Q4 2018 Earnings Call Transcript

Published: 19 Feb 2019

[Operator:]

Good morning, my name is Heidi and I'll be your conference operator today. At this time I would like to welcome everyone to the Fourth Quarter 2018 Earnings Call for Atlas Air Worldwide. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session [Operator Instructions]. Thank you. Atlas Air, you may begin your conference.

[Ed McGarvey:]

Thank you, Heidi and good morning everyone. I'm Ed McGarvey, Treasurer for Atlas Air Worldwide. Welcome to our fourth quarter 2018 results conference call. Today's call will be hosted by Bill Flynn, our Chief Executive Officer; and Spencer Schwartz, our Chief Financial Officer. Today's call is complemented by a slide presentation that can be viewed at atlasairworldwide.com under Presentations in the Investor Information section. As indicated on slide two, we would like to remind you that our discussion about the company's performance today includes some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future events and expectations and they involve risks and uncertainties. Our actual results or actions may differ materially from those projected in any forward-looking statements. For information about risk factors related to our business please refer to our 2017 Form 10-K as amended or supplemented by our subsequently filed SEC reports. Any references to non-GAAP measures are meant to provide meaningful insights and are reconciled with GAAP in today's Press Release and in the appendix that is attached to today's slides. During our question-answer period today, we would like to ask participants to limit themselves to one principal question and one follow-up question so that we can accommodate as many participants as possible. After we've gone through the queue, we will be happy to answer any additional questions as time permits. At this point, I'd like to draw your attention to slide three, and turn the call over to Bill Flynn.

[Bill Flynn:]

Thank you, Ed and good morning, everyone. We are very pleased to have you join us. 2018 was another great year for Atlas. We drove substantial growth in the scale, diversity and profitability of our business. As noted in our press release we generated record volume, revenue and earnings, both in the fourth quarter and for the full year and we expect to generate record volume, revenue and earnings in 2019. We're excited about our future and the future of air freight. Our strategic initiatives have expanded our capabilities and enabled us to serve a greater range of customers. They also provide a solid platform for future growth initiatives. Our focus is on express and e-commerce in fast growing markets in Asia and elsewhere such as South America where we have the strongest year in the company's history. As air freight continues to grow, further globalization will require time-definite air networks to facilitate the flow of goods. We're well positioned to capitalize on the scale and scope of our domestic and worldwide operations, drive higher volumes, revenue, adjusted EBITDA and adjusted net income and further reduce our net leverage ratio. We expect to benefit from the full year of flying by the aircraft we added in 2018 for customers such as Asiana, DHL Express, Inditex and SF Express. We will see our first full year of flying 20 767-300s for Amazon. We look forward to continuing - we look forward to operating three incremental 747-400 freighters for different cargo airlines which will increase our near-term fleet to 115 aircraft. And we anticipate that the flying we do for the military will be higher than in 2018. These opportunities build on the growth in our business mix, customer base, fleet and operational capabilities. In addition to delivering record results in 2018, we added 16 aircraft to our operating fleet in response to customer demand and grew to more than 100 planes. We ended the year at a 112 aircraft across five fleet types. These aircrafts are well suited to our growing domestic and regional flying as well as our international operations. We also ramped up for Amazon as scheduled, which included successfully managing multiple station openings through the United States. We enhanced our balance sheet by lowering our net leverage ratio. Thanks to our strong and experienced team, we executed extremely well during the peak season. Moving to slide 4, our fourth quarter adjusted earnings reflected a 17% increase in block hours and 22% increase in revenue. It also included a 21% increase in adjusted EBITDA and 31% increase in adjusted net income. We began flying for SF Express, China's leading express operator during the quarter. And we ramped up to 20 aircraft for Amazon. Slide 5 highlights our framework for 2019. It reflects our outlook for another year of volume and earnings growth. For the full year, we expect volumes to rise to around 340,000 block hours, revenue to grow to approximately $3 billion, adjusted EBITDA to increase to about $600 million and adjusted net income to grow by a mid-to-upper single-digit percentage. Similar to historical patterns, we anticipate that over three quarters of our adjusted net income in 2019 will occur in the second half of the year. Maintenance expense in 2019 is expected to total approximately $420 million. The increase from 2018 mainly reflects an increase in daily line maintenance driven by the growth of our fleet and the anticipated growth in our block hours this year. Similar to 2018, we expect line maintenance to comprise about two-thirds of our total maintenance expense in 2019. Our outlook also anticipates depreciation and amortization of about $260 million and core capital expenditures which exclude aircraft and engine purchases between a $135 million to a $145 million mainly for parts and components for our fleet. Looking to the first quarter, we expect volume to total about 75,000 block hours, revenue of approximately $680 million, adjusted EBITDA of approximately $110 million and adjusted net income similar to the $23.8 million we reported in the first quarter of 2018. Our first quarter outlook also reflects anticipated revenue in our Titan dry leasing business from maintenance payments related to the schedule return of a 777 cargo aircraft which we expect to receive late in the first quarter. This will be partially offset by a higher level of heavy maintenance expense compared with the first quarter of last year. This is a good point to ask Spencer to provide some additional detail about our fourth quarter 2018 results. And after Spencer's remarks, I will add a few additional comments and then we'll be happy to take your questions. Spencer?

