Air Transport Services Group - Q1 2020

Transcript

Speaker 0

Welcome to the Q1 2020 Air Transport Services Group Incorporated Earnings Conference Call. My name is John, and I'll be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. And I will now turn the call over to Joe Headey, CEO of APSG.

Sir, you may begin.

Speaker 1

Thank you, John. Good morning, and welcome to our Q1 2020 earnings conference call. With me today are Quint Turner, our Chief Financial Officer and Rich Corrado, our President and my incoming replacement as CEO. We issued our earnings release yesterday after the market closed. It's on our website, atsginc.com.

We will file our Form 10 Q later this week. The Q1 of 2020 was a good one for us, but it also reflects a different world than when we last talked to you in early March. We are adapting to the coronavirus pandemic where necessary, but we are not compromising the core principles that have made us successful: safety in everything we do, superior customer service and solid returns on your investments in us. Throughout the Q1, our business was on a strong pace with solid increases over the Q1 of 2019, including results from Omni for each period. Revenues increased by 12% to $389,000,000 and adjusted earnings minus warrant and other effects were up 13%, which translated to $0.43 per share, up 0 point 0 $6 On a similar basis, our adjusted EBITDA increased 9% to 124,000,000 dollars Our airline operations were particularly strong in the Q1 and that pace continues through today for the cargo portion of their work, principally for Amazon and DHL, who are benefiting from a surge in e commerce activity.

Meanwhile, our CAM leasing business remains solid and is still on track to lease 8 to 10 newly converted 767 freighters this year, including at least 4 for Amazon and 3 for UPS. Quint is ready to flesh out those consolidated results. Rich will cover our segments and operating highlights, and I'll close with more comments on our new, more focused outlook for the Q2. Quint? Thanks, Joe, and thanks to all of you on the call for joining us this morning.

As always, I'll start by saying that during the course of this call, we will make projections or other forward looking statements that involve risks and uncertainties. Our actual results and other future events may differ materially from those we describe here. These forward looking statements are based on information, plans and estimates as of the date of this call, and Air Transport Services Group undertakes no obligation to update any forward looking statements changes. These factors include, but are not limited to, the following, which relate to the current COVID-nineteen pandemic and related economic downturn. Our expectations regarding the receipt of funds by 2 of our subsidiary airlines pursuant to the payroll support program under the CARES Act and the final terms of the grants issued through such program the potential for reduced flight operations disruptions to our workforce and staffing capability, the impact on our customers' creditworthiness and the continuing ability of our vendors and third party service providers to maintain customary service levels and other factors that could impact the market demand for our assets and services, including our airlines our operating airlines' ability to maintain on time service and control costs, the cost and timing with respect to which we are able to purchase and modify aircraft to a cargo configuration, fluctuations in ATSG's traded share price 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 our agreements with key customers and lenders, changes in general economic and or industry specific conditions, and other factors as contained from time to time in our filings with the SEC, including the Form 10 Q we will file this week.

We will also refer to non GAAP financial measures from continuing operations, including adjusted earnings, adjusted earnings per share, adjusted pretax earnings and adjusted EBITDA. Management believes these metrics are useful to investors in assessing ATSC's financial position and results. These non GAAP measures are not meant to be a substitute for our GAAP financials, and we advise you to refer to the reconciliations to GAAP measures, which are included in our earnings release and on our website. As Joe said, our first quarter results were very good on both the top and bottom lines. Both before and since the coronavirus pandemic caused widespread curtailment of economic activity in March, our air cargo business has been solid, reflecting our customers' imperative to move essential supplies rapidly to help abate the spread of infection and support stay at home guidelines.

On a consolidated basis, 1st quarter revenues were 389,000,000 dollars up $41,000,000 or 12% from the prior year. That gain stems primarily from more aircraft in service and expanded airline operations. Block hours rose 31% versus the Q1 last year. The Department of Defense remained ATSG's largest customer, representing 30% of our revenues for the Q1, 29% of revenues came from Amazon and 11% from DHL. On a GAAP basis, 1st quarter earnings from continuing operations were $134,000,000 versus $23,000,000 a year ago.

GAAP earnings per share for the quarter were $2.27 per share basic versus $0.38 a year ago. The 22% decline in the price of ATSG's common shares during the Q1 had the largest impact on our GAAP earnings. That triggered an unrealized reduction in the value of our warrant liabilities with a corresponding gain in income. None of the warrants ATSG has issued to Amazon have been exercised. ATSG's operating expenses increased by $38,000,000 or 13% over last year.

Salaries, wages and benefits increased 26% as our airlines added pilots over the last 12 months to crew additional 767 freighters for Amazon. Depreciation and amortization expense increased 11% as the CAM owned fleet increased. Maintenance expense decreased, primarily due to some external MRO customers reducing their scheduled maintenance commitments in March, along with reduced unscheduled engine repairs at our airlines. Fuel cost increased 25%. In mid year last year, Amazon started up a regional hub in the Wilmington Airpark and Logistics Services took over fueling operations for aircraft at that location.

Interest expense decreased more than $1,000,000 to $16,000,000 for the quarter. The change reflects lower effective interest rates stemming from ATSG's unsecured debt offering in January and from reductions in lender pricing and market rates for our variable rate debt. Several mostly non cash items in our GAAP earnings continued to obscure our operating performance in the Q1. This time, we recorded unrealized gains and losses in our warrant and interest rate derivative liabilities, amounting to net $108,000,000 gain after tax compared with a $5,000,000 net gain on the same basis in the Q1 of 2019. On a net basis, this and other items reduced our reported GAAP diluted EPS by $0.41 per share versus a $0.12 increase in the Q1 last year.

