Q4 2017 Earnings Call Transcript

Published: 23 Feb 2018

[Operator:]

Good morning. My name is Heidi and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter 2017 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.

[Spencer Schwartz:]

Thank you, Heidi. And hello, everyone. I'm Spencer Schwartz, Atlas Air Worldwide CFO. Welcome to our fourth quarter 2017 results conference call. Today's call will be hosted by Bill Flynn, our Chief Executive Officer. and me. Today's call is complemented by a slide presentation that can be viewed at AtlasAir.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 2016 Form 10-K as amended or supplemented by our subsequently filed SEC reports. Any references to non-GAAP measures are meant to provide meaningful insight and are reconciled with GAAP in today's press release and in the appendix that is attached to today's slides. During our question-and-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.

[William Flynn:]

Thank you, Spencer. And good morning. 2017 was an exciting year for Atlas and we expect that to continue in 2018. As noted in our press release, we generated record revenue in both [indiscernible] and for the full year. We generated record fourth-quarter earnings and robust full-year earnings growth and we expect to generate even higher revenue and earnings in 2018. We are capitalizing on our focus on express, e-commerce and fast-growing Asian markets. We're operating in a strong airfreight environment, underpinned by global economic growth. With the building blocks we have in place and our strong market position, we see opportunities to grow with existing customers and to add new ones. We expect our adjusted net income to grow by a mid-20% level when compared with 2017. Moving to slide four, our fourth-quarter adjusted earnings reflected a 19% increase in revenue, 18% increase in block hours and 14% increase in adjusted EBITDA. In addition, we achieved double-digit increases in direct contribution in all of our segments. We also placed and began operating five additional 767-300 aircraft for Amazon during the quarter, raising the current number operating to 12. That's in line with the expectations we had when we commenced this new service in 2016 and it's in line with our expectations for a total of 20 aircraft by the end of this year. Slide five highlights our growth framework for 2018. As I noted a moment ago, we anticipate continuing business strength and growth in 2018 with our adjusted net income expected to grow by a mid-20% level compared with 2017. We expect significant increases in our volume, revenue and adjusted EBITDA in 2018, with volumes rising to around 300,000 block hours, revenue growing to approximately $2.5 billion and adjusted EBITDA of about $500 million. Our outlook also includes the benefit of a lower income tax rate following the passage of the US Tax Cuts and Jobs Act. By comparison, even without any benefit from tax reform, we would've expected our adjusted net income to grow this year by a percentage in the teens. Consistent with historical patterns, we anticipate that more than 70% of our adjusted net income will occur in the second half of this year. Looking at the first quarter, we expect adjusted EBITDA of approximately $90 million and adjusted net income to be approximately double the $8.3 million in the first quarter of 2017. For the full year, we expect total block hours to increase approximately 19% compared with 2017, with about 75% in ACMI and the balance in charter. To meet the anticipated increase in ACMI and charter demand, we have entered into operating leases for six 747-400 freighter aircraft. Two of these aircraft entered service in the third and fourth quarters of 2017, four will enter service throughout 2018. Aircraft maintenance expense should total about $315 million, mainly reflecting an increase in daily line maintenance due to the anticipated growth in block hours. Depreciation and amortization is expected to total approximately $220 million. In addition, core capital expenditures, which exclude aircraft and engine purchases, are expected to total about $100 million to $110 million, mainly for parts and components for our fleet. At this point, I would like to ask Spencer to provide some additional detail about our fourth-quarter results. After Spencer, I'll have some additional comments and then we'll be happy to take your questions. Spencer?

[Spencer Schwartz:]

Thank you, Bill. Our record fourth-quarter results are highlighted on slide six. On an adjusted basis, income from continuing operations net of taxes totaled $66.6 million, which was a 13% increase over the fourth quarter of 2016. As Bill noted, our results reflected robust increases in revenue, block hours and adjusted EBITDA. We also generated substantially higher direct contribution in all of our segments. On a reported basis, our net income totaled $209.5 million. That included both a $130 million benefit related to the revaluation of our deferred tax liabilities, as well as an unrealized gain of $23.7 million on outstanding warrants. Our adjusted earnings in the fourth quarter included an effective income tax rate of 31.4%. For the full year, we had an effective rate of 28.4%. On a reported basis, we had an effective income tax benefit rate of 95.7% during the quarter and 56.5% for the year. And that was principally due to the revaluation of our deferred tax liabilities at the lower US tax rate. With respect to 2018, we expect our full year adjusted income tax rate to be approximately 17%. Based on our current tax framework and the aircraft that we've purchased and placed into service, we do not expect to pay any significant US federal income tax for this or the next decade. Looking at slide seven, record ACMI segment revenues in the fourth quarter were primarily driven by a significant increase in block hour volumes. Block hour growth during the period reflected 747-400 flying for several new customers, 747-8 flying for Cathay Pacific, additional seasonal flying for express operators and the ramp up of 767-300 operations for Amazon. Higher charter segment revenues in the fourth quarter were primarily driven by an increase in rates reflecting the impact of strong commercial yields. In dry leasing, higher segment revenues reflected an increase in the number of 767-300 aircraft placements. Moving to slide eight, segment contribution totaled nearly $163 million in the fourth quarter, a 14.5% increase from the fourth quarter of the previous year. ACMI earnings primarily reflected a significant increase in block hours, partially offset by higher line maintenance costs associated with the increase in flying. The improvement in charter contribution during the period was primarily due to the strength in commercial yields, partially offset by higher maintenance costs and the redeployment of 747-8 and 747-400 aircraft to the ACMI segment. In addition, segment contribution in both ACMI and charter was affected by labor-related operational disruptions. In dry leasing, higher segment contribution during the quarter primarily reflected a reduction in interest expense due to the scheduled repayment of debt related to dry leased 777 aircraft and the placement of 767-300 converted aircraft. Turning slide nine and our balance sheet, we ended 2017 with cash, including cash equivalents, restricted cash and short-term investments, totaling $305 million. Our cash position at December 31 reflected cash provided by operating and financing activities, partially offset by cash used for investing activities. Net cash provided by financing activities during 2017 included $332 million from our financings of 767-300 aircraft and $249 million of net proceeds from our issuance of convertible notes, partially offset by $207 million of payments on debt obligations. During the fourth quarter, we completed the financings of six additional 767-300 aircraft, which raised cash of $146 million. Net cash used for investing activities during 2017 primarily related to payments for flight equipment and modifications, including the acquisition and conversion of 767-300s, spare engines and GEnx engine upgrade kits and core capital expenditures. Our debt has a low weighted average interest rate of 3.1%. Almost all of that is at a fixed rate and the vast majority is secured by our aircraft assets, which have a value in excess of the related debt. Moving to slide 10, we remain committed to maintaining a strong balance sheet while growing our fleet. As the slide shows, our net leverage ratio has remained fairly consistent since 2016, while we have grown our fleet by 31 aircraft during that same time. Our net leverage ratio at the end of the fourth quarter was 4.8 times. As we have previously said, looking forward, we expect it to improve gradually over the next few years as we place more aircraft in service and to begin to generate substantially higher EBITDAR. Now, I'd like to turn it back to Bill.

