Air Transport Services Group Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 11 speakers on the call.

Operator

Good day, and thank you for standing by. Welcome to the Q3 2023 Air Transport Services Group Incorporated Earnings Conference Call. At this time, all participants are in listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to turn the conference over to your first speaker today, Joe Payne, Chief Legal Officer.

Operator

You can now go ahead.

Speaker 1

Good morning and welcome to our Q3 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.

Speaker 1

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, unplanned changes in the 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 were 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.

Speaker 1

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 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.

Speaker 1

Management believes these metrics are useful to investors and 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 Hete, our CEO for his opening comments.

Speaker 2

Thank you, Joe. Good morning, everyone. We appreciate you all joining us. Before we discuss our Q3 results, I would like to address the leadership transition we announced yesterday. This change is the result of careful and thoughtful deliberation by the Board of Directors.

Speaker 2

On behalf of the Board, I want to express our sincere gratitude to Rich for his contributions to the company. We wish him all the best. I am honored and energized to be stepping back into the CEO role. Having served as ATSG's CEO from August 2003 to May 2020 and continuing as a Board member after that, I believe I bring a unique perspective and skill set to the position. That aside, we're operating in an incredibly dynamic and challenging market environment.

Speaker 2

There are certain issues that are within our control and others that are not, but we recognize that our recent financial results need to improve. There is more work to be done and I'm committed to working collaboratively with the entire team to position our business for the future. Despite the challenging macroeconomic headwinds, ATSG is an incredibly resilient organization. With our differentiated business model, Diverse customer base and unique competitive position, I believe we are poised to capitalize on the long term opportunities ahead. I look forward to continuing to build on our strong foundation to deliver value for our shareholders.

Speaker 2

With that, I will now turn the call over to Quint Turner to discuss financial results for the quarter and I will return to close our prepared remarks. Quint? Thanks, Joe and welcome to everyone joining us this morning. While July started out in line with our expectations, our results were impacted by macro and operational challenges later in the Q3. The next slide, Slide 4 summarizes our financial results for the Q3.

Speaker 2

Our revenues grew 6,000,000 or 1% versus a year ago to $523,000,000 This was driven by higher revenue in the ACMI Services and partially offset by a decrease in revenue in the leasing segment. Our GAAP pre tax earnings were down $41,000,000 and diluted earnings per share were $0.24 versus $0.57 in the Q3 of 2022. On an adjusted basis, pre tax earnings fell $36,000,000 to $31,000,000 and EPS was down $0.28 to $0.32 In our Aircraft Leasing segment, CAM, pre tax earnings were down $14,000,000 compared to a year ago at $23,000,000 11 767-200 freighters have been returned as scheduled since September 2022, including 2 in the Q3. Power by cycle engine revenue was also reduced due to fewer 767-200s in service as well as fewer cycles flown by those 200s still in service. Additionally, The lack of aircraft sales during the quarter versus 2 in the prior year period negatively impacted our year over year comparison.

Speaker 2

Taken together, the effect of these items, all related to our 767-200 fleet, reduced pretax earnings from the prior year quarter by $13,000,000 Interest expense was $4,700,000 higher than the prior year quarter. Those items offset $7,300,000 in additional lease revenue from 10 more freighters added to service. In our ACMI Services segment, pre tax earnings were $12,000,000 down $13,000,000 compared to the Q3 of 2022. This was driven by a mix with more military and less commercial flying, fewer hours over long haul international routes for cargo customers, The effects of inflation, payroll costs and service challenges in our passenger operations. Earnings from cargo operations together were down $6,000,000 and passenger operations pre tax was down 7,000,000 Total airline block hours were down 1% versus the prior year quarter as increased passenger hours were unable to fully offset a drop in Cargo hours decreased 4% and passenger block hours, including combi flying for the military were up 14%.

Speaker 2

Our 757 Combi operations resumed services over a transpacific route last fall. Turning to the next slide, our 3rd quarter adjusted EBITDA was $137,000,000 down 16% compared to the prior year period. On a trailing 12 month basis, adjusted EBITDA was down $39,000,000 to $594,000,000 As you can see, even with the year over year decrease, CAM still makes up the bulk of our EBITDA and we still consider this to be our core business. We project 16 freighter lease deployments in 2023, including 12 767-300s and our first 4 A321-200s. Since September 2022, Our in service fleet increased by 6 aircraft.

Speaker 2

The next slide details our capital spending. Total CapEx for the quarter was $168,000,000 comprising $120,000,000 in growth CapEx and $48,000,000 in sustaining CapEx. As you may recall, we lowered our capital expenditures outlook for the year last quarter. We continue to expect total capital spend of $785,000,000 for 2023, dollars 240,000,000 of that The next slide covers our updates to adjusted free cash flow, as measured by our operating cash flow, net of our sustaining CapEx. Operating cash flows decreased $30,000,000 to $118,000,000 for the quarter and were $600,000,000 for the trailing 12 months.

Speaker 2

Adjusted free cash flow was $400,000,000 over the last 12 months. That equates to approximately $6 per share based on our outstanding shares as of September 30. On the next slide, you can see that available credit under our revolver facilities in the U. S. And abroad was $428,000,000 at the end of the Q3.

Speaker 2

This table reflects the recent convertible note refinancing transaction we completed as well as the subsequent share repurchases we made. Combined, we bought back 9,400,000 shares over the past year with $5,400,000 of those purchased in the 3rd quarter alone. Our balance sheet remains strong with net leverage under 3 times, putting us in a strong position to complete this year's investment plans. Now, I'm going to turn the call over to Mike Berger, Our President, who will summarize the issues that have developed since September and how they have affected our outlook for the rest of the year. Mike?