Our adjusted earnings, EPS and adjusted EBITDA exclude those mostly non cash items. As a result, our adjusted EPS for the Q1 was $0.43 versus $0.37 a year ago, up 16%. On the same basis, our adjusted EBITDA increased from $114,000,000 to $124,000,000 or 9% for the quarter. We spent $143,000,000 on CapEx during the Q1, including 105,000,000 dollars to purchase 5 767-three 100 aircraft and to continue freighter modification on those being readied for customer deliveries. We still expect a 2020 CapEx spend of about $420,000,000 mostly to acquire and modify more 767s for deployment through next year.

Joe will share more about our fleet development progress shortly. We ended the Q1 with significant borrowing capacity, thanks to the fortuitous timing of our unsecured $500,000,000 bond offering at the end of January. We use that to reduce our outstanding secured revolver borrowings, giving us significant liquidity. At present, under terms of our senior secured credit facility, we have access to additional borrowings under our revolver of approximately $300,000,000 Our total debt to adjusted EBITDA at quarter end was approximately 3.6x. We expect to continue to benefit the remainder of the year from lower interest costs tied to LIBOR on our variable rate debt.

As we told the market last night in our earnings release, 2 of ATSG's subsidiary air carriers, Omni Air and ATI, which carry passengers, each submitted an application for worker protection grant funds available under the CARES Act. ABX Air, an all cargo airline, has not been significantly impacted by the coronavirus and is not expected to participate in the program. In late April, Omni received notification from the Treasury Department that its application for grant funds under the payroll support program has received preliminary approval and that it can expect to receive approximately $67,000,000 to be paid in monthly installments through September. ATI's application for a grant under the payroll support program is pending. Our air carriers intend to use these funds to maintain their respective airline staffing necessary to serve the Department of Defense and commercial customers during an extended period of economic uncertainty due to the pandemic.

That summarizes our consolidated financial results for the quarter. Rich is ready to share some segment highlights. Rich? Thanks, Quint.

Speaker 2

Over the past 2 years, the principal factor in our earnings growth has been the improvement at our airline. That progress continues in 2020. ACMI Services on a pretax basis earned $18,000,000 in the 1st quarter, up $6,000,000 from a year ago. The 3 airlines earned revenue from the operation of 69 aircraft at the end of the quarter, 6 more than a year ago. That includes 35 freighters we leased to customers and operate on a CMI basis.

Increased support for Amazon drove the bulk of that gain, thanks to 8 more 767s we operate for them, 6 of which were CAM leased last year. Also, the prior year's maintenance expense included higher costs for unscheduled engine repairs and crew training for Amazon assignment. Interest expense allocated to our airline segment, mostly from debt used to fund the Omni acquisition, was lower than a year ago, due mainly to lower rates associated with the repricing of our variable rate loans and our unsecured notes offering in January. The pandemic had a limited effect on our ACMI operations in the Q1. It began with reduced combi flying by ATI to remote military installations in late February and extended to reduced commercial and contracted military passenger flying for Omni in mid March.

Several ad hoc assignments for the federal government in March offset part of the cuts to contracted flying. Those ad hoc assignments have continued in April but are anticipated to decline during the Q2. CAM, our leasing business, performed as expected with pretax earnings of $16,000,000 slightly below what it earned a year ago. Earnings from the larger leased fleet were offset by a $4,000,000 increase in depreciation and amortization and a $300,000 increase in interest expense, both tied to its expanded fleet and capital requirements. CAM deployed a 3rd converted 76 freighter to UPS during the quarter.

It also accepted lease returns of 3 freighter aircraft, 1 767-200, 1 757-200 and 1 730seven-four 100. We expect to complete the sale of the 730seven-four 100 freighter in the 2nd quarter. CAM has purchased 4 feedstock 767s for conversion to freighters and one existing 767 freighter this year. At the end of the quarter, CAM had 12 767s in or awaiting conversion to freighters, all of which we expect to deploy this year or in 2021. Results of our businesses, grouped as other activities, included $10,000,000 in 1st quarter customer revenue growth, but minimal pretax earnings.

The lower margins reflect Amazon's decisions to in source some of the gateway services that our logistics services unit had performed for them in the prior year. We also had a different mix of scheduled heavy maintenance work and higher low margin jet fuel sales at Wilmington Aircraft and the Amazon network. During the quarter, Logistics Services and its subsidiary TriFactor announced a new agreement with the U. S. Postal Service to design, develop and manage a new USPS regional sorting center in Aurora, Illinois.

The new center is scheduled to start up in the Q3. Overall, the ATSG businesses performed well during the winter season with minimal aircraft downtimes and good on time performance over the express network routes we cover. Our dedication to continuous improvement programs across our operating business also continues to pay off. As with all businesses, the pandemic has led to changes in our operating procedures to protect the health of our employees and that of our customers, But it has also created opportunities for us to be part of the solution, carrying medical supplies and other essential goods rapidly to U. S.

Destinations and supporting others on similar missions. Like the rest of the logistics industry, we and our employees know that we continue to play a vital role in our nation's recovery from one of the worst episodes in its history. At ATSG, our employees have stepped up with creative solutions that are focused on safety and service for our customers. But adjusting to the speed and scope of recovery will present challenges for many months. We have continuously demonstrated our agility in the past, and this will serve us well going forward.

I'm confident, however, that the vulnerabilities that the pandemic has exposed demonstrate that the strategic importance of commercial air cargo and outsourced military air transport will become greater than ever. We are seeing new awareness of the need to onshore the production and storage of vital commodities versus relying on international suppliers, which bodes well for the regional air networks that we serve. This adds to the expectation that the increase in e commerce shopping and air fulfillment will lead to lasting changes in buying habits. And we expect that it will be many months, if not years, before the major passenger airlines fully restore their networks, so cargo carriers can expect to receive volume that had traveled in belly space of passenger jets for some time to come. We will keep you up to date on how our business evolves and grows as these trends play out.

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

Speaker 1

Thanks, Rich. I wish we were able to hand you the CEO role and begin my retirement under more favorable circumstances, but the management team you will lead has already shown that they are more than up to the challenges ahead. That team includes talented and battle tested leaders in each of our business units. Our operating teams down the line are full of people who can extend ATSG's record of exceptional performance. The ATSG businesses have responded with fresh thinking, innovative solutions and close cooperation with customers that need their support now more than ever as the coronavirus unsettles the economy and our industry.

You may have heard that our maintenance techs here in Wilmington responded on short notice and under very tight deadline when we were called to modify avionics on the 767 that normally carries the New England Patriots. They were sending that plane on a special mission to China, its first trip to Asia, to bring back more than 1,000,000 masks for healthcare workers in the Boston area. We have also worked closely with DHL and Amazon to protect the people who handle the cargoes we carry by adopting new sanitizing and shielding practices. Those measures will remain in place and become stronger as this crisis unfolds. As Rich noted, Omni's military business has been more significantly Q2 due to a global curtailment of non essential troop movements to limit coronavirus spread among U.

S. Forces. Omni stands ready to pick up the pace when those movements resume and for the ad hoc transport that is likely to continue as well. That service included providing passenger capacity to repatriate Americans who were stranded abroad when the pandemic unfolded. As evidenced by our 31% growth in block hours, the ATSG airlines remain very busy through the winter, mainly in support of Amazon's air network.

We expect those operations to continue to grow, and we are already recruiting and training the pilots that will fly at least 4 additional Amazon 767s we will deploy for them later this year. We now own all the 767s we expect to deploy as newly converted freighters this year, plus a few that will fill orders for delivery next year. The Agent 10 767-three 100 freighters we expect to convert and deploy this year will complete a decade of rapid growth in the medium wide body component of our fleet. This will bring us to 50 7 67-three 100 freighters our airlines will operate by the end of 2020 compared with just one at the end of 2010. We expect that aircraft type to remain the primary component of regional air cargo networks for many years to come and we will continue to deploy them at a similar rate in 2021.

At the same time, becoming a major aircraft lessor means coping with aircraft returns as customers' needs change. We will receive some aircraft back from external lease and ACMI deployments this year. Transitioning costs and loss of lease revenue from those aircraft will offset some of the gains from leases of newly converted 767s. Our 767-300 investments will continue even as we pursue opportunities with other types as evidenced by our joint venture investment in the STC for the passenger to freighter conversion of Airbus A321s. We expect them to replace at a minimum the more than 300 757 freighters now in operations and also be the preferred narrow body choice for air networks for many years to come.

Quint mentioned that our CapEx guidance for 2020 remains at $420,000,000 which will be down $34,000,000 from our 2019 spend. We have access to additional 767 feedstock under our arrangement with Jetran and available conversion slots if needed. At the same time, we are boosting our 767 passenger capacity at Omni this year with one leased in aircraft in the Q1 and another one in the third. These fulfill Omni's commitments to a 3rd party lessor made before we acquired Omni in 2018. We are pursuing both military and commercial options for them as they arrive.

When we last spoke with you in early March, the coronavirus was already sweeping the globe and beginning to affect both our cargo and passenger flying for the military. But the broad scale contraction of economic activity that followed soon after was beyond what anyone anticipated at the time. I want to affirm that 2020 will be a growth year for adjusted EBITDA, the yardstick we choose to measure our progress. We expect to exceed the $452,000,000 we delivered for 2019, but are currently not able to forecast how strong that growth will be. Instead, we are providing guidance of $110,000,000 to $115,000,000 for the 2nd quarter alone.

That's $5,000,000 to $10,000,000 more than the $105,000,000 in adjusted EBITDA we generated in the Q2 last year. I'm confident that if the economic recovery from the pandemic continues and once the military reopens its transport network, Rich and Quint will be able to revisit 2020 guidance when they report Q3 results next August. ATSG is fortunate in its leasing operations are centered on freighter aircraft for customers who have not seen the demand disruption of passenger operators. In fact, we continue to see significant customer interest in long term leases for freighter aircraft. The only passenger aircraft we own are primarily utilized to service the US military and other governmental agencies with limited exposure to commercial passenger operations.

Once virus suppression efforts are relaxed, we expect the demand from our governmental customers to return to historic levels quickly. That concludes our prepared remarks, John. We're ready for the first question.

Speaker 0

Thank you. We'll now begin the question and answer And our first question is from Jack Atkins from Stephens.

Speaker 3

Hey guys, good morning and congratulations on a great quarter.

Speaker 2

Thanks Jack. Thanks Jack.

Speaker 3

So a lot of places we could go here. I'm going to ask a handful and then jump back in queue. But I guess maybe if we could just sort of start off with the places in your business where the pandemic and the containment efforts related to COVID-nineteen are impacting things. I just it sounds like it's principally related to military flying at Omni. It doesn't sound like you saw much of that in the Q1.

And then is it impacting your MRO operations as well? And how does all this play together with the CARES Act funding, Quint, that you're receiving? I just want to make sure we understand how it's all flowing together.

Speaker 1

Yes. Good questions, Jack. As we mentioned in the release, the passenger business that we have, we have a little bit at ATI with the combi And of course, Omni is a passenger carrier. So those were the areas most impacted and the ones we expect to be impacted the most going forward. The flights for the military, the Department of Defense, particularly for May June, were expected to be perhaps down.

Actually through the Q1, even though there was some reduction as early as late February and into March for the combi, we were able really pretty much into April through April to continue to have a chance to do ad hoc moves for the Department of Defense. There were some repatriations of American citizens that were abroad and so forth that helped to offset that. But the DoD has put some restrictions in place for some of the troop movements that will be more evident in May and going forward. And we'll just have to see how long that persists and how it plays out. You also mentioned the MROs.

And as you know, we do a mix of our own aircraft and aircraft that our lessees use. And that's probably what about 50% to 50% of the business and about half of it is external customers, passenger carriers, we do Frontier and United And Delta. And Delta. And given what's going on in the passenger side, that business is likely to be scaled back

Speaker 3

as we go forward. But where

Speaker 1

we have opportunities is we can bring in more in house of our own aircraft. We were planning on actually farming some of our maintenance checks out this year because of the amount of external business we had. So we had the ability to pull some of that back in and avoid that external cost, which is nice given our business model. As far as the CARES funding goes, the CARES funding was aimed at airlines. So it was not aimed at MROs.

But of course, as business volumes are impacted in MROs, we have the ability to reduce our costs, make changes in staffing and so forth based on the volume of work that they have. So we'll be able to deal with that we feel going forward. And we, of course, disclosed in our release the situation with the CARES funding. We've been told that Omni has been approved for $67,000,000 which will certainly help offset the impacts there and the ATI application remains pending at this time.

Speaker 3

Okay, got you. Thank you for all that additional color there, Quinn. And so I guess as we sort of think about 2021, obviously, there's a lot of different moving pieces in 2020. But when you think about the longer term impacts from COVID-nineteen on your business, and you think about how that would play out, not asking for 2021 guidance, obviously, but I mean, is there any reason to think that any of these different there's any structural change to your earnings power when you look out at 2021 relative to sort of the way you were thinking about it 90 days ago from all of this?

Speaker 1

Well, certainly on to the extent that impacts to the passenger side of the business linger, there's always a chance for some spillover of that, although the majority of our passenger flying is done for the military. And where we think we are fortunate is that when restrictions ease and begin to be lifted, troops need to be deployed, redeployed. And so we see that demand is coming back to historic levels rather quickly once those restrictions are eased. Unlike the commercial passenger side where I think the pace at which demand comes back is more in question. Now Omni does do a little bit of commercial passenger flying.

They have some vacations business they fly and have flown for many years, for example, for folks traveling from Hawaii to Las Vegas. And just as with the rest of the commercial passenger market, that was impacted. It's not a particularly large piece of business though in the overall scheme of things for ATSG. And on the cargo side, as you're alluding to, we that's done that's been strong and demand for our lift and our services there remains strong. So as we look at 2021, provided that the world makes some progress at all with this virus, we see us less impacted certainly than many others who have more persistent lingering effects.

Speaker 2

Jack, I think it's important to note also on the leasing side, we've got a number of aircraft conversion now that will come out towards the end of the year. That will be deployed in 2021, and we've seen no degradation in the demand for the 2021 converted freighters that we'll be leasing as well. So still strong demand for the folks that need freighters.

Speaker 3

Okay. That's great, Rich. And I guess that leads into my last question, and I'll turn it over. But and this was going to be for you. But could you talk about the extent to which ATSG is benefiting from lower passenger belly space, both in whether that's in the domestic market or internationally?

And given this what feels like a structural shift and acceleration of the move towards B2C and e commerce, What are you hearing from additional customers who may be wanting to set up their own networks, maybe a smaller version of what you're doing for somebody like an Amazon. Is that beginning to sort of percolate a little bit?

Speaker 2

No. We haven't heard from any new customers wanting to establish new networks at this point. We've had some conversations in the past. Nothing is accelerating on that. And in general, in the market, I think you know that with the 85% to 90% of the passenger flying not going on right now, the belly capacity, particularly with the larger long haul jets is not available right now.

And so even though air cargo in general is down, the capacity is down even more because of the passenger jets being down. So there's more volume for main deck freighters than they normally would be. So there's a heavy demand right now. We're seeing a lot of requests for charters. We are currently bidding a couple of long haul charters that will last for months.

They're regular routes for existing customers that we're hoping to get. We don't keep a lot of assets around and crews around to fly charter work. So these are coming out of some other deployments that are transitioning and so it's kind of fortuitous for us. So heavy demand, we've also had hundreds of requests to Omni to fly cargo. And obviously, it's complex and the U.

S. Regulatory basis has been a little bit behind the rest of the world in allowing cargo in the upper deck. And so we're just now getting into the ability to reconfigure the aircraft. So where that goes, we're not sure because the cargo rates are very volatile. They're high because of the lack of capacity in the long haul lanes.

But we think we'll get some good long term business out of this for some longer routes. And one thing is for sure is that the network flying that we do is very strong and looks to be so for a long time to come.

Speaker 3

Okay, great. Thanks for the color guys. And Joe, congratulations again on your semi retirement here.

Speaker 2

Thanks, Jack.

Speaker 0

Our next question is from David Ross from Stifel.

Speaker 2

Good morning, gentlemen. Hey, Dave.

Speaker 4

Based on the current pipeline backlog that you guys were talking about, how much growth CapEx is going to be left for 2021 assuming that you don't add any more new contracts or new planes to the mix. We think most is being spent this year for both 2020 2021 growth, but how much might be left for next year's growth?

Speaker 1

Dave, we think, this is Quint. We think right now in terms of looking at it, at just feedstock procurement, we expect to take, I think, 5 aircraft next year, 5 new airframes as feedstock for conversion. Otherwise, and you compare that to this year where we are taking 8 aircraft and we are by the end of the year, I think, Rich, we will have what 3 aircraft that are pretty much converted, that are waiting for 2021 deployment. So the investment for those will all be in. Correct.

I think that we continue to expect next year to be CapEx wise down versus 2020. We are not prepared to give specific guidance on it, of course, today, but it will be a fairly significant decline in CapEx next year, we believe. Yes.

Speaker 2

One of

Speaker 1

the things we'll be looking at next year as well Dave is starting to potentially make investments in the 321. We still expect to get our STC for car conversion this year and look forward to starting to add that to our leased fleet in 2021.

Speaker 4

And given the growth in the fleet, where would you say maintenance CapEx sits right now, Quint, about $90,000,000 100,000,000

Speaker 1

dollars That's approximately correct, Dave, yes. Just keep in mind, under the business model, the customer's responsibility when we lease them an aircraft for the heavy maintenance piece. We obviously carry the legacy 767-200 fleet as part of our maintenance CapEx, but for all the 3rd party leases, that becomes the lessee's responsibility.

Speaker 4

And then last question is just around the Amazon CVG hub and the build out there. Any updates on when you think that's going to be ready to fly and impacts for ATSG and its operations?

Speaker 0

We really don't get a lot

Speaker 2

of guidance out of Amazon in that respect. But just based on what it looks like right now from the

Speaker 1

they would know

Speaker 0

better. And

Speaker 4

you guys still have room at Wilmington to grow in the meantime?

Speaker 2

Yes. There's plenty of room in Wilmington. I mean, we used to fly 115 aircraft out of here. And I think the Amazon operation is in the 10 to 15 right now. I don't think they plan to get it much bigger than that.

But again, they don't share their plans with us

Speaker 1

until we need to know. Need to know basis.

Speaker 2

Well, thank you very much.

Speaker 0

Yes. Thanks, Dave. Our next question is from Helane Becker from Cowen.

Speaker 5

Thanks very much, operator. Hi, team. Joe, it has been a pleasure. And while you are leaving the business in good hands, I will still miss you. Now for my questions.

Are you noticing the price of 7 67 feet stock? First of

Speaker 6

all, there's obviously a lot that are being parked and

Speaker 5

a lot that more are being retired, right? So are you noticing prices coming down? And can you go back and renegotiate any

Speaker 6

of the prices that haven't delivered yet?

Speaker 2

Elaine, it's Rich. So there's some bids out now for handfuls of planes that were probably already in process. It generally takes an airline a little bit of time to package up fleets or anything of significant size, I think the records together, the engine records together. So we haven't we know there's more coming certainly. And until you get into the bidding and the negotiation pieces, it's difficult to say.

Supply and demand would tell you that there's going to be more in the market and therefore the price should come down, but engines drive a lot of what the value is on the airframe. And of course, the conversion is that price is around $15,000,000 about half of what you'd expect of total cost to be. So that's not going to change. So we expect that the prices will come down. As far as renegotiating, what we've currently got in the pipeline, that's not really what we're looking at, at this point in time.

But we think we still have a good value and we'll produce a good product and that will be have a competitive lease rate at the end of the day.

Speaker 5

Right. Okay. And then my other question is, what's the right mix of new aircraft and number of lease expiries every year that you think makes sense for the business?

Speaker 1

That's a pretty wide open question, Helane. I mean, when you think about the number of aircraft, obviously, market demand is going to dictate what we continue to acquire over time. And if you look at our history in terms of our leases, for example, a lot of them come in bunches on a calendar year basis. You've got the DHL, which runs through 2022 for a number of aircraft and then you start looking at when we started the Amazon business in terms of potential returns. But by the same token, you look at it and say, well, heck, where are they going to replace those number of aircraft in such a short order?

So our expectation is generally those leases are going to get rolled over. And if they do, then it's really a function of keeping up with what the market growth requirements are. At some point in time, you're going to see a peaking as far as, at least I believe so, in terms of the number of 767s that will be demanded by the market. There will be some upgrades from the 200s to the 300s over time. But that's one of the reasons we got into the 321 is we think that's going to be the next real growth opportunity from a car conversions converted freighter perspective.

Speaker 5

Correct. Got you. And then the other question I have is your 3 customers provide a big percentage of the business. And Joe, you and I go back to the start when ATSG's predecessor was spun out from Airborne and you had one customer was all your revenue and you've done over the years an amazing job of diversifying the business. And in some years, given really sort of bad being dealt a bad hand in some years that we can reminisce over at some point in our future.

But what are the opportunities for other growth? Like I don't know if you or Rich want to answer this, but where do you think the business should trend? I mean, I know Amazon is going to keep adding more business, right? We think they need to scale up to something like 200 aircraft. But what's the right mix there for diversification?

And what are the opportunities that you see?

Speaker 1

Well, Helane, I'll let Bridge answer the future piece, but to your earlier point, you do go back with us all the way to day 1 essentially when DHL was 99% of our book of business. I remember you showed up for our 1st shareholder meeting here in Wilmington way back when. And so you're the one person that's been with us through thick and thin. We've had a lot of thick and we've had a lot of thin over that period of time. So before you sign off, I just want to say it's been a pleasure working with you as well.

And with that, I'll turn it over to Corrado to talk about where things he sees things going.

Speaker 2

No, it's a good question, Helane. And one we frequently discuss here because it is what we do is try to grow the company, right? So the 767 market is going to continue for several years. We think it's a strong market. They're still building new freighters.

And there's as we already discussed, there's more feedstock coming available. So we plan to continue to drive that as long as the demand is there. We've invested in the A321, and we're hoping to get the SDC approved mid year this year and then start putting that aircraft into the same business model we have today, in fact, extending it because we'll have this SDC. We would like to convert it in that PEMCO as we do 737s now, lease the airplane, fly the airplane if our customers want to, etcetera, etcetera, so we can build a nice business model around it. It's a replacement for the 757, which has an installed base of over 300 in the market right now.

So it's a significant market opportunity, plus it can compete with the 730seven-four 100 installed base. So it's got a very flexible opportunity for us. So that's one area of growth that we think. And keep in mind that when you're looking to grow aircraft, it comes from 2 places. 1 is growth in cargo, so so as the market grows and the other one is for replacement.

And the A321 is a solid replacement for the 757, which is getting long in the tooth at this point. So that's one area that we are heavily focused on, continuing to grow the 767, transition into the A321 as an additional growth platform. And the other thing is, we've always managed the company with a conservative balance sheet. Of course, we spent some money on omni and we've got, I think we're at 3.5x roughly right now EBITDA on our debt. And we traditionally float around between 2 and 2.5, and we're managing the company and managing the growth to drive towards that again.

And the reason for that is to remain flexible to M and A opportunities and adjacencies and opportunities that enhance the business model and diversify the revenue base further. So those are the two areas where I think we have the strongest opportunity for growth in the future. 1, building on our expertise and our business model and our differentiated business model today and the other one looking for opportunities to differentiate to diversify the revenue and build the company growth going forward.

Speaker 0

Our next question is from Chris Staphoulopoulos from Susquehanna International.

Speaker 7

Good morning, guys. Hey, Chris. So on the military side with the stop order movements, could you give us a sense of where we are in terms of utilization levels and any indication that those might improve. I'm guessing that the military passengers will fly before we do for obvious reasons. And then you alluded to in an earlier question the opportunity to potentially use these for main deck ops, but it sounded like there were some regulatory issues there.

What's the likelihood that you could repurpose those aircraft and use them for freight?

Speaker 2

On your first question on the military side, so the military order was to cut back on nonessential troop movements. So they still have been moving troops, but it's just been cut back. I believe we've been told around mid June, they should start to ramp that back up. The other governor on that, if you will, is the airports that those military routes fly through. The initial restriction that interrupted some of our flying, particularly on the combi basis, but also in some of the omni routes was that the airport routings that we went through were not available to us to smoothly run the route.

For example, you couldn't fly from Singapore into Bahrain. And that was part of a normal route for us. And so they had to be rerouted in some of the flying chain. So that's one of the restrictions. So we're looking for mid June for that to snap back.

We believe that the passenger flying as it relates to the military will be more of a V shape than what you'll see in the passenger environment with leisure and business travel where that will probably be a much slower role to come back. As it relates to Omni's utilization for its potential for main deck cargo on the passenger jet, a couple of things. One is, we haven't had the capability yet because those 777s have been utilized, either for military routes or for repatriation of Americans abroad. And so they probably wouldn't be available till June as we're looking at it now. We believe that the approvals are now in for the way in which you can put cargo in the upper deck.

And so there's opportunity to do that. That's not a long term business profile. It's more of an opportunistic solution to support mostly PPE movements. Generally, you're not going to the cargo rates for flying that do not support the level of freight that you would get in a converted or using cargo in the upper deck of a passenger jet. So as soon as that those moves calm down, that business goes away.

So it would only be an opportunity to utilize those jets if they're available.

Speaker 7

Okay. And then there was also you made some comments earlier about you've had some interest in the charter market or short term ACMI, which is an area historically you haven't participated in. Could you give some more color there?

Speaker 2

Yes. So we because the military we've got some military routes that we fly cargo on, ATI and ABX fly every other week certain routes. So in those off weeks, we do have some assets available. And so we've been able to get a few charter routes that way. But it's not a regular thing that we count on or look to establish a common ongoing revenue and profit stream out of that business.

We just looked at kind of utilize our excess capacity, which is not as predictable, as companies that keep assets around as a charter business. We find that when investing in a long term asset like an airplane and using it in the charter market is not a good long term strategy for that asset. We'd rather lease it or get long term ACMI or CMI as an as an example, the 757 flying that we had from DHL is transitioning. We're down to 2 aircraft. We had 4, we were down to 2 last month.

Those crews are becoming available, and so we're looking to do some additional flying of some long term routes for existing customers using those crews and available aircraft to take advantage of that. So that's good. It's fortuitous, and it's going to add to our plan going forward for the rest of the year.

Speaker 7

Okay. And then two questions for Quint. Quint, your liquidity exiting the quarter and assuming that there's no pickup in Omni and this doesn't come back in June, what the how we should think about the drag on cash through the quarter for that piece of business? And then in your prepared remarks, you spoke about keeping an eye on the credit of your customers now, Amazon, DHL, UPS, high credit customers. But I'm curious if you could just give some color on your other book of business.

Thanks.

