Air Transport Services Group, Inc. (NASDAQ:ATSG) Q4 2023 Earnings Call Transcript

Air Transport Services Group, Inc. (NASDAQ:ATSG) Q4 2023 Earnings Call Transcript February 27, 2024

Air Transport Services Group, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and thank you for standing by. Welcome to the Q4 2023 Air Transport Services Group, Inc. Earnings Conference Call. [Operator Instructions] 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.

Joe Payne: Good morning, and welcome to our fourth 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 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, unplanned 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 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 tensions or conflicts, human health crisis 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 pretax 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 Joe Hete, our CEO, for his opening comments.

Joe Hete: Thank you, Joe. Good morning, everyone. As you may recall from our Q3 call, we saw some significant changes to our market environment in the second half of the year, resulting in multiple headwinds that continue to impact our financial results in the fourth quarter. These include lower demand in our leasing segment and reduced block hours in our airline operations. The most significant factor was an acceleration in lease returns of our 767-200 freighters, which reduced adjusted EBITDA by approximately $33 million in our CAM leasing segment in 2023. These aircraft were in high demand as Amazon built its own Air Express network starting in 2015 and even more so during the pandemic when customers kept the aircraft in service longer than originally planned.

While we always envision the market transitioning to the 767-300s from the 200s, the market softness has accelerated that process. In addition to the lower lease revenue, we also lose power by cycle engine revenue as the 200s are removed from service and the aircraft remaining in service fly fewer cycles. Despite the macroeconomic and operating challenges weighing on our results in the second half of the year, we leased 13 aircraft, including our first three Airbus A321-200 freighters. By now, I’m sure most of you have seen our earnings release and the guidance we’ve given for 2024. Quint will review our 2023 financial results in a moment. Many of the challenges he will describe are expected to continue in 2024. As a result, we are taking a more conservative approach to how we provide our adjusted EBITDA guidance this year.

Traditionally, our guidance has included upside potential from the expected signings of future leases and additional ACMI flying. Today, we are providing a forecast of $506 million in adjusted EBITDA for this year, which only includes existing and signed future leases, net of expected lease returns. We believe this approach gives a better indicator of our expectations. We will also outline drivers we believe could provide upside to that. Given our expectations for continued market challenges in 2024, we are aggressively reducing our capital spending outlook and I’m committed to generating positive free cash flow this year. I’ll discuss the specific I’ll discuss the specifics of our capital plan for 2024 after Mike gives you some details are on our adjusted EBITDA outlook.

But the key is that we are budgeting $410 million down $380 million nearly half of the 2023 levels. With that, I will now turn the call over to Quint Turner to discuss our financial results for the fourth quarter. Quint?

Quint Turner: Thanks, Joe, and welcome to everyone joining us this morning. I’ll start on Slide 4, which summarizes our financial results for the quarter. Revenues were down $16 million or 3% versus a year ago to $517 million. This was driven by lower revenue in the ACMI Services segment, partially offset by higher revenue in our Leasing segment. In the fourth quarter, we saw a GAAP pretax loss of $16 million down from pretax earnings of $61 million in the prior year period. The 2023 GAAP results include a noncash $24 million settlement expense associated with the partial termination of a previously frozen pension plan. This resulted in a diluted loss per share of $0.24 versus diluted earnings per share of $0.50 in the Q4 of 2022.

On an adjusted basis, pretax earnings fell $45 million to $20 million and EPS was down $0.35 to $0.18. In our Aircraft Leasing segment, revenues increased 18% for the fourth quarter and 6% for the full year, reflecting the benefit of a full year of revenues from six 767-300 freighters leased during 2022 as well as partial year revenues from 10 additional 300s and three Airbus 321s we leased in 2023. CAM’s pretax earnings were down 34% for the quarter and down 23% for the full year. Interest expense and depreciation were $6 million and $5 million higher in the fourth quarter of 2023, respectively. For the year, the reduction in CAM’s pretax earnings was primarily due to $33 million less in aircraft and engine lease results related to 767-200 freighters.