[Spencer Schwartz:]

Thank you, Bill, and hello everyone. Our record fourth quarter results are highlighted on slide 6. On an adjusted basis, income from continuing operations, net of taxes totaled $87 million, which was an increase of 31% over the fourth quarter of 2017. As Bill noted, our results reflected record block hours, revenue, adjusted EBITDA and adjusted net income. Our segments also generated substantially higher total direct contribution. On a reported basis, income from continuing operations net of taxes totaled $211 million, which included an unrealized gain of $134.8 million on outstanding warrants. Our adjusted earnings in the fourth quarter included an effective income tax rate of 20.5%. For the full year, we had an effective tax rate of 15.2%. With respect to 2019, we expect our full year adjusted income tax rate to be approximately 20%. Looking at slide 7, higher ACMI segment revenues in the fourth quarter were primarily driven by an increase in volumes, which reflected increased flying for Amazon and the start-up of new or incremental flying for several customers including Asiana Cargo, DHL and SF Express. In charter, higher segment revenues reflected an increase in total volumes and increases in average cargo and passenger rates. Overlapping the end of peak season, we also operated 32 flights during the college football bowl season for 15 universities. In our dry leasing segment, higher revenues were primarily driven by an increase in the number of 767-300 aircraft throughout 2018 as well as the placement of one 777 freighter in February and the second one in July. Moving to slide 8, segment contribution totaled $185.1 million in the fourth quarter, a 14% increase over the previous year. ACMI earnings primarily reflected increases in 747-400 rates and volumes. These were partially offset by two key items. First, higher heavy maintenance costs including an increase in the proportion of heavy maintenance cost attributed to the segment due to our volume-based allocation methodology and the higher levels of ACMI flying during the December peak flying period. And second, higher crude cost including enhanced wages and work rules resulting from our internal agreement with Southern Air pilots. The improvement in charter contribution during the period was primarily due to increases in military and commercial cargo yields, excluding fuel and higher military cargo demand partially offset by an increase in heavy maintenance. Both ACMI and charter contribution during the quarter reflected the redeployment of two 747-400 VIP passenger aircraft from ACMI to Charter following our acquisition of these aircraft from a former ACMI customer. We have used these 747s to grow our VIP Charter business and our earnings. In dry leasing, higher segment contribution during the quarter primarily reflected the placement of additional aircraft. Turning to slide 9, you can see the multi-year growth for Atlas. And as we said that growth is continuing in 2019. Our performance and our outlook reflect the strategic initiatives that we have put in place over many years. The robust compound annual growth rates we have generated reflect the addition of 45 aircraft to our fleet since the beginning of 2016. They also reflect our move into 777 and 737 operations through Southern Air, expansions with existing customers such as DHL Express and the U.S. military and key new customer agreements such as with Amazon, Asiana Cargo, Cathay Pacific, Nippon Cargo and SF Express. As a result, we are driving record volumes, record revenue and record earnings. We are capitalizing on our strong market position and are focused on express, e-commerce and fast growing global markets. Our financial and operating performances also reflect the leadership and strength of our ACMI and charter businesses, the growth and the new UI contribution of our dry leasing operations, ongoing efficiency and productivity initiatives and a well-disciplined balance sheet approach. We have built a solid platform for future growth initiatives. Turning to slide ten, we ended the fourth quarter of 2018 with cash, including cash equivalents, restricted cash and short term investments totaling $248.4 million. Our cash position at December 31, reflected cash used for investing activities, partially offset by cash provided by operating and financing activities. Net cash used for investing activities during 2018, primarily related to payments for the acquisition of 777 and 767 aircraft, 767 conversions to freighter configuration, spare engines and upgrade kits and core capital expenditures. Net cash provided by financing activities during the period, primarily reflected proceeds from our financings of 777 and 767 aircraft, partially offset by payments on debt obligations. We are focused on maintaining a strong balance sheet. As the slide shows, we have grown our fleet to take advantage of great opportunities. In doing so we have applied a disciplined approach to financing. As a result, our debt has a low weighted average interest rate of 3.3%, almost all of which is at a fixed rate. In addition, the vast majority is secured by our aircraft assets, which have a value in excess of the related debt. As you can also see, our net leverage ratio, which remained fairly consistent while we increased our fleet significantly, began to move lower in the second half of 2018. We ended the quarter at 4.2 times, down from 4.8 times and we expect our net leverage ratio to continue to improve gradually during 2019 as we benefit from flying the aircraft we added to the fleet in 2018, continue to generate strong EBITDA and reflect debt payments of approximately $70 million per quarter. Now I'd like to turn it back to Bill.