Speaker 1

Yes. Chris, as we noted, we purchased 5 of the 8 aircraft in our CapEx in the Q1. We had, what, dollars 143,000,000 we spent in the Q1. So we'll see on a sequential basis some reduction, right, in terms of what we're spending for CapEx as we move through the year. So that will help our cash position certainly.

And then we spoke about the CARES funding for Omni, which certainly will help with that as well. ATI application is pending. So we really anticipate and you can see that we're saying that in our guidance that we expect as best we can project that we will still exceed last year's adjusted EBITDA of 4.52 percent, 4.53 percent. So I mean, I think we'll be in good shape liquidity wise. Certainly, as we said in our remarks earlier, having completed the bond offering at the end of January gave us a lot of flexibility.

And the business model we have that has certainly helped insulate us, If you think about the cargo side, that business really remains strong. And we have in some sort of a scenario where we really for whatever reason had to pull back harder, a lot of our capital spending is in the conversions itself, which gives us some flexibility, further flexibility should we need it. So I think we'll be in good shape cash flow wise.

Speaker 7

And then on credit with your sort of customers outside of Amazon, DHL, UPS, how we should think about that?

Speaker 1

Well, of course, as Rich mentioned, the cargo business, particularly in the network operator, integrators, has remained really strong and so no issues there. The DoD is a great payer. We just need that business to get back to its full volume that it was at previously. And I guess from our standpoint, it would be more at the MRO location where we do have, as we said, some external customers, some of the big flag carriers that we operate with. And of course, they were participants in the CARES Act as well.

They have scaled back their business volumes with us. And in some cases, they've cleaned up outstanding amounts. And we feel good about where we're at in terms of receivable position from those customers. So we really don't anticipate any issues with that. Okay.

Thank you.

Speaker 0

Our next question is from Steve O'Hara from Sidoti and Company.

Speaker 8

Hi. Thanks for taking my questions.

Speaker 2

Hey, Steve. Hey, Steve.

Speaker 8

Hi. Yes, first, I'd just echo the comments by everyone else. Joe, it's been a pleasure. And I know it's tough to leave at a time like this, but it seems like timing is pretty good.

Speaker 0

Good to be working.

Speaker 1

This is our annual road trip, Steve, through Ohio.

Speaker 8

I know, I know. I'll ask you, Kristen, Rich on that. But so I guess just in terms of the outlook for 2020, I mean is the current expectation that 2Q is kind of your toughest comp here given the I mean it seems like the cargo side is performing pretty well. Obviously, the MRO, there's some questions there. But with military maybe coming back or beginning to come back in June, would you expect 2Q to be kind of the toughest comp?

Speaker 1

Well, I think you hit on the key is the pace at which things come back and the degree to which things come back, particularly on the military side, assuming that things do resume to something resembling normal operations by the Q3, I think it's fair to say 2nd quarter does present perhaps the biggest comp. We still expect that cargo business to remain strong. And of course, the leases that we have, we're fortunate again that we're lessor, but we really don't we concentrate on cargo leases and the cargo business has remained robust and the demand is strong as Rich said earlier. And the passenger aircraft that we have in our portfolio are primarily operated for the military and other governmental agencies. So, I would say you're correct, Steve.

The Q2 probably is a little bit the one that is probably most in question, I guess.

Speaker 8

Okay. And then just in terms of the aircraft coming online, and I know Amazon is lined up to pick a number of those. But when you talk about demand strength, are you seeing kind of improving demand in terms of long term desire to kind of take these aircraft under contract assuming kind of a swifter economic recovery? Or is this maybe people thinking this is kind of a new normal in terms of cargo demand? And I guess that's on a regional basis more so than long haul.

Speaker 2

Yes, this is Rich. So the demand profile from our existing customers hasn't changed. The aircraft that are in queue for those folks are they remain in queue, they remain focused on taking those airplanes. And as it relates to other markets and other opportunities, there's a large level of interest in folks inquiring, if you will, about things. But you look at some of these some parts of the world and some of the smaller groups and things like that.

And it's more inquiry than it is kind of solid opportunity with an existing airline that's looking to add the 76 freighter. And so we would question the credit opportunity. So it's kind of a dual market out there. The existing strong credit folks that we deal with and the existing customers that we have are growing and they're looking to take more aircraft. There's more inquiry from folks that need a lot more diligence on our part before we get into some of those parts of the world.

Other than the ones we've talked about, the Amazon and the UPS jets that are going in this year, we've got an existing operator in Malaysia that's looking to take an additional 200 that's in paint right now. And we've got another 300 going to another air carrier in the Americas. Good demand outside the core large customers that we deal with and we look for that to be strong going forward. The other thing I should say is on the A321, I didn't mention before, but the feedstock on that aircraft was always one of the things that we were keeping a real strong look at because it needed to come down a little bit before that the economics of that airplane got into an advantage over the 7 an older 7.5, if you will, and it's there now given the way the feedstock values of the A321 and the amount of them that are parked right now. So that's another real solid plus that the demand for that aircraft should be there right away when the STC is available and we start to deploy those things going into 2021 2022.

Speaker 1

And I think the other thing to think about, Steve, is clearly with the pandemic here, buying habits of the public have changed significantly. People aren't going to retail outlets like they were in the past. It's more convenient and safer for them, I guess, to have it delivered to their homes. So I think the demand from an e commerce perspective only got accelerated by the pandemic issues.