That was over 90% of the decline in CAM’s annual pretax earnings versus the prior year. As of year-end, 90 CAM owned aircraft were leased to external customers, one fewer than a year ago. Additionally, 10 767-200 freighters were removed from service during the year. In our ACMI Services segment, pretax earnings were a loss of $2 million down from $26 million in the fourth quarter of last year. This was driven by unfavorable revenue mix impacts and fewer block hours flown for the military. In the fourth quarter, block hours flown for the military were down 24%. This represents the lowest fourth quarter military hours since 2017. On a combined basis, the total block hours flown by our three airlines were down 4% versus the prior year quarter.

Turning to the next slide. Our fourth quarter adjusted EBITDA was $130 million down 20% compared to the prior year. 2023 adjusted EBITDA was down $79 million to $562 million. Of the decline in adjusted EBITDA, CAM decreased by $9 million and ACMI Services and Other declined by $70 million. CAM’s decline was driven by $33 million less in adjusted EBITDA related to 10 767-200 lease returns and fewer block hours flown by the 200s remaining in service resulting in lower power by cycle engine revenues. Again, the decline in ACMI Services and other was driven by lower block hours in our airline operations and a lower margin revenue mix. Slide 6 details our capital spending for the quarter and past 12 months. Total CapEx for the quarter was $212 million comprising $151 million in growth CapEx and $61 million in sustaining CapEx. As Joe mentioned, we are projecting substantially lower capital expenditures for 2024, which he will address in more detail in a moment.

The next slide updates adjusted free cash flow as measured by our operating cash flow net of our sustaining CapEx. Operating cash flows increased $54 million to 128 million. for the quarter and were $654 million for the trailing 12 months. Adjusted free cash flow was $435 million up 52% versus last year. On Slide 8, you can see that available credit under our bank revolver in the U.S. and abroad was $358 million at the end of the Q4. We bought back approximately 7.4 million shares over the past year, all within the first three quarters. Our balance sheet net leverage ticked up to 3.2 time. Turning to the next slide, I’d like to spend some time discussing our outlook and assumptions for 2024. Then I’ll turn the call over to Mike Berger, our President, to discuss the market environment.

For 2024, we expect adjusted EBITDA of $506 million down approximately 10% versus the prior year. We also project adjusted EPS in a range of $0.55 to 0.80 dollars diluted for 2024, reflecting higher depreciation, interest expense and income taxes. This includes only the two 767-300 freighters we have already leased this year and two others for which we hold signed leases for delivery later this year. It also assumes the return of seven 767-200s from Amazon and three 767-300s when their leases expire later this year. Please note that this adjusted EBITDA forecast excludes any contribution from additional aircraft leases or other new business not currently under contractual commitment. We believe upside exists from these opportunities, which our commercial teams are aggressively pursuing.

On a combined basis, we believe these opportunities could provide $30 million in additional adjusted EBITDA should they materialize, driving our potential adjusted EBITDA to $536 million. Now, I’ll turn the call over to Mike to discuss the outlook and the operating environment in more detail. Joe will follow-up with the capital spending outlook. Mike?

Mike Berger: Thanks Quint. As you just mentioned, we see opportunity for upside in our 2024 forecast. Before I do that, let me set the table by walking through the key drivers of our expected results. Biggest drivers of the decrease in adjusted EBITDA forecast of $506 million versus the 2023 actual amount of 564 million dollars our lease returns of 767-200s and the effect of higher cost and lower block hours in our airlines. The return of the 200 resulted in a $55 million decline in the leasing related EBITDA forecasted versus 2023, due to lower 767 lease revenue, along with lower PVC related engine revenues. Almost all the remaining 200s have a number of years of useful life remaining. When we spoke to you last quarter, we noted commentary from some of our lessees experiencing lower customer demand, which was negatively impacting their financial results and outlook.