[William Flynn:]

Thank you, Spencer. Moving to slide 11, 2017 was an exciting year for Atlas and we expect that to continue in 2018. We're capitalizing on express, e-commerce and fast-growing global markets. We're operating in a strong airfreight environment underpinned by global economic growth. And the solid foundation we have built provides opportunities to grow with existing customers and to add new ones. As a result, we anticipate significant growth in our volumes, revenue, EBITDA and adjusted net income. With that, Heidi, may we have the first question please.

[Operator:]

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

[Bob Labick:]

Good morning. Congratulations on a nice quarter and year.

[Spencer Schwartz:]

Thank you, Bob.

[William Flynn:]

Thank you, Bob.

[Bob Labick:]

Lots of questions. I'll stick to the one and one follow-up. I wanted to start with the six leased 747-400s you talked about. Could you give us a little more background about, I guess, where you got them, the terms of the leases and then, more specifically, on where you will be placing them? It sounds like potentially in charter, but not sure. So, if you could give us more color around that, please?

[Spencer Schwartz:]

Sure, Bob. I'll give a little bit of that. So, two of them were put in service in 2017, one in September and one in October. And then, four will be placed in service throughout 2018. The aircraft, as you said, they're on lease. They'll be with customers in both ACMI and charter. So, they're somewhat fungible. There are six of them. So, some will be with ACMI customers. Some will be in charter. Some will be moving around between those. And all of them are included in the guidance and framework that we provided today.

[Bob Labick:]

Got it, great. And then, just following up on that one. In terms of capacity in the industry, there hasn't been that much coming off and revenue per block ex-fuel in charter was up strong year-over-year, suggesting rates are favorable. Can you just talk a little bit about other capacity coming on or your expectations for rates going forward?

[William Flynn:]

I'll talk perhaps, Bob, first starting with the market. So, I think as we've discussed before, the market really inflected all the way back around July, August of 2016 and we've seen just a continued solid growth, kind of month over month. And certainly, a very good peak in 2017 and a very strong outlook for 2018 and beyond. And I think even expeditors recently, in their recent call, talked about the strength in the market and we're seeing it broadly across all the markets we serve. This kind of global economic growth that we're seeing really across the board underpinning that very strong demand. There is not a lot of excess capacity in the market to kind of get to the beginning of your question. There are only a few 400s parked – 747-400s parked, which will take quite some investment to bring back into service. There's not a lot of production that's coming off the production lines on newbuild. And certainly, folks are looking to source 6, 7s to put into e-commerce and regional markets. So, we think, overall, a good balanced environment between demand, capacity and what that suggests for the ability to price.

[Bob Labick:]

That's fantastic. Thank you.

[Spencer Schwartz:]

Thank you.

[Operator:]

And your next question comes from the line of Kevin Sterling with Seaport Global Securities. Please go ahead.

[Kevin Sterling:]

Thank you. Good morning, Bill and Spencer. How are you doing?

[Spencer Schwartz:]

Great.

[Kevin Sterling:]

Congrats on a really good quarter, capitalizing on some of that strong freight we're seeing out there. Bill, can I dig a little bit deeper into those operating leases because I'm intrigued by that because, historically, you guys buy the planes and now you might be pivoting a little bit more to operating leases. Do you think that will be a model going forward to satisfy maybe spikes in demand or strong demand we're seeing? Will you do operating leases, you think, going forward? And then, secondly, are these leases for one customer or is it multiple customers?

[William Flynn:]

So, a lot in that question there, Kevin. Let me start.

[Kevin Sterling:]

We've only got two. So, I'm going to ask a lot.

[William Flynn:]

Okay, very good. Last year, in our third quarter's call, we talked about all the customer growth we had in ACMI in addition to the growth that we're building in the fleet with Amazon. And so, we talked about the two aircraft with Cathay Pