability, specifically around the 330, have been generally higher based on some of the issues that Airbus has had getting their new product on the 350 into service. But overall, in general, rates have stayed very, very constant.

Okay. And if I could just slip in one more here, I think you have four open labor deals, two on the pilots, two on the FAs between ATI and Omni. Just where are we on negotiations and sort of any sort of timelines we should look for? Thanks.

I think as I've said on previous calls right now, we don't expect to have, the pilots are the primary drivers from a cost standpoint to get any agreements until sometime in 2025. Negotiations continue to progress under the auspices of the mediation, National Mediation Board. So it's, you know, that's baked into our numbers looking to the fourth quarter where we anticipate having any additional costs as a result of settling up any of those labor agreements.

Okay.

Thanks, Jeff.

Thank you. Our next question comes from Michael Charmouli with True Securities. He may proceed.

Hey, good morning, guys. Thanks for taking the question. Good morning. Just to stay on that, on the labor front with the pilots, is there any increased disruption there, are you seeing any turnover from pilots? I mean, I think you called out crew training costs, but is that a factor or any kind of headwind on expenses there from that just overhang?

No, in fact, you know, the attrition has dropped off markedly since last year, almost down probably about 50% from where it was a year ago, which reduces our, you know, our turnover costs. But we do have the gear up costs associated with the additional Amazon sales baked in there. As far as disruptions, you know, no disruptions relative to crews. I mean, everybody's doing the job they're supposed to do on a day in, day out basis and moving the airplanes on a timely basis for our customers. Okay. And I think

it's worthwhile just to reiterate, you know, the amended deal that we got with with ABX Air through 2030. We're really proud of that deal, as well as establishing what we're, what our expectations are going forward.

Got it. Got it. Okay. And then just generally on the cargo market, I mean, you talked about ACMI and the block hours. Are you seeing any pressure just with the continued increase of passenger planes and that underbelly storage?

No, not from a belly standpoint. We don't see any pressure. Keep in mind the majority of our customers and specifically our main customers fly within the major integrator networks. So when they're flying networks, they don't have a tendency to get the variability piece of it, you know, from a seasonality standpoint and available capacity standpoint. So we've seen very much stability in that side of the business.

Okay. Last one for me. I don't know if I missed it. The $25 million of property and proceeds, what did that stem from and should we expect any more of those in the second half of the year?

Yeah, not Michael, it's Quint. There were five airframes that, you know, we sold aircraft, a couple of 300s and then three 767-200s that made that up. And keep in mind, you know, like the 300s, those are unmodified. You know, we were monetizing, as you know, we had some assets that were not in conversion, that were sort of awaiting conversion. So we were opportunistic and took that opportunity to move some of those. And as we've been saying, you know, we've had customers interested in buying some of these 767-200s that came back. You know, and some of those customers, of course, will continue to procure engine power from us, which is good. So we, you know, we monetize some as far as in the future, we'll, you know, we'll be opportunistic. But, you know, it's, as you know, it's something we don't typically that often do.

Okay, perfect. Thanks, guys. I'll jump back into queue. Thank you.

Thank you. Our next question comes from Ian Zaffino with Oppenheimer. You may proceed.

Hey, good morning. This is Isaac Salazan on for Ian. Thanks for taking all the questions. Can you just provide a brief overview on status and timeline of conversions as we move through the rest of the year? I know you mentioned the two A330s are expected to be converted in the fourth quarter. But can you also just touch on those 767s and maybe have you think about the timing of those with respect to the demand outlook and, you know, potential for additional leases? Thanks.

Yeah, thanks for the question. You know, we expect to, you know, deliver, as I said earlier, you know, a few more aircraft from a 767 conversion standpoint. You know, we're still actively converting aircraft, you know, with II and Tel Aviv. And we see the continuous demand for, for more 767s on a go-forward basis in 2025. We've often said and we still firmly believe that the 767 is the heartbeat of our company. And we will continue to convert 767s as they're in demand.

Okay, understood. And then as a quick follow-up on the passenger block hours or just flying at ACMI, could you, I think you mentioned a little bit of repair marks on AMNI. Maybe you could just help us understand, you know, where things are there as far as military flying and activity for them. Thanks.

Yeah, in terms of the AMNI hours, you know, as we said, the, I think the passenger block hours were offers a year ago by about 4% or so. You know, however, you know, on a sequential basis, you know, they're, you know, not anything like that. They're doing a bit better than that on a sequential basis, you know, actually being up on a sequential basis versus the first quarter. I think that, you know, the exercises, as you know, that's the visibility is always a little tougher on the AMNI flying. However, you know, it is third quarter is usually not a bad quarter for them. Their busiest month is in October, typically for the timing of exercises. But then they tend to fall off after that. And so, you know, it's a more normal pattern. We're getting to that point of the year where there's a contractual increase, you know, with the government's fiscal year beginning in October. And that's going to be helpful. So, you know, I think, you know, we're expecting it to be relatively stable the second half of the year, similar to the first half.

Okay, great. Thank you very much.

Thank you. And as a reminder, to ask a question, please press star 1-1 on your telephone. Our next question comes from Ben Rubinstein with Robotian Company. You may proceed.

Good morning. Thanks for taking my question. So, at the Investor Day last year, you talked about, you had a slide that showed the estimated carrying value of your claims being 350 million less than the market value. I'm just curious where that stands today.

That was based upon, you know, what the cost to convert aircraft is adjusted for the average age since conversion and taking into account the useful life post conversion, which is, you know, about 20 years plus. And, you know, actually the cost to convert has gone up since then. You know, like a lot of things, you know, inflation has affected that. So, to produce that fleet of aircraft today has gone up, only gone up since Investor Day. And so, as Mike stated a minute ago, the midsize freighter is still in demand, you know, as the big driver for that is e-commerce growth and network flying is where those aircraft are deployed. So, I don't think that's really changed. Of course, the aircraft have aged a little since September and that, you know, that depreciation would also be impacted. But if we ran that calculation again today, I don't think that has changed.

Okay, thanks. And then just quick on the converts, the converts doing 2020-2029, is there any willingness or ability to repurchase those?

You know, I guess in terms of buying the converts back or buying stock after convert, I mean, what are you

asking? I mean, if you could buy them back at a discount, you know, why not do that? I'm just curious if that's something that you guys thought about.

Yeah, I mean, I guess anything is possible, but, you know, those aren't, that would have to be something that both parties would want to do and it would be a negotiation, obviously.

Thank you.

Thank you. I would now like to turn the call back over to Mike Berger for any closing remarks.

Thank you. I want to express my appreciation to all of our employees across the ATSG companies for all the work they do every day for our great company. I also want to give a shout out to all of our customers. Our teams are super focused on delivering customer satisfaction every day. Since the start of the year, we have emphasized we must execute on our 2024 plan and regain the trust of our investors and shareholders. Very simply, we must do what we say we're going to do, no excuses. We have raised full year guidance to continue to look for growth opportunities and drive further incremental free cash flow. We are executing on this by still growing in our core leasing business. As you heard, we have delivered eight newly converted freighters so far this year and provided an optimistic view for more deliveries by the end of the year. Our lease plus strategy is unique and brings a powerful solution to the market. We will continue to grow our global presence that is underpinned by connecting key economic and market indicators. In closing, I will say that we're pleased with the improvements we have made so far in 2024 and we have more to capitalize on. Let me be clear, we're not done by any means. Thank you and have a great day.

Thank you. This concludes the conference. Thank you for your participation. You may now disconnect.