Speaker 3

Thanks Quint. Most of you are aware that our Investor Day event in September, we our 2023 adjusted EBITDA guidance of $610,000,000 to $620,000,000 At the $615,000,000 midpoint of that range, That implies $320,000,000 in the second half, on top of the $295,000,000 we delivered in the first half. We reviewed the latest results from each of our businesses before the event. And while we told you then about the risk around CAN's second half lease deployments Its second half outlook for our airlines, we thought our plan was still attainable. But since then, a great deal has changed in the macro environment For air cargo capacity, as most of you are aware and are hearing on earnings calls and reading the trade press and the performance of our passenger airline, Omni Air.

Speaker 3

To illustrate how those changes have affected our outlook, I'm going to focus on adjusted EBITDA and show you why we are reducing our guidance by about $45,000,000 to a range of $560,000,000 to $580,000,000 This slide shows that our prior guidance for the second half on the left, the midpoint of our new guidance of $270,000,000 on the right and some key factors Behind the changes, the vast majority of that $45,000,000 reduction about 43,000,000 stems from 2 pieces of our business, freighter leasing at CAM and Omni's passenger flying. It's important to note that our cargo airlines, ABX Air and ATI are on track to meet their adjusted EBITDA targets for the year. Quint told you about the service delays and related higher costs that affect Omni's results for the Q3. Some of those higher costs are continuing, but the main reason for Omni's new 4th quarter outlook is the conflict in the Middle East, which began on October 7. Events in that part of the world have affected Omni's normal 4th quarter requirements for its government customers, which typically peak in October each year.

Speaker 3

Also, Omni's outlook for higher margin commercial flying in the 4th quarter is lower than before. Omni's 3rd quarter results include a good July and in August that was close to plan. Obviously, the disruptions in the Middle East were not part of our plan when we spoke to many of you in late September. We are closely monitoring Omni's progress and the global factors that drive its demand. Of the $45,000,000 guidance reduction Overall for the second half, more than a third of it is attributable to Omni.

Speaker 3

Moving to CAM. Our new second half guidance reflects issues in 3 key areas freighter and related engine leasing through the end of the year, Planned changes in its 767-two hundred fleet, including sales of those aircraft types and our current Assessment of the new information we're receiving from some of our current 767-300 lease customers outside the U. S. CAM had a strong July for freighter lease deployments, although some were delayed from earlier in service projections. We now expect to deliver 16 newly converted freighters by the end of the year, which is 3 fewer than we mentioned before.

Speaker 3

Leases of engines for 767-300s, which had been a significant contributor in the first half, have decreased. Quint mentioned in his remarks that the CAM had intended to sell 767-200s in the second half at Prices that would yield significant returns on those fully depreciated assets. We expect to sell a couple this quarter and others in 2024. Additionally, in mid October, we were contacted by certain airline customers of CAM expressing that they were experiencing lower customer demand, which is negatively impacting their financial results and outlook. Our guidance reflects appropriate adjustments to address the potential effect of that new information.

Speaker 3

I think I speak for the entire management team in saying that we were probably even more unhappy to have to give you this dues as you are to receive it. The air cargo industry is undergoing rapid changes this fall, as you are hearing everywhere else. Unfortunately, we are not immune to that. We still believe that our strategic direction to serve the airlines who will remain in the express package fulfillment business will eventually yield great results. Now, I'll turn the call back to Joe Hee for some closing remarks.

Speaker 2

Thanks, Mike. To echo Mike and Quint's words, I want to add that the Board believes just as strongly in the long term goals of the company to grow and achieve strong returns from leasing and operating midsize freighters and passenger aircraft. The growth capital we have spent over the last several years plus what we will spend in the next several years made sense to us even before the pandemic when freighters were the hottest commodity in the aircraft business. I regard our foundational assets, midsize freighters Leveraging my decades of experience in this industry to assess all of our options to deploy our capital for greater shareholder return and best in class customer service. 1 of Rich Corrado's many talents, which was a key part of why we chose him to run the company, was his insights about the markets we serve and where our range of capabilities fit best.

Speaker 2

That insight has served us well for several years, but those market conditions have changed. Our new reality is that growth will be more difficult to achieve than before. We faced similar periods before and I'm confident we can maintain the resilience that We can best invest for the greatest shareholder return and sharply reduce our capital spending program in 2024 and beyond. We now plan to spend $505,000,000 in 20.24. That's down $100,000,000 in capital spending compared to the 2024 plan provided at the end of September and down $280,000,000 from this year's projected spend.

Speaker 2

That new 2024 outlook is driven by fewer conversions and only essential feedstock purchases. That includes purchases of Airbus A330 30 aircraft we will begin leasing next year. 2024 plan projected lease deployments of 14 converted freighters, including 6 767-300s, 5 A321s and 3 A330s. We are introducing no additional 767-300s for conversion beyond the 7 currently in process. As I've said in the past, we always have the flexibility to not convert some of the aircraft we own until market conditions improve.

Speaker 4

It's too

Speaker 2

early to estimate our 2024 adjusted EBITDA, but with these capital spending reductions and the items that Mike mentioned earlier. We plan to provide new adjusted EBITDA guidance for 2024 during our Q4 earnings call in February. I can make one positive prediction about 2024, however, cutting our growth CapEx spending means our free cash generation will be higher than it would have been under the prior plan through 2024 2025. That concludes our prepared remarks. Quint and I along with Mike Berger, our President and Paul Chase, our Chief Commercial Officer

Operator

And our first question comes from Frank Galanti with Stifel.