As a reminder, that was primarily related to international demand. Since then, we’ve seen some improvement in the leasing demand in international markets, particularly as it relates to the midsize freighter market that CAM serves. In particular, we’ve seen some more A330 leased in recent months. Furthermore, we’ve seen more A321 deployments, especially in Europe and Asia. With regard to the A321s, we recently received the EASA approval for our freighter conversion design and are now able to release these aircraft into the European market. We continue to see the A321 as a logical replacement for older generation narrow body aircraft like the 757. We’ve also seen encouraging signs in the 767 market, as one of our customers recently extended two 767-200 Leases into 2025.

We will continue to stress the operational capabilities, cost efficiencies and reliability of all our aircraft types. As Quinn said, our outlook assumes only those leases currently under customer commitment. As the market normalizes further, we are well positioned to take advantage of opportunities beyond these commitments. Now, I’ll turn the call back to Joe Hete for our CapEx plan.

Joe Hete: Thanks, Mike. As mentioned, we now expect total capital spend of $410 million a reduction of $95 million from our 2024 expectations on the third quarter call, and that’s down $195 million from the forecast we gave you at our Investor Day last September. Drilling down, we now expect $165 million for sustaining CapEx and $245 million for growth. The expected $330 million reduction in growth CapEx versus 2023 reflects fewer feedstock purchases and freighter conversions than our prior plan. The expected $50 million reduction in sustaining CapEx versus 2023 is driven by fewer expected engine overhauls in 2024. The gross spending outlook includes the completion of 14 in process freighter conversions and the acquisition of nine additional feedstock aircraft.

Those include five Airbus A330s that we committed to purchase several years ago. Looking ahead, we expect to see a further decrease in growth CapEx in 2025. Our reduced spending outlook for 2024 is expected to meaningfully improve our cash generation and we are targeting positive free cash flow for the year. Despite these challenges, I am confident in the demand for our midsized freighter assets over the long term, and the strength of our lease plus market strategy. Furthermore, our fleet investments position us to remain the leader in midsize freighter leasing, and will allow us to deploy more freighters as market conditions improve. That concludes our prepared remarks. Quint and I, along with Mike Berger, our President and Paul Chase, our Chief Commercial Officer, are ready to answer questions.

May we have the first question?

See also 12 Things Retirees Need to Know About Social Security and Taxes and 13 Best Diversified Dividend Stocks To Invest In.

Q&A Session

Operator: Thank you [Operator Instructions]. Our first question comes from Christopher Stathoulopoulos with Susquehanna Financial Group. You may proceed.

Christopher Stathoulopoulos: Hey, good morning. This is Anthony on for Chris. Thanks for taking our questions. Your full year 2024 adjusted EPS guide or EBITDA guide implies a 10% year over year decline. I know you mentioned some of the puts and takes of that, but how should we think about your flying versus EBITDA decline for this year? And how should we think about your consolidated EBITDA for this year?

Quint Turner: Thanks, Anthony. It’s Quint. In terms of the EBITDA decline year-over-year, You’ve got the CAM piece which is as we mentioned the big factor there was a 767-200 reduction. And we talked about versus 2023, our 2024 guide has an impact just on the 767-200s roughly a $55 million decline just on the CAM piece. And so CAM is going to be down year-over-year in total in adjusted EBITDA. And at the sort of the top of the range, how we gave sort of the $506 million and then we said there was upside, it’s about a $20 million decline versus that top of that range for 2024. And of course, some of the upside is CAM that’s in that $30 million that we cite between the $506 million and the $536 million. As far as the airline segment, it’s again the 767-200 removals and year-over-year one of our airlines ABX Air was still operating some longer routes related to the pandemic and those ended in the first quarter.

And it’s about the AVX piece is down. Certainly, again at the top of that range about a little shy of $20 million, it’s a revenue decline, right, because of the block hours are down year-over-year. And the other two airlines are pretty flat.