[Bill Flynn:]

Thank you, Spencer. Moving to slide 11; 2018 was another great year for Atlas. We drove substantial growth in the scale diversity and profitability of our business. We are a leader in global aviation outsourcing and we're excited about our future and the future of Air Freight. Our focus is on express, e-commerce and fast-growing markets. We are capitalizing on the scale and scope of our domestic and worldwide operations. We're building on the growth in our business mix, customer base and operational capabilities. We have the aircraft and provide the services that customers want and we are grateful to our dedicated team that delivers them. Heidi, may we have the first question, please?

[Operator:]

Certainly. Your first question comes from the line of Bob Labick with CJS Securities. Please go ahead.

[Robert Labick:]

Good morning and congratulations on a nice year and nice outlook.

[Spencer Schwartz:]

Thank you Bob.

[Robert Labick:]

I want to start with Spencer, I think you did touch on this a little bit but I want to dig in a little deeper on a direct contribution from ACMI, I think going into the quarter we had expected a little bit more growth and I know you talked about heavy maintenance being a little higher, I guess and due to allocation and crew cost but if you could elaborate on the - I guess flatness in direct contribution there and then talk about next year within your guidance, not specifically but do you expect ACMI direct contribution to grow?

[Spencer Schwartz:]

Sure, Bob. So in looking at ACMI direct contribution it's really driven by a couple of things. One is that we had higher heavy maintenance cost. We had incremental engine overhauls during the fourth quarter that were driven by operational requirements. And then we have an allocation methodology, so for engines when there are engine overhauls, our methodology is to expense those overhauls as they are put in into shop for the overhaul. And then we have to allocate the maintenance expense between our segments, ACMI and charter. So for engines they're generally pretty fungible, and they move between aircraft to aircraft. So our allocation methodology that we've used consistently is we base it on the number of block hours during the period when the maintenance occurred. So it's unusual for us to have so many engine overhauls during December, but we did this year to help us prepare for peak and also for 2019 flying. So as a result, December we always have the most ACMI hours versus charter hours. And so a lot of that engine overhaul, heavy maintenance, more of that gets allocated to ACMI as opposed to charter. So that happened during the quarter as well. And then, we also had the crew increase as we talked about. We enhanced the Southern Pilots wages and work rules with the interim agreement. And then, Bob, I think you asked whether for 2019. Yes, we think that in 2019 we'll have the - with all the things that I think we talked about, in 2019 we expect our overall segment profitability in ACMI to grow. In fact grow significantly.

[Robert Labick:]

Okay. Superb, thank you. And then just. No, no, that's great. It's very helpful I appreciate it. I guess for my follow up. Just could you give us a sense of the growth in the fleet for the ballpark that's within your guidance as well? I know there is a three new CMI coming on. Are you contemplating in your guidance any additional fleet at this point?

[Bill Flynn:]

There is some growth that's built into our plan. But we are not providing details on that at this point, Bob. Most of the growth from 2018 to 2019 in our plan is from the aircraft that we've added throughout 2018 and the benefits that we'll get from that. And then it will also be the first year of that accretion from the full 20 767s operating for Amazon this year. And there is a little bit more in there, but nothing too expensive.

[Robert Labick:]

Great, okay. Thanks so much.

[Operator:]

Your next question comes from the line of Jack Atkins with Stephens. Please go ahead.

[Jack Atkins:]

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

[Bill Flynn:]

Thank you, Jack.

[Jack Atkins:]

So Bill, I guess this is a question for both you and Spenser. But if I could just start maybe with just a high level question for you, and then would love to get Spenser sort to take on how it impacts the 2019 guidance or what's assumed in the 2019 guidance. But obviously there is just a ton of potential outcomes on the macro front whether it's Europe that we're talking about Brexit or just the economic out there, or China and U.S. trade. I would be curious to get your sense for how all those things are playing together and what's happening in the minds of your customers right now as they are planning for their business for 2019. And then Spenser, just as we sort of think about that all together, what does the guidance assume for those items in terms of sort of how do we bracket what's good what's bad for your guidance if we were to see as potential hard Brexit for example or no China U.S. trade deal. Just trying to think about the potential outcomes and how it impacts 2019 for you guys?

[Bill Flynn:]

Yeah, thank you, Jack. I think that's a very good question and there are several elements to it. So first of all if we can step back maybe a little bit, one of the questions we're often getting is well with the discussions and the kind of push and shove going back and forth between China and the U.S., what have we seen so far? And the answer is from the tariffs have been imposed and announced, we haven't seen a large impact yet. Now that doesn't mean there wasn't any impact or that they're may not be, should the U.S. and China fail to reach some agreement, even with the talks that are going on now that there wouldn't be. But we haven't seen it yet. And when I think about our customers, we're not seen - made an impact in the schedules that they're giving us to fly both near term and as we think about this schedules and deployment into 2019. So it doesn't mean that there won't be but we can't point to significant impact at this point. There is that cloud of uncertainty that kind of sits on the top of these kinds of considerations. We just haven't seen that - we haven't seen that yet. Thinking more broadly, what doesn't Brexit mean? Near term and specifically for us, we actually don't have very large operations in the UK. At present we haven't had large UK operations for quite some time now, since BA got out of freighters years ago. We do have substantial operations in the continent. So to the extent that flows change or we see more flows and coming in and out of Europe that's potentially an upside for us or and or an upside for our customers overall. And the other point that I do want to make Jack - and we've said this a number of times, the way to think about Atlas in many ways is to think about our customers because the vast majority of our customers are publicly traded companies. So another way to kind of triangulate on impact maybe what are the customers, our customers saying about themselves and their growth plans, given our large position we have at DHL, the 20 aircraft that we're operating for Amazon, the overall strength of the charter market, the customers that we've added and the fleet growth we've had. So we've incorporated that into our guidance and Spencer will perhaps add framework - Spencer has a few more comments on to add. So as you know we sit here today, we've tried to incorporate the uncertainty that exists out there coupled with what our customers are telling us about their business plans and the schedule they want us to fly for them.

[Spencer Schwartz:]

And Jack, it's Spencer. I don't have a whole lot to add to that. When we put together our plan for the year we worked closely, as Bill said, with all of our customers and so our plan reflects their plans and their expectations for the year and the flying that we expect to do with them. So all of that is built in. The other thing that we talked about I think during our last earnings call is that we just don't see there being that big of an impact for airfreight overall from the tariffs. And the beauty of our business is that we operate airplanes and they can move anywhere we want and at any given time. And so if manufacturing, for example were to move out of China to somewhere else, we can operate it from there. And so it's just by the nature of our business, we expect our business to continue strong.

[Bill Flynn:]

And I would just add, our military segment we talked about it in my remarks we're expecting higher levels of activity in military in '19 over '18 as well.

[Jack Atkins:]

Okay, that's helpful. Thank you for that response. And I guess for my follow up, Spencer, the change in lease accounting standards, which I think took effect on January 1, how will that impact the balance sheet for you guys, if at all, and should we expect to see some moving pieces perhaps on the income statement in 2019 with rental expense perhaps moving interest expense trying to think through how that's going to flow through your income statement this year?