Speaker 5

Yes. Hi. Thanks for taking my questions. Right. So it's a pretty material change from

Speaker 2

Just a couple of

Speaker 3

weeks ago, 6 weeks ago.

Speaker 5

And obviously, in the prepared remarks, you hit on a lot of it. But can you sort of talk about How you're thinking about demand for the 767-three 100 and 200 actually. So you'd mentioned 767s are I think I got that number right. That seems like a change from just even earlier this year On expectations, is that demand wane all on the international side? Can you sort of talk through those dynamics, please?

Speaker 4

Yes. Hey, Frank, it's Paul Chase here. Thanks for the question. We'll talk about this year first. And we're filling the orders this year using our existing pipeline.

Speaker 4

But In the future, in 2024, that pipeline has slowed. So we're keeping an eye on that. And that's one of the reasons that the business has decided to pull back on the CapEx. So With most of the deliveries that we expected to go internationally, sure, we're seeing some weakness there, but we're keeping an eye on it.

Speaker 5

Okay. And then what about the 200s? What sort of change there from a demand perspective, Expectations wise.

Speaker 4

Sure. I mean the 200s, right, I mean it's a fleet that we're working on sunsetting over time and we're really just being opportunistic about Upcoming maintenance events and what we have to invest in the aircraft from a capital perspective. So it's really a case by case basis on those aircraft and we're working them through.

Speaker 3

And as you heard in the remarks, we still plan to sell a couple of those 200s as well this year as well into 2020 well as to 2024, Frank.

Speaker 5

Okay. That's helpful. And then on the capital allocation front, Joe, you'd mentioned wanting to take CapEx down. Can you sort of talk about what Is locked in like what kind of wiggle room do you have in 2023, 2024 to bring CapEx down further? And then What do you think sort of peak leverage ratio is that you guys are comfortable getting to?

Speaker 5

And I had a final question on to that. What do you think about share buybacks at these prices?

Speaker 2

Well, Frank, like I said, I haven't had an opportunity to get my arms around all the details in terms of what's committed to and what isn't committed to. As I mentioned in my remarks, we always have the flexibility once we own the feedstock not to run it through the conversion processes, which is where the lion's share of the dollars are spent, not on acquiring the actual feedstock itself. So as Paul mentioned, we're seeing a little bit of a softening on the 767 side. So feedstock that we've committed to or already own, We'll just park it and take the things like the engines. We have the opportunity to lease the engines out to other operators to generate some income.

Speaker 2

We even have the flexibility if the demand is there to throw an aircraft or 2 to Omni as for their use. And of course, if somebody needs a passenger Aircraft, we can always lease that to a 3rd party as well. So we've got a lot of flexibility there. But at first blush, and like I said, this is Right now, I'm drinking from a fire hose, so to speak. We're able to identify a significant amount, as I mentioned, over $100,000,000 worth CapEx just from what was presented back in September to the market.

Speaker 2

As far as capital allocation going forward, Right now, we're below 3 times from a leverage perspective. 3 times has always been kind of a ceiling for us. We like to stay no more than that, although we may creep up Just a tad here and there. But ultimately, as mentioned, we expect to generate free cash flow in 2024 and into 20 25 as we pulled back on the CapEx spend. And at that point, we'll make a determination whether the best return to shareholders is to pay down the debt.

Speaker 2

Obviously, interest rates are at very high watermark these days and what they were at the time I left 3 plus years ago. And whether that makes more sense or to return the capital to shareholders via share buybacks.

Speaker 5

That's very thorough. I really appreciate it. Thanks very much.

Speaker 2

Yes. Thanks, Rick. Thank you.

Operator

One moment for our next question. And our next question comes from Joe Atkins with Stephens Incorporated.

Speaker 6

Hey, guys. This is Grant on for Jack. Thank you for taking my questions. Just wanted to kind of ask around, I know it's kind of early on 2024, but if you could just maybe kind of frame up how firm some of those commitments are that you have for next year? And maybe

Speaker 2

could you just talk to kind of

Speaker 6

the range of outcomes that you're looking out as you think out towards 2024? Thanks.

Speaker 3

Thanks for the question. So 2024, as we said, we're fully expecting to deliver at this point 14 freighters, Newly converted freighters, the breakdown of those are 667s, 5 A321s and 3330s. We've got the feedstock secured for those. And as you've heard us say, at this point, on the 767 side, All those aircraft are in or awaiting conversion. So we're in good shape on 2024 in regards to the forecasting.

Speaker 3

Longer term, as Joe mentioned, we'll see where the market goes, we'll see where the demand goes, we'll see what The cost does, but long term forecast from the freighter standpoint, specifically from Boeing and Airbus as we look out to the future is still robust as well as from a replacement standpoint. But as you could see and we've talked about, a flexibility in our model allows us to throttle back some And produce that free cash flow that we talked about for 2024 and 2025.

Speaker 6

Okay, great. So just kind of to follow-up on that. So Kind of this pressure you're seeing on the leasing demand side in the 3rd Q4, it kind of sounds like you think maybe it's a little more Confined to the challenges we're seeing in the market today. And as long as things don't deteriorate too much into next year, you think you can kind of hold the line on where you're at and Get all these points out the door.

Speaker 4

Yes. This is Paul Chase here, Grant. Yes, I do believe that's the case.

Speaker 6

Got it. Thank you, guys.

Operator

One moment for our next question. And our next question comes from Helane Becker with T. D. Cowen.

Speaker 7

Thanks very much, operator. Hi, everybody. Thank you for the time. Just a couple of questions in here. Can you address The delays out of IAI, it's one of your biggest conversion firms and yet many of their employees have been called To service.

Speaker 7

So how can you be confident that you're going to get aircraft out on time in from there?

Speaker 3

That's a really good question. And let me start by saying, the II folks It's been incredible to work with since this event has happened in early October. We have really had consistent and daily, and I say multiple times a day, communication with our partners at II in Tel Aviv. And they're doing a heck of a job in terms of coming to work and getting the job done. And we see that On a consistent basis.

Speaker 3

So we're really confident Helane that the numbers that we have presented today in terms of The aircraft for 2023 2024, we're going to see and we see them working and delivering aircraft as recently As last week and this week. So it's a fair question, but I can assure you that II has stepped up And it's a very, very difficult time and been extremely resilient to produce and go about their business.

Speaker 7

Okay. That's great. That's great to hear. The other question I had was, I think MAS returned 3 aircraft to you recently. Is that included in the numbers that you gave us for returned aircraft A and B, Since some of your issues seem to be related to some of your newer international customers, Do you have and I don't mean to be nasty about this, but do you really have the expertise to grow beyond your core Business or do you need to bring in more talent to be able to assess risk, so that you don't get a lot of aircraft back When the market turns?

Speaker 3

Yes. So let me address the MOS situation, the MOS piece first. To be clear, they haven't to date returned any aircraft. And in fact, They were actually scheduled to take an additional aircraft as recently as a short time ago. So we fully expect Them to honor their commitments to the leases, and that's been our communication to them.

Speaker 3

In regards to the international expansion, we've talked about that international growth for some time now. And then when we look out to the future growth of the industry and see where that growth is going to come from, clearly all the data Suggests very strongly, it's going to come very well from Southeast Asia, East Asia, Central Asia and across other parts of the world. And that's where we've been focused on. In regards to the talent piece of it, that's really an excellent question. We've had a lot of discussions internally about that.

Speaker 3

We're building up that component of our CAM business to ensure that we address that. You may have heard or remember that we opened up the Irish entity last year And we really have a big focus now of hiring some folks within the next 6 months or so that will be based outside the U. S. To address some of those concerns that you just mentioned. But make no mistake about it, a big part of our future is international And we are a global organization.

Speaker 3

We're looking forward to that growth going forward.

Speaker 7

Okay. That's very helpful. And then for my last question, To your point about Investor Day, which was September 27 being sure of what you were seeing in the business. I mean, how I don't mean to be stupid, but how can that be? How can you not know that you were missing the quarter That close to the end of the quarter.

Speaker 7

I mean, I know that you're going to close the books after September 30, But things couldn't have just fallen apart in 3 days. To your point, you were seeing the decline in the business And you talked about it during Investor Day about being aware of what was going on. We saw we heard had heard from FedEx late August. We knew that UPS had issues, but how did you not like figure out that things were Not that robust. And then when you did, how could you not have Street Prior to last night.

Speaker 2

Well, Helane, this is Quinn. I mean, the In terms of the quarter, we started out ahead of plan in July. And August It was a bit worse, but we were not materially away from plan at the end of August. And truly in September, we had a as we mentioned in our press release, we had some service challenges with Omni. They had a very atypical quarter in terms of service delays.

Speaker 2

And that can and did lead to A lot of cost overrun in the travel area as well as the flight crew and over time. And that was in terms of the Q3, I'm not talking about the second half guidance, but just the third quarter, That was a significant downturn in their September results. And that what we did not have that visibility Certainly at Investor Day. The other source of the 3rd quarter miss was primarily CAM. And CAM, as we've said in prior quarters, one of the things they're working through is the disposition of some 767-200s that have come back And they're selling some of those aircraft.

Speaker 2

And those sales were being worked and anticipated to be done by the end of the quarter. In fact, right up until the very last day. And in some cases, of course, you're relying on The buyer and the other party that carry through with the transaction and they're still working towards those transactions, but The timing of getting those executed did not occur during the quarter and that was a I know that was over a $5,000,000 CAM item just in the 3rd quarter. So we had truly a lot of the deterioration in the 3rd quarter occurred late in the quarter And we did not have that visibility at the time. And we of course mentioned in the earnings release The Israeli conflict, assessment of some customer news that we received in October, all that occurred subsequent to the which impacted our second half guidance that was not known to us at the end of September.

Speaker 2

So I don't know if that I know It's quite a change and I understand the question. But truly there were a lot of developments subsequent to Investor Day, which impacts our guidance. Elaine, this is Joe. Obviously, that's a question that myself and the rest of the Board members have asked a number of times in terms of how could we go out at that point in time. And while there's reasons for all of it, we don't find it acceptable.

Speaker 2

And as Mike noted in his comments that it was More difficult for us to have to make that kind of news to the market, as opposed to you hearing it. So rest assured that that is at the top of the list of Getting back in terms of where the numbers we put out are credible to the market, and not something that you have to be to question going forward?

Speaker 7

Well, yes, I mean, I think the other thing, Joe, you might want to think about is how everybody reports up to you, So that you don't get these surprises and the Board doesn't get surprised at the end of a quarter like this because your stock is down 25%. So You've got a lot of rebuilding to do just from a credibility perspective in the market going forward. It's not going to be easy to get that 25% back.