Christopher Stathoulopoulos: Great. That’s great color. Thank you. And then in terms of the margin, can you speak a little bit on the expense side? So you have the 767-200 returns, less revenue on the power by the hour contracts. But how should we think about some of your expense buckets for this year? Are you expecting any notable increases? Anything moving kind of inflation plus?

Quint Turner: Well, in some of the bigger buckets, on the salary and wage contract labor kind of expense, we’re actually predicting a decline on that — in those costs versus 23%. And naturally with some lower flying volumes and so forth, plus some measures we’ve taken to sort of increase the cost efficiencies, we’re expecting headcount to be flat and down depending upon the subsidiary company. So there you’re looking at a decline, it’s $20 million to $30 million call it. On the maintenance expense line, again you’ve got a decline anticipated, some airplanes of course coming out of service and there you’re looking at roughly at least our forecast is for about a $24 million decline year-over-year on the maintenance expense line.

Now keep in mind that also includes some cost of goods sold that our MROs handle that the offset is in the revenue line. And then another big one, of course, is depreciation and amortization. And there we’ll see some increase. Coincidentally, it’s about the same as the decline in maintenance. So figure about a $25 million to $26 million increase on the D&A line.

Joe Hete: This is Joe Hete. Just to follow-up on what Quint said, if you think about the way our contract is structured with Amazon, for example, with the 200s versus the 300s, Amazon is responsible for a lot of the heavy maintenance on the 300 side. So the maintenance expense that we book relative to operating those aircraft is smaller than what you’d see with the 200s. So as the 200s come out of service, you’ll see a corresponding drop in the maintenance expenses related to that on top of the loss of the — or to offset partial loss of the cycles and lease payments on the aircraft in total. As Quint mentioned, if you look at the 200s overall, which on our P&L, which we’re flying for Amazon, the revenue piece of it’s down about $60 million year-over-year just for that portion of the business.

Quint Turner: Yes. In terms of — I was going to say too, in terms of the interest line, of course, that is up as well. Some of that’s a function, of course, of the average interest rate change year-over-year. And of course, will depend upon what happens to some degree with interest rate going forward through 2024. But we anticipate north of a little north of $20 million increase in total interest. The cash interest piece of that though is only up about $10 million or $11 million of that.

Mike Berger: The last piece of that would be just some targeted cost cutting that will take place within the businesses and we’ve already done that at one of our companies.

Christopher Stathoulopoulos: Great. Final question here. In terms of the SWB expense for this year, you mentioned a decline. I’m guessing you’re not anticipating any labor agreements being signed this year. Can you speak to if you’re expecting any for next year?

Joe Hete: This is Joe again. From the labor standpoint, no, we don’t anticipate that we’ll have an agreement with any of our open collective bargaining agreements whether it’s with pilots or flight attendants this year. As you can would expect there’s a stark difference in terms of what the expectation may be on the parts of the union side of the equation versus what the company believes it can afford. They’re all being handled under the auspices of the National Mediation Board. We haven’t had any negotiating sessions this year, for example, yet with the ATI side of the equation. We have had one with the Omni pilots and with the Omni flight attendants so far this year. But we don’t anticipate that any one of those contracts will get settled out this year. So it will probably roll into 2025.

Operator: Our next question comes from Ian Zaffino with Oppenheimer. You may proceed.

Ian Zaffino: Hi, Quint. Can you just let us know how many 200s are now in service and what your expected returns are throughout the year, either number of aircraft or dollar amount? Thanks.

Paul Chase: Yes. Thanks for the question. It’s Paul Chase here. It’s 14 aircraft that will be in service by the end of the year and the budget already reflects the aircraft that we expect to come out this year.

Ian Zaffino: Okay. You can provide the amount or just you’re giving us the net amount?