[Spencer Schwartz:]

Sure. Thanks Jack. So the new lease accounting standard is - will be adopted as of January 1. So you'll see it in the first quarter results as a dry lessor the new guidance really doesn't expect our dry leasing revenue, as it's consistent with the current guidance. As a lessee, it requires the recognition of a right of use asset and then an offsetting right of use liability. The good news is that we don't expect any impact to our income statement. So for the balance sheet, you will see a right of use asset and then right of use liability. The liability will be about $650 million. And that is really consistent, if you look at how we calculate our net leverage ratio, you can see that we always include the present value of leases and that has been somewhere around $600 million, $650 million. So this is very consistent with what we've been using previously. And now it'll just be on the balance sheet with an offsetting asset and liability.

[Jack Atkins:]

Okay, that's great. Thank you for the color guys.

[Bill Flynn:]

Thanks, Jack.

[Operator:]

Your next question comes from the line of Helane Becker with Cowen and Company. Please go ahead.

[Helane Becker:]

Thanks, operator. Thank you for the time, guys. So Mike, my two major questions on China and Brexit, you answered. So thank you very much. The other question I had, I think Spencer about your 4Q, your numbers including some amount of growth this year. So I have two questions related to that, if you don't mind. The first question is when you think of growth, how are you thinking about that, are you thinking about additional new customers, or are you thinking about increased flying for current customers? And I know you don't like to speak about the Amazon contracts specifically, but I'm just wondering if there are opportunities to add aircraft for them you know since much like your competitor did recently. And then the other question I have is with respect to - completely unrelated with respect to military flying. I know you don't break that out anymore. But I'm just kind of wondering with all the changes that we see happening, how should we think about that going forward, if we need to think about that at all? So kind of a lot there, but you can pick and choose.

[Spencer Schwartz:]

Okay. Well, thanks Helane. Well couple of things, I think - just kind of in marketing one-on-one, it's considered to be somewhat easier to get more business from current customers than to bring on new customers. But I think we're in a position, we're going to see growth across all of our customers. I think we have growth opportunities and we're always discussing growth opportunities with all of our current customers. You saw that in 2018, and indeed in 2017, we brought new customers in. We've had good growth with those customers as well. We took on additional assets other than 67s to serve those customers in 2018. And Michael Steen, our Chief Commercial Officer, and his team are in ongoing discussions with a broad array of customers for growth. As we both noted, this is our full year of operating the 20 aircraft for Amazon that we put into service over the last two years. And so we look forward to those operations. And beyond that we're not going to really comment at any one specific customer other than to say we see good growth potential for the company overall. And in terms of the military, I think we have said it's about half of our commercial Charter operations in terms of ours to combination of passenger and cargo. We've - I've also said earlier that we expect '19 to be at higher levels in '18 and some of that is activity - levels of activity but there's another point to make as well. The military has a large fleet of C-17 and a smaller fleet of the C-5 but not a lot of new at least announced plans for additional new mobility aircraft. And so what we've seen in growth over the last several years is certainly volume but in addition the military has elected to put more flying into the commercial operators for a time or sometime because in their program view they've overflown their C-17 fleet for about a 10 year period and are looking to if not rest to minimize utilization of that fleet to extend the program life of the asset and use a higher rates of commercial aircraft to accomplish that. And so that's another important factor that's driving growth in our military flying.

[Bill Flynn:]

And Helane, I'll just add that our military entitlement remained fairly steady, around 53%, 54%. In that we continue to see higher cargo demand and modest increases in rates. And during the fourth quarter we flew around 87% one-way missions and almost all of those eastbound. So really, really continued great flying for the military.

[Helane Becker:]

Okay, thank you very much.

[Operator:]

Your next question comes from the line of David Ross with Stifel. Please go ahead.

[David Ross:]

Thank you. Good morning, gentlemen.

[Bill Flynn:]

Hi David.

[Spencer Schwartz:]

Hi David.

[David Ross:]

When we look back on 2018 certainly, there was a cost associated with putting all of those planes up for Amazon. Can you quantify, I guess, how much of a headwind, the ramp up cost, start-up costs, training costs, however you want to describe it was in 2018, because presumably, I guess that disappears this year?