Speaker 2

No, it's not. It's one of those things like I said, that's top of my list of things to focus on, Helane. That's point number 1.

Speaker 7

Okay. Well, thank you. I don't know if I should say welcome back, Joe, but here you go. Yes.

Speaker 2

Careful what you ask for, right?

Speaker 7

Just thanks for the time.

Speaker 2

Thanks, Elaine.

Operator

One moment for our next question. And our next question comes from Christopher Stilathopoulos with Susquehanna Financial Group.

Speaker 3

Thank you, operator. Good morning,

Speaker 8

everyone. So Joe, your comments around growth more difficult to achieve, Mike's comments around what sounded as point to the challenges within air cargo. I'm just I'm still having difficulty sort of parsing out what's temporary, what's going to persist here, how much of I understand perhaps what happened with the second half, but essentially now we have a double guide down with 2024 guidance at risk. So how much of this is Kind of cyclical slowing here within air cargo. You talk about some international wins perhaps slowing.

Speaker 8

What's operational? Are we having issues here with Pilot attrition, is it something else? Is it weather, geopolitical, supply chain? You spoke to IAI. I just want to understand, of course, then within CAM, rising interest rates, depreciation, we all understand that.

Speaker 8

But just if you could help kind of put it into buckets here because there's A lot obvious here to digest, but the magnitude of this miss and what is being viewed as 2 guide downs is significant. So if you could help just sort of frame the moving parts.

Speaker 2

Yes. Before I turn it over to other members of the team, obviously, I think it kind of falls under the category of all the above of the things you listed out there. I mean, it's no secret that the macroeconomic conditions around the globe are more challenging these days. And as we have said in the past, our customers are at the Amazons and DHLs of the world. So As you see decreasing cargo volumes around the globe, that's going to have a trickle down effect to some of our lease customers.

Speaker 2

But as I think Quint noted in his remarks from Mike, if you look at our core cargo business with the Amazons and DHLs of the world, that portion of Pretty stable. So with that as a backdrop, you can see that if you've got the smaller operators around the globe to support them and conditions are not really good from a total macro perspective, then that's going to have that trickle down effect. So with that, I'll turn it over to Mike and Quint, Paul, to further comment.

Speaker 3

Yes. Let me try to unpack the market piece a little bit more, Chris, for you. So The overall market demand has certainly softened and slowed. There's no question about it. We had the flexibility within In our order book, if I could put it that way, that as the market faced challenges in 2023, We have the ability to bring 2024 leases and customer leases forward to 2023, Okay.

Speaker 3

And that was due to the strength of our order book that you've heard us talk about now for some time. Given that, as we pull stuff forward, obviously, we then took the opportunity really, and you've heard this said earlier, to really demonstrate the Flexibility in our model and throttle backs down some of our growth in 2024, specifically around the 767, which will allow us to reduce our CapEx dramatically in 2024, which ultimately will lead to the free cash flow that was referred to earlier. As it relates to the A321 and the A330s, we just inducted our first A330 into conversion a couple of weeks back. We still fully anticipate to deliver the 3 A330s in 2024 that we talked about. And from and in this year, we still will deliver 4 A321s and 5 next year.

Speaker 3

So The overall demand specifically, we just had the ability and flexibility in the model to shift things around, Throttle down on the CapEx in terms of some of the conversion costs that will help us on a go forward basis.

Speaker 4

Yes. And Chris, I'd just like this is Paul Chase here. I'd like

Speaker 8

to reiterate just a couple of

Speaker 4

things that Jhoi said earlier. I mean, unfortunately, with some of This pullback in demand, it allows us the opportunity to look at the assets we have differently. So we are looking at aircraft that are sitting, that aren't being converted to pull those engines off and deploy those assets. So Allowing us to do that, but I'd also like to say is in conversations with customers, there are plenty of customers who have noted the macroeconomic environment who intend to do business with us in the future On their side, it looks better. So there's still this pent up demand as well.

Speaker 4

So I feel pretty confident.

Speaker 8

On the labor piece, You spoke in prior quarters about elevated levels of pilot attrition, if you could talk to that and also plans around hiring for next year?

Speaker 2

Yes. I mean, pilot attrition is a problem throughout the industry. We're not immune from it by any stretch of the imagination. We're still managing to bring people in the front door. The key is to keep people from going out the back door.

Speaker 2

But when you've got other airlines offering significant hiring bonuses, etcetera, That becomes a challenge, but airplanes are still moving every day. We do have some service failures according to their schedule. So that hasn't been an impediment to the business overall. Obviously, we've got an ongoing negotiation with ATI. As I I said earlier, I'm still drinking from a fire hose, so I haven't had a chance to dig into it in great depth.

Speaker 2

The negotiations are under the auspices of the National Mediation So there's no ability for pilots to walk out until you go through the whole mediation process. I've been down this road many times in 40 plus years. So, we've got a lot of experience in terms of how you work through these issues. At the end of the day, you've got to have a contract that works for both sides. So if you've got on the union side asking for FedEx or UPS wages or industry leading, and that's not in the cards from what we get from our customers and that's not something we can agree to.

Speaker 2

So the key obviously in the end is finding a happy middle ground between their demands and our needs to keep things on the rails.

Speaker 8

Okay. So a follow-up here. I know you're not ready to give guidance for next year here. But if we look at the exit rate For this year, we annualize that gets us to around $540,000,000 If we compare that to, I think, the low end of the guide you gave a few weeks ago, that's kind of a high teens growth. Quint, maybe if you could talk a little bit about the puts and takes as we think about as we hope at our models today, whether this is a wholesale revision or some fine tuning, have 14 aircraft.