Joe Hete: Well, there’s seven 200s that we anticipate would be removed, what, in April, I think for Amazon. And the number Paul quoted in the 14 is what we anticipate having operating at the end of 2024. And I think in terms of the anticipated future removals of 200s that we sort of had this lot of aircraft associated with Amazon and based on the cycle age of the aircraft that came out last year and of course the seven early this year, but those 14 by and large have plenty of life in terms of their cycle age. We don’t anticipate the rate of removal over the next few years to be more than two or three spread out during that timeframe.

Ian Zaffino: Okay, great. Thank you. And then just as a follow-up, maybe more of a philosophical question here, but stocks at below $13, your book value is $21, I think if you do some depreciation adjustments on the 300s probably at $28 or so. What are you guys doing or how are you thinking about a way to maybe close that value gap? I’ve got to leave it as an open question. Thanks.

Joe Hete: That’s a good question. But like I said, I’m not sure there’s a silver bullet in terms of giving you an answer in that regard. Obviously, our performance over the last 12 to 15 months call it hasn’t been what it should have been in terms of reviding guidance downward a couple of times. Certainly, that’s had an impact on the price of the stock. If you look at the overall transportation sector, I don’t care if you’re talking about FedEx, UPS, trucking companies, shipping companies, everybody is down on their forecast, actuals for 2023 and then down on forecast for 2024. So there’s not a lot to point to in terms of the near term, in terms of the market starting to come back. But I think the key is that we’re well positioned going forward with the assets that we have, the investments we’ve already made to be able to react quickly if and when the market finally turns around whether that’s 2024 or 2025 where we start to see a rebound in that respect.

So from our perspective, it’s two things obviously market being key, but the other one is execution on our part in terms of better performance overall. That’s been a focus of mine since I came back in November to have better execution on the part of all the operating units and a more conservative approach in terms of the capital spending as evidenced by the significant reduction and we talked about earlier on the call from a CapEx standpoint. So I think all those things combined, a more balanced capital allocation strategy going forward after generating some free cash flow puts us in a better position to start moving the stock back up where it should be.

Operator: Our next question comes from Helane Becker with TD Cowen. You may proceed.

Helane Becker: Thanks very much, operator. Hi, gentlemen. So my one question, just a follow-up on the pilot negotiations. Are there any accruals that you’re taking in anticipation of an agreement? Or will it all be reflected in one quarter after negotiations conclude and there’s an agreement?

Joe Hete: Well, I think as I noted earlier, I think we’re a ways off from coming to a final agreement in terms of where that will finally land as anybody’s best guess in between. I can tell you if you look at the ATI side, for example, it’s about $70 million in pilot salaries for the year. So depending upon what you want to target is, what you think the expected settlement would be, you can calculate a number using that as a baseline from the negotiation standpoint. So it’s going to have obviously a negative impact to the bottom line if and when we finally get an agreement. Just not prepared at this point to comment any further in that regard.

Helane Becker: Okay. That’s helpful base anyway. And then I think you said on Omni, you’re doing fewer hours for the military. How should we think about that for fiscal 2024?

Joe Hete: Yes, Helane, if you look at Omni over the last starting in 2022, 2023 was down about 11% year over year from the military hours perspective. Looking forward to 2024, because military doesn’t give you a lot of advance notice in terms of what the expectations are. We basically flat line that from an hours perspective for our 2024 plan. So if it rebounds to normal levels or what we’ve seen in the past is normal levels, obviously there will be a significant upside potential for the business, but as Quint said if you look at the fourth quarter numbers, for example, we haven’t seen numbers that low since 2017. So it kind of tells you where things are with all the turmoil going on across the globe that the military is kind of keeping everybody in position.

Helane Becker: Right. Got it. And then my final question and you kind of answered this on lease expirations. So is this like a peak year for lease expirations and we should think about like 2025,2026 and beyond being the two to three or five a year versus 10 or 12 a year? Because I feel like last year was also a big year for lease expirations.