[Spencer Schwartz:]

Correct. It disappears, we had start-up costs in '16, '17, and 18. All throughout those periods, we had to bring on pilots before they started flying. We had to train those pilots. We had to bring in trainers. And so there's - there are start-up costs related to all of that. But we haven't quantified that, but we did have to - had to - had to start those costs in advance of the actual flying taking place. The majority of it really took place in 2016 and '17. And then of course as we added more planes, earnings overtook the start-up costs, but they did continue throughout the period. And then '19 will be the first full year that doesn't have those start-up costs related to the 767-300s.

[David Ross:]

So if I'm hearing you correctly there were fewer start-up costs in '18 and there were in '16 and '17?

[Spencer Schwartz:]

Correct. Yes.

[David Ross:]

Okay.

[Spencer Schwartz:]

Plus higher earnings as well.

[David Ross:]

Of course, I was trying to separate out the two. And then Bill some of the other airfreight related companies have been talking about Europe specifically in terms of macro weakness. I don't know how much Charter business you do over there, if that's more ACMI flying for DHL and other customers. But to the extent you have any comments on - where you see growth or softness and global activity, is Europe softer than Asia Pacific, U.S., South America and any commentary that would be helpful?

[Bill Flynn:]

I think the majority the majority of our operations in and out of Europe are both ACMI, CMI and military. Because of the flights we operate in and out of Germany, either as a destination or as an intermediate point between Germany and operations into Saint Carmen. That's a big - that's a large part of our flying overall. We certainly have some Charter operations in and out of Europe, but I wouldn't say it's the majority of our commercial Charter operations. And as we've talked about and commented several times now, our focus is really on those faster growing markets in Asia as both origin and destination and certainly South America. The - coming out of Lunar New Year, which is where we are now, it does seem a little bit slower in terms of the recovery coming out of New Year, Lunar New Year on volumes into Europe, out of Asia more broadly than it is on the Transpac. So obviously something we need to watch and understand what Brexit means. It's kind of hard for all of us to predict what that means. As I mentioned earlier, we're not - don't have a big position in UK flows either way. So we're somewhat insulated from that impact, not sure what it means for the rest of Europe.

[David Ross:]

Excellent. Thank you for the color.

[Bill Flynn:]

Thank you.

[Operator:]

Your next question comes from the line of Seldon Clarke with Deutsche Bank. Please go ahead.

[Bill Flynn:]

Operator we've got some static here.

[Operator:]

Yes, I recognize that. Your next question comes from the line of Kevin Sterling with Seaport Global Securities. Please go ahead.

[Kevin Sterling:]

Thank you. Good morning, gentlemen.

[Bill Flynn:]

Hi, Kevin.

[Spencer Schwartz:]

Hi, Kevin.

[Kevin Sterling:]

So Bill, especially you guys, you talked about 2019 and growth with existing customers and new customers, how does the feedstock situation look? So, if I'm a new or even existing customer, and I come to you and say, hey, I need 10 to 15 planes. Are you constrained by the feedstock availability or do you think you could get aircraft to convert to freighters?

[Bill Flynn:]

Well, a couple of things, you've seen our ability to acquire aircraft and convert where we needed to do that. We've also been able to go into the market and lease in aircraft to take advantage of opportunities as well. There there's aircraft available in the market it depends on the type and also a good part of our growth has been CMI where customers have provided the aircraft for one or another reason and have elected us, selected us to operationalize and fly the aircraft for them. So I think there are several - depending on the customer or the aircraft type, I think there is several avenues of growth for us in 2019 and beyond, Kevin.

[Kevin Sterling:]

Okay. Thanks Bill. My second question revolves around labor cost. How should we think about this cost trending in 2019 and how we should think about maybe a new labor agreement with your pilots? I know you talked about the higher cost here in Q4 with Southern pilots, but how should I think about 2019 and then new labor agreement with your existing pilots?

[Bill Flynn:]

Well, overall, Kevin, our goal is to get a new joint collective bargaining agreement with our pilots, an agreement that works for really for our pilots, works for us as a company and certainly works for our investors. And we continue in discussions with our pilots, with their union representatives now, I mean obviously it's key for us as a company be able to attract and re-train and - retain excuse me, and grow our pilots. And the good growth that we've had over these last several years we've been able to do that to bring pilots on board, but also because of the diversification and the growth provide meaningful opportunities for people to join, train as a first officer and then in a relatively short period of time move over to the left seat and become a captain. As I said we're in discussions now it's really takes two parties to get to a new agreement. We're in that process but we're not providing perspective on what those what increases in cost may look like and that we'd be negotiating public if we did but we continue those discussions and look forward to getting to that agreement.

[Kevin Sterling:]

I got you, but can we assume or assume that higher labor cost somewhat or at least some cost are baked into your 2019 guidance, is that a fair assumption?

[Bill Flynn:]

What's in the 2019 guidance, Kevin is we entered into the interim agreement with our southern pilots in September so there was an impact in September and then in the fourth quarter. So that impact is there throughout all of 2019 so you'll see that throughout 2019 that part is baked in. Otherwise just sort of standard increases.

[Kevin Sterling:]

Okay, well, that's all I had. Thanks for your time. Congrats on a great quarter in 2018.

[Kevin Sterling:]

Thank you.

[Bill Flynn:]

Thanks Kevin.

[Operator:]

And your next question comes from the line of Seldon Clarke of Deutsche Bank. Please go ahead.

[Seldon Clarke:]

Hey guys thanks for the questions, sorry about that no appearance earlier. Want to ask about free cash flow for next year just given what you committed to right now in terms of aircraft purchase, do you expect some cash flow to be positive in 2019? And just could you give us a sense on maybe what you're targeting from that leverage ratio longer term?

[Spencer Schwartz:]

Sure Seldon, it's Spencer. So our free cash flow for 2018 versus '17 grew 29%. So a phenomenal jump based on our earnings in 2019 we expect it to continue to improve as we'll have all of the Amazon aircraft operating and continue to grow the business and enjoy the rest of the 18 aircraft that we added for the full year. So yes we expect free cash flows to continue to grow. And then with regard to the net leverage ratio we expect both as we pay down debt as well as grow our EBITDAR we expect that leverage ratio to continue to decline, getting to somewhere around at the mid-three level. So we were at about 4.9 or 5 times not too long ago and expect to be at mid-threes by the end of this year, really important initiative for us.

[Seldon Clarke:]

Okay, and just to clarify on the in terms of free cash I'm talking about like net of additional aircraft purchases. So whatever you have committed to in terms of like the Nippon aircraft for this year, not that kind of adjusted free cash flow number you guys provide?

[Spencer Schwartz:]

Well, the Nippon cargo aircraft that's a CMI basis and so those are not our aircraft. As far as aircraft capital expenditures we really don't have sort of committed expenditures at this point. We do however have core capital expenditures and we provided that number earlier. We expect that to be about a $135 million to $145 million for 2019. And that really reflects the requirements for parts inventory for the 747400s that were released in 2018. The incremental Amazon 767 and then just general fleet requirements for the 747400 and 747-8.

[Seldon Clarke:]

Got it, that's helpful, thank you. And then just asking a little bit different way in terms of your guidance for block hour growth, could you give us a sense of how that breaks down from an organic perspective or going from some of the new aircraft you're adding?

[Spencer Schwartz:]

Block hour growth is generally driven by the incremental aircraft that we added throughout 2018. The military flying is growing. We also, as we talked about we took two aircraft that we were operating in ACMI for CMI customer. We bought those aircraft we moved them into charter and they fly for the NFL. So the utilization in the block hours were actually down just given the nature of the NFL flying. But continue sort of similar earnings on those aircraft. So overall and looking at block hours it really is the aircraft we added 16 aircraft throughout 2018 all throughout the year and so we'll enjoy the block hours from all the flying. Otherwise utilization generally pretty consistent 2019 versus 2018 other than the military which is going to increase as Bill talked about.

[Seldon Clarke:]

Okay. I appreciate it. And then just last one kind of longer term. Is there - should that maintenance expense come down a little bit on the like per block hour basis after 2019 just given something like the timing of the aircraft purchases and things like that?

[Bill Flynn:]

Well, line maintenance expense is the vast majority. It's about two-thirds of our overall maintenance expense. And that is - that varies based on block hours. It's basically a variable cost. And the line maintenance on a per block hour basis generally grows similar to inflation. It grows a couple of percent, 2%, 3% per year. So you should expect to continue to see that for line maintenance. And then heavy maintenance really depends on when engines need to be overhauled and when calendar, letter [ph] checks are due on the air frames. We did have a number of engine overhauls in December. And as a result of that, we're forecasting that we have three fewer CF60-80 engines. Those are the engines that we operate in our 747-400s and 767s where we will have three fewer of those in 2019 versus 2018 as a result of some of the overhauls that happened during the fourth quarter.

[Seldon Clarke:]

That's helpful. I appreciate the questions.

[Bill Flynn:]

Thank you.

[Spencer Schwartz:]

Thank you.

[Operator:]

[Operator Instructions] And your next question comes from the line of Chris Stathoulopoulos with Susquehanna International. Please go ahead.

[Christopher Stathoulopoulos:]

Good morning. Thanks for taking my question. Two questions here, so looking at the competitive landscape, there has been a few notable events in the recent months compared to ATSG expanded their agreement with Amazon, KKR made $1 billion investment with lessor, [indiscernible], I think part of which is going to be used 2x6 wide-body cargo jets and last week 3PL Operator Expo suggested a key customer likely Amazon walked away from a piece of their business. So I wondering if you could give us kind of broad strokes, your thoughts on perhaps Amazon, the potential to expand that business or what you are seeing with regards to increased competition from lessors Al Twar or someone who has been more of a traditional competitor, ATSG or [Indiscernible]? Thanks.

[Bill Flynn:]

Yeah. Well, let me take that. This is Bill. I'll answer the first one. So the KKR investment in with Al Twar, looks like to me that the Al Twar team found an additional source of capital investment to go to Palida [ph]. Al Twar is a long time player in aircraft leasing. They were Guggenheim at one time, but the same leadership team over there and they've been a long time participant in freighter. So I don't see it as a new introduction. I think what it points to is that there is a - air freight is anticipated to grow, assets will be required to support that growth and KKR I guess saw the opportunity to work with the team at Al Twar and participate in that overall. We're not going to comment on Amazon specifically. We don't and we don't specifically comment on any one customer for that matter on competitors generally. I think just a couple of thoughts, Chris. We've added 45 aircraft in three years. We've averaged about one aircraft every three weeks. We've added a great book of customers. Certainly Amazon is an important customer and we're now finally at well, 20, but we've added other customers that we've talked about, the creative ones like NCA where it's all CMI to the earlier question. We're now putting our balance sheet at work to fly those aircraft. We added SF Express. They're the largest express operator in China today with the fleet, their own fleet domestically of north of 40 aircraft, and our operation for them is their first international operation overall several continents. So when I look at our position, we've got a great book of customer, we have diversity among our customers overall. Someone's doing something background there. And I think our opportunities - our growth opportunities with current customers an earlier a question that we had and potentially new customers is we're really well situated to be able to do that.

[Spencer Schwartz:]

And Chris, its Spencer, just to add briefly that Al Twar in particular is a key business partner of ours. We have nice relationship with the company and their management team.

[Bill Flynn:]

We have leased an aircraft for them.

[Spencer Schwartz:]

That's right, and there are good source of aircraft for us.

[Christopher Stathoulopoulos:]

Okay, thank you, and then my follow-up question. I think with regards to block hours it works out to and apply growth around 15% and then you know depending on the utilization levels that we've plug-in there, we can kind of back into a fleet total. But how should we be thinking about headcount growth for 2019 if we assume a similar sort of trend of around 19 or 20 heads per aircraft. Is 10% sort of like the right number to think about headcount for this year? Thanks.

[Bill Flynn:]

With regards to crew, yes, it really just depends on the aircraft, the aircraft type, the operations for the aircraft. So that's with regard to crew. With regard to ground staff it depends on how many stations we'll be opening and then we also have ground staff that are supporting our overall fleet initiatives and fleet growth. And so we'll be adding there as well.

[Christopher Stathoulopoulos:]

Okay, thanks for the time.

[Bill Flynn:]

Thank you, Chris.

[Operator:]

And there are no further questions in the queue.

[Bill Flynn:]

Well, thank you, Heidi. And Spencer and I would like to thank all of you on the call today for your interest in Atlas Air Worldwide. We certainly appreciate your spending and sharing your time with us today and we look forward to speaking again with you soon. Thank you, operator.

[Operator:]

And this conclude today's conference call. You may now all disconnect.