Speaker 8

If I understood correctly, we have elevated depreciation, interest rates. Lease rates positively are moving higher, but it sounds like there is some slowing with the cargo. Just if you could help frame the puts and takes as we think about EBITDA for next year? Thank you.

Speaker 2

Thanks, Chris. Yes, 1st, in terms of the guidance sort of revision, right? Because you asked about that earlier, how much of that carries over, how you think about it. Around a little more than 40% of that, call it, dollars 45,000,000 guide down since the end of September It is related to Omni and it's not due to any loss of customers or business. It's due to a couple of factors.

Speaker 2

First off, Q3, and we mentioned they had an unusual service quarter, which drove a lot of costs and in terms of delays, because that drives that additional travel and Crew costs that I mentioned earlier, that was a big piece of their miss for the quarter. The 4th quarter A portion of the guide down is related more to and we mentioned in the release, the Israeli situation we believe will impact some passenger requirements. Omni has a typically a very busy October. And with the onset of the conflict occurring early in October And looking through the remainder of the quarter, we just feel like that may have the effect of deferring some of their business until later And it's difficult to predict whether that'll be by the end of the Q4 or spill into the Q1, but it's not Like they lost some piece of business that will never occur or some customer. So I wouldn't say that the omni piece of that 45,000,000 is a systemic thing that you should think about necessarily for next year.

Speaker 2

Then the other pieces of that Got it down, of course, primarily our CAM. And the largest piece of CAMs and it's similar to Omni, I'd put it somewhere a little north of 40% of that. And the pieces of that are the 767-two 100 sales, which we had targeted for the second half. I mentioned we mentioned they didn't sell any in the 3rd quarter and they have some slated as Mike indicated for the Q4. But as you might expect, we've tried to take a For the Q4, but as you might expect, we've tried to take a conservative view on that because the timing has proven to be difficult to pinpoint in terms of the other party tied up to sale.

Speaker 2

And then we've seen some reduced flying of the 767-200s that we provide engine power to customers for. And so the combined effect of that It is probably more than half of the CAMS piece of the guide down is related to the 767-two 100 fleet. And then they have had some later start ups of new leases of 767-300s than we had anticipated. And some of that is related to that softness in the market we believe, right? We've got the MOS airs and other customers that are feeling the pinch And Art perhaps is in quite the hurry to take the airplanes as it would be in a more robust macro environment.

Speaker 2

And so that's a piece of that as well, as well as our view again trying to be conservative on the realization of customer revenues from some of those folks through the Q4. And we've tried to take a reasonable estimate of that in terms of our revised guidance. Those were the biggest pieces of the $45,000,000 guide. Now as far as the 2024 outlook, Joe and Mike spoke about the CapEx reduction, which of course Yes. It's much easier for us to revise at this point because we know what Eric as Mike said, we're not going to Refill the conversion lines once the airplanes are produced at II, so that will reduce our 24 CapEx.

Speaker 2

And we know what So we've looked at that and said we're going to bring our CapEx down $100,000,000 That doesn't mean that's where we necessarily stop. We're continuing to scrub that and we're going to look for more opportunities to lower the expenditures there As we move forward, I'm sure Joe in particular will be looking at that very closely. Get my right pad. In terms of the adjusted EBITDA to revise the guidance gave at the end of September for 2024 because of the situation in Israel, the customer and macro market Softness that we've mentioned. We want to let that play out further and update that guidance in February.

Speaker 2

But that said, we are confident that the adjusted EBITDA that we put forward for 2024 will be higher It's in our 23 that we've guided to. And we look forward to in February once we've had some of these events Continue to evolve and updating the market further, but we have enough, we believe, visibility to 2024 certainly to Say it will improve upon 2023's result.

Speaker 3

Yes. Just want to highlight the one thing that Quint mentioned Specifically around Omni is that troop rotations will take place. We just from a timing standpoint can't predict that piece of it.

Speaker 8

Right. Okay. So if I hear you the sort of base case risk adjusted view, if you will, of EBITDA for next year is higher Then let's say the midpoint of yesterday's revised guide?

Speaker 9

Correct.

Speaker 8

Okay. And last one on the power by cycle contracts, Quint, how many of those sort of pandemic era contracts are rolling off of this year?

Speaker 2

Well, the what I was speaking of was related to the 767-200GE powered ADA engines and we maintain a pool. You may remember When our previous arrangement for Power by Cycle ended with a supplier, we instead went to a pooling Concept where we would make that power available to lessees for 767-200s. So we have We provide that availability and customers pay us by the cycle on that. And we maintain that pool of engines, which you can expect as that 767-two 100 fleet comes down, our CapEx spend to do that will likewise come down. But what we have seen is, as we're paid by the cycle, we've noted this year that sequentially each We've seen those airplanes that are still out there with customers flying fewer cycles.

Speaker 2

And I think that is an indicator that there Perhaps of some softening market because there aren't there isn't as many flights taking place, not as much perhaps For those customers, volumes are a reason to fly the airplane. And so that has impacted, as I mentioned, The EBITDA from the 200 fleets that can't get. But I'm not sure, Chris, if you were asking about our own power by cycle arrangements that we have with suppliers to maintain other engine types or you were just focusing on The comments around 767-two hundred PBC?

Speaker 8

Not the 200s. Overall, I'm guessing that you did There were some contracts that were put together early mid days of the pandemic and was curious how many of those are rolling off at year end?