Speaker 8

Okay. And then maybe lastly, just in terms of maybe a pull forward of e commerce demand or kind of a maybe a shortening of the curve in terms of adoption versus kind of a maybe a weaker economy with job losses and things like that. I mean, how do you think about maybe the potential for economic weakness here with all the issues with job losses and things like that? And how do you think that might affect the business in the maybe near term?

Speaker 1

Steve, this is Quintin. That's one of the pluses, I guess, in terms of the we lease the airplane. We don't sell the cargo on it. We lease the aircraft itself. And so as Joe said, buying habits are a plus, right, that should help add volume and to the extent that's been accelerated by the pandemic.

But understanding your question, I guess, we'll have to see what the longer term effects on consumer spending are and everything in terms of that volume piece. But in terms of us leasing the aircraft and having these long term leases in place, we're pretty insulated from the direct exposure to that.

Speaker 8

Okay. And maybe just a follow-up on that. I mean, in terms of the results for the quarter, how much of it was kind of driven by volumes and maybe abnormal flying for the quarter versus kind of having more aircraft in service for long term customers, things like that. Is there a way to kind of think about that maybe for the quarter and then maybe going forward if things kind of play out where maybe flying demand is reduced, but you do have more aircraft in service?

Speaker 0

Well, I

Speaker 1

mean, I think we saw better performance out of the ACMI Services segment, which helped drive improved results compared to the prior year quarter pretty significantly. You recall last year, we had a lot of ramp up costs as we were taking on what ultimately was what 6 actually 8 aircraft for Amazon. And this year, with at least 4 in the back half for them on a CMI basis, a little bit not as steep a ramp in terms of the cost. That helped. We had some engine cost last year that we did not some unscheduled engine repairs last year that we didn't have this year.

So all those things helped generate a better result for the ACMI Services segment. As far as the flying that we did, we mentioned there were some ad hoc opportunities for Omni that, while not part of their typical scheduled route, certainly did help during the quarter mitigate reductions in some of those and restrictions in some of those locations that Rich mentioned that affected some of our military flying. And so that was certainly a factor. Had we not had that in the Q1, it would have not been the quarter that it was. But that was only somewhat of a replacement for what we didn't fly on the more scheduled basis.

Speaker 0

Okay.

Speaker 2

All right. Thank

Speaker 1

you very much.

Speaker 0

Thanks, Steve. Thanks, Steve. Our next question is from Stephanie Benjamin from SunTrust.

Speaker 6

Hi. Good afternoon, everybody.

Speaker 0

Hi, Stephanie. Hi, Stephanie.

Speaker 6

I just wanted to touch on quickly on the 5,767s that you called out that were purchased already in the Q1 as part of your CapEx plans. Can you speak to the really the timing of service that you're kind of viewing those aircraft when they should be deployed? And but also just the types of customers interested, are these customers largely looking at replacement or is it growth in cargo, geographic expansion? Any color there is helpful. Thank you.

Speaker 2

Yes. So there are all of those aircraft are designated for U. S.-based operations. I'm just trying to go through in my head when they're going to come out of conversion, but I think a couple of them will be 2021 deployments and the remainder will be deployed throughout 2020.

Speaker 6

Got it. And all my other questions have been asked. Thank you.

Speaker 0

Thank you. Thank you. And we have Jack Atkins again from Stephens.

Speaker 3

Hey, guys. Thanks for taking my quick follow-up here. Clint, I guess this one's just a quick one for you on modeling. Does the Cures Act funding impact the book tax rate at all for modeling purposes?

Speaker 1

No, it shouldn't. We're projecting 1 about 24%, 25% once you exclude the warrants from the impact, and that does not affect that.

Speaker 3

Okay. That's great. Thank you.

Speaker 0

Thanks, Jack. Thanks, Jack. And we have another question from Chris Stathoulopoulos from Susquehanna.

Speaker 7

Hey, thanks for the follow-up. Quint, the PSP, was that a straight grant or did it include a loan provision as well?

Speaker 1

It was in terms of the Omni piece, it's a grant.

Speaker 7

Okay. And have any of the carriers applied to the LP program under CARES Act?

Speaker 1

No, they have not.

Speaker 7

Okay. And last question, any update on just labor where we are with ABX? Thanks.

Speaker 1

ABX, actually they're in negotiations this week, Chris, with the obviously the mediators are involved in the process. And again, as we have said on previous calls, cautiously optimistic that we will get a deal sometime this year. But like I said, they are still in the negotiation process.

Speaker 7

Thank you.

Speaker 0

And I will now turn the call back over to Rich Perado for closing remarks.

Speaker 2

Thank you, moderator. I'd like to congratulate Joe Eady on his retirement from the CEO position and his assumption of his new role as Chairman of the Board. Joe built this tremendous organization establishing a real strong foundation. This includes a significant differentiated business model and the safety and service culture that transcends the parent holding company to every ATSG subsidiary. We need to preserve that important part of ATSG and use our culture to propel our value proposition into the next growth phase of the company.

Our challenge moving forward is to keep all the good stuff, if you will, that got us here. But if there's one thing that the current COVID challenge has taught us, is that change comes rapidly in today's world, and we must maintain our flexibility and agility as a core strength as we adapt to the changing business needs of our customers. I'm excited to be leading such a seasoned, hardworking and innovative group of employees as we take off into the future, understand that together we can build on that solid foundation that Joe Headey built, but with renewed challenge to take this company to the next level with the same worth ethic, integrity and customer focus that defined our reputation. Thank you for your interest in ATSG. Have a great day and stay safe.

Speaker 0

Thank you, ladies and gentlemen. That concludes today's call. Thank you for participating and you may now disconnect.