Mike Berger: Yes. Helane, it’s Mike. As we mentioned on the 200, we had the group that we mentioned on the Amazon on the seven. We’ll have 14 remaining in service as we stated by the end of the year. Then we anticipate two or three over the next couple of years on the 200 side. We are expecting 3 lease returns, I should say expirations not returns on the 300s this year as well. Two will come very late in the year, the back half of the year, and we’ve already had one. So you’re correct that we had an abundance lease expiring in the last year or so.

Helane Becker: Okay. But then it returns to a more historic level?

Mike Berger: Correct.

Helane Becker: Okay. All right. That’s really helpful. Thank you.

Operator: Our next question comes from Frank Galanti with. You may proceed.

Frank Galanti: Yes, great. Thanks for taking my question. So I wanted to follow-up on the ACMI business, specifically flying for the DoD and sort of Omni’s role in that. Is the number of block hours down because of pure demand from the government or is that an indication that there’s other cargo operators taking those block hours that otherwise would have went to ATSG? And from a strategic perspective, is that given there’s been a couple negative margin quarters, does it make sense to maybe fly one or two less planes to sort of protect the downside and obviously experience less on the upside. Can you sort of talk through strategically thinking through that decision?

Joe Hete: Yes, Frank, this is Joe. From the military side, remember the cargo piece of it is such a small piece of our overall business. We have one airplane that does one or two trips a month, potentially over to Asia. It’s really about the passenger side of the equation. From the standpoint of demand from the military of what we’ve seen, it’s down overall for everybody that participates in the craft program. We don’t keep tabs on the cargo side of it since we’re not a big player there. We don’t have the large wide body aircraft to participate on the cargo piece of the military business. But in terms of putting aircraft down obviously from the standpoint of carrying an aircraft you don’t need, there’s a significant expense attached to just maintaining that aircraft.

So we’re looking at our fleet allocation overall on the Omni side of the business. As we said, when we acquired Omni way back in 2018, one of the things that we looked at was the fact that they did use the 767 for the bulk of their military business and we view that as a feedstock opportunity for converting to cargo at some point in time. But the key is that when the military calls, you need to be prepared to respond accordingly. We’ve always prided ourselves on being the number one provider in our asset class types for the U.S. Military and so we feel it’s our obligation to be able to have sufficient assets to be able to respond. But rest assured, we’re constantly looking at the fleet composition to see if there’s an opportunity to reduce the overall cost.

Mike Berger: I just think it’s important to also understand that omni is flying not only the entitlement is provided, but over its entitlement, which is traditionally as well. But the overall demand is down.

Frank Galanti: Okay. And then I wanted to ask on sort of guidance, and sort of what’s changed from a messaging perspective. The press release now calls out, some planes available for release, I think, at 14. Are you assuming that those claims are not going to be leased? Like with historical guidance, would that have been you would have come out with $30 million to $40 million and you would have assumed most of those would have been on lease? Like what sort of changed from a conversation with customers perspective on those planes available for lease and sort of a messaging from HSG’s perspective?

Paul Chase: Sure. It’s Paul here. I think in the past, the methodology would include the probability of certain leases in a stronger market. And as we saw in 2023, the market has been softer. So what we wanted to do is take a more conservative approach and use leases that were already locked up with customers and deposits and then have upside going forward as Joe mentioned in his earlier comments.

Joe Hete: Yes. So Frank, for example, the $506 million as we said assumes four 767-300 leases, two of which have already been put in place this first quarter and I think maybe a third that could is likely probably in March. And so other than that, we haven’t in that $506 million number included contribution from additional leases even though we as Paul says, we continue to pursue those and we believe that there’s a good chance, particularly if the market normalizes to make good on some of those. And we also have returns that we mentioned. We have what three 767-300s I think coming just to the natural ends of their current leases. And there’s potential to release those aircraft. But in that starting point of $506 million, we haven’t assumed that. So that’s certainly part of that upside potential of that $30 million that we spoke of.

Paul Chase: And there will be some depreciation in our EBITDA numbers already, but factored in on the assets. But obviously, if the revenue comes along, it will be nothing but improve the overall EBITDA of the company.