Speaker 2

Well, I mean the other engine types, the other aircraft types and the engines that power them, we don't maintain a pool of engines. Under the lease, The customer is typically responsible for the maintenance of those engines throughout the life of the lease. Now we ourselves You now have a power by cycle arrangement with an outside vendor to take care of our engines. For the 767-300GE powered fleet. And I believe we've entered into 1 with IAI for the PW4000 is correct, the Pratt engines.

Speaker 2

But that's different than us offering a product to a customer. That's us Buying from a supplier. So I'm not sure which side of the PVC you're getting at there.

Speaker 8

That's good. Thank you for the color. Thank you, everyone.

Operator

One moment for our next question. Our next question comes from Howard Rosenkranz with Value Advisory.

Speaker 9

Hi, guys. Thank you for taking the call. Hi, guys. So the second hello, guys. So the second half looks like So the midpoint of your guidance is $270,000,000 I'm just trying and based on so The Omni part is largely the Middle East.

Speaker 9

Is that the big change there?

Speaker 2

That's in the Q4, Howard, from the that would be of the second half, it's obviously that happened in October. So that's In the Q4, yes. That's the biggest impact on Omni.

Speaker 9

Okay. And the rest of the stuff is lower demand or the absence of the engine Sales, just to summarize, right?

Speaker 2

Yes. I mean, we went through some of the puts there a minute ago, puts and takes.

Speaker 9

Right. Okay. Just having a little trouble processing in my 40 years in the business. I never saw this happen. So the $270,000,000 the midpoint of the guide should be the absolute, absolute you already communicated your you'll Expect that the guide you'll introduce were or that extensively 2024 will be higher than 2023.

Speaker 9

So but just to take the bear just To take $270,000,000 as a second half number, you have some anomalies, you have some you have all of these factors. So sort of a worst case scenario is that, that suggests that your $540,000,000 $550,000,000 is the absolute bare bones, just so we can understand what sort of a bare bones number there is out there?

Speaker 2

Well, I think when we said it would be better, we were talking about for our full year 2023. So the full year 2023 guide is higher than $540,000,000 right? So We're talking about our guidance for the full year, 2023.

Speaker 9

Okay. I thought you were talking about 24 When you made some comments about 2024, okay. Maybe I'm Yes, we are.

Speaker 2

We're saying 2024s will improve upon 2023s full year adjusted EBITDA.

Speaker 9

Yes. Okay. That was the point I was making. I was just trying to understand what the Obviously, there seems to be a lack of filter of information that's going on at the company. So All right.

Speaker 9

Well, thank you very much for your time and certainly good luck to all of us. Thank you.

Speaker 5

Thanks Howard.

Operator

One moment for our next question. And our next question comes from Michael Ciarmoli with Truist Securities.

Speaker 10

Hey, good morning guys. Thanks for taking my questions. I guess, can we just maybe elaborate a little bit on how Israel is directly impacting Omni. I mean, at Investor Day, I know the focus was on a potential government shutdown. Sounded like all flight activity was booked and locked in for the end of the year.

Speaker 10

Obviously, the U. S. Doesn't have any direct exposure, but I would think Regardless, troop rotation movement would be good for Omni. So what's exactly happening with Israel?

Speaker 2

Well, I'll take a stab at it and let others join in. Michael, this is Quentin. But again, and we refer to them as passenger requirements. Obviously, we're not going to go into a lot of detail on what Omni may be hearing directly from their customer. But Just in general, I think the Israeli conflict caused an atypical Interruption to what would normally be their busiest period that be in October.

Speaker 2

And as we remarked earlier, We do not believe that over a longer stretch of time, it will be a negative impact to Omni because Those passenger operations will occur. It's just difficult to say whether they will fall inside the Q4 or they will extend beyond that. And you're correct that in many cases, world events have resulted in additional revenue opportunities for Omni. Norm, and you only have to look back at the Afghanistan withdrawal, the NATO situation Near the Ukraine to find some examples. So Omni remains the I believe kind of A linchpin, if not the linchpin carrier for commercial passenger moves for the DoD and we fully expect that to continue.

Speaker 2

Omni has demonstrated that While there's more volatility, they can also do very well in those situations. So We're not saying that's changed. Okay. The possibilities are lower now. We're not saying.

Speaker 2

Okay. You've got to understand that military is going to do their contingency planning. And of course, like I said, anything that they do in that regard is not something that's divulged to the public. But eventually, as Quint noted, troops have to move. Normally, October is a busy month because rotating troops in and out before the holiday season.

Speaker 2

But when you've got a crisis boiling like we have in the Middle East, it's one of those things where everything kind of has to take on put on be put on hold until you can better assess the situation and what potential ramifications are.

Speaker 10

Got it. Got it. And then just on the I mean, I get it on cutting CapEx And it's going to improve cash flow, but this is now multiple cuts to CapEx. And I guess What sort of the direct formula you can give us? Because as we look out now, I mean the 25 EBITDA guide has obviously moved, but how much does the lack of Growth CapEx spending impact the EBITDA generation that we were originally going to see?

Speaker 2

Well, Michael, I mean, again, there's of course, in addition to the CAM segment, which is Where the EBITDA drive is from CapEx spend, there's the ACMI Services and we've spoken a lot about Some of the things we're all with the Israeli situation and That is the reason we're deferring 24's CapEx guidance next year. But I think that Next year, the aircraft that come out will as Mike said, 14 or 15 aircraft will still drive significant EBITDA. There will still be some headwind from 767-200s being removed from service at the same time. And he talked about 14 or 15 aircraft. I think 8 of those are Airbus aircraft that come out next year.

Speaker 2

And I think so we're still going to have significant EBITDA contribution from newly converted aircraft that go on lease. But we're going to hold off on the total EBITDA guide until we've had a chance to see how some of these other factors play out. But we are confident that it will exceed 2023's actual. Keep in mind, the EBITDA contribution of an asset is basically only a fraction of what the CapEx spend is for that similar asset. So it takes years to get That cash back in terms of leasing the aircraft out.

Speaker 2

So near term, it will have a minor impact on the EBITDA, But a significant impact on the CapEx spend.

Speaker 10

Okay. And Joe, last one for me and I hate to go here, but back to Helene's line of questioning. I mean, we can literally monitor in real time flight operations. I just I mean, what were you guys not Seeing, I mean, I would think you could see your power by the cycle on a daily basis, your flight operations on a daily basis, the block hours on a daily basis. I mean, it just seems like there was a failure of internal controls here.

Speaker 10

And I mean, if you're seeing all these trends in real time and we've Hearing and talking about a macro slowdown for months, I just it just doesn't really square To me, I don't know if you guys if you just weren't monitoring that data or weren't looking at it, but it just Yes. I just seemingly there seems like there was something that should have been jumping out and flashing red, especially on September 27.

Speaker 2

Yes. And in part, you're correct in that regard in terms of but it's not an internal control. It's more understanding what the ramifications are of a delay. For example, when Omni had an aircraft that was down for 3 days, you know an airplane is down for 3 days, but the part that wasn't connected was the fact that you had to put up 200 or 300 passengers in the middle of nowhere. I think it was in Guam was where the aircraft got way late.

Speaker 2

And it got nailed there for 3 days. So it's the Downstream ramifications of it. Everybody knew the airplane mechanical, for example. As far as power by the cycle side thing goes, the users of the 200s Turn in their hours at the end of the month, we don't get a daily recap from them that I flew 2 hours yesterday and 5 hours a day before. At the end of the month, you totaled up what their utilization was.

Speaker 2

So you really wouldn't have visibility into the PBC portion of it until the end All you're doing is forecasting what you saw previously.

Speaker 9

Okay, okay.

Speaker 10

Got it. All right. Thanks guys. Yes. Thanks, Michael.

Operator

One moment for our next question. Our next question comes from Chris Stathoulopoulos with Susquehanna?

Speaker 8

Thanks for getting me on here. I'll keep this quick. Just quick if you could walk us through Cash, total liquidity, including your revolver debt maturity? And also Just remind us the pilot opened contracts, whether those were embedded in the out year guidance? Thank you.

Speaker 2

Sure, Chris. In terms of the last question first, I guess, the pilot open contracts, of course, we're not giving guidance. We're not refreshing our 2024 guidance, but if you're asking if we had it included at the end of September, Yes, we did when we talked to the market. But today, we're not refreshing out your guidance on the expense side. But when we do, it will make in those status of the pilot agreements.

Speaker 2

As far as the liquidity section, and of course there's a slide in here, Slide 8, which kind of lays it out. But we have a revolver That so I believe a $1,100,000,000 capacity revolver that we've got undrawn Unused capacity of over $400,000,000 on our current leverage ratio After including the unsecured portion of our debt, which is A new convertible, dollars 400,000,000 convertible due in 2029, as well as The remains of a convert we did in 2017, that's $54,000,000 that matures next year and an unsecured bond that matures in February of 2028 of 580,000,000 Taking that into consideration and looking at the leverage ratio, we're currently levered, I believe it's like 2.88 times our trailing EBITDA. And so, still conservatively levered With some reduction in EBITDA, we will be around 3 times levered. We might even slightly go above it Depending upon how that comes out. But with the reductions in CapEx that we spoke about, there's not a There'll be the ability if we choose to allocate capital to delever, there'll be an ability to do that as we look to the next couple of years.

Speaker 2

I mean, as we said in our remarks, the cash flow the business produces from the base of leases we have, you think about 75% or more of our revenue is through Amazon, DHL and the Department of Defense. That stable cash flow will continue and generate a lot of capital that can be allocated to deleverage should we choose

Speaker 8

And you think you said in your Investor Day, you had more than $1,500,000,000 of available unencumbered aircraft collateral. There's been some movement, I think, which would be a positive given your 767 exposure on values. Is that number, Give or take around 1.5 of unencumbered collateral still the right way to think about it?

Speaker 2

Yes.

Speaker 8

Okay. Thank you.

Operator

This concludes the question and answer session. I would now like to turn it back to Joe Hete for closing remarks.

Speaker 2

Thank you, Sean. To our stakeholders, we get it. Receiving the news we reported yesterday after an upbeat outlook in September is hard to accept. We need to restore your trust by making only the commitments we know we can keep. Many of you on today's call know me and the fundamental cash generating power of the business that the ATSG team and I built over many years They're investing for growth and shareholder return.

Speaker 2

I agreed to return to CEO to guide the company through the next phase of its development, which will require us to focus on maximizing returns on the aircraft assets we have today, while taking a more measured approach to investing for new ones. I've already told our employees that I welcome all their ideas to make us stronger and advised our customers that our commitment to best in class service remains the basis for everything that we do. Thank you and have a quality day.

Operator

This concludes our conference for today. You may now disconnect.

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Earnings Conference Call
Air Transport Services Group Q3 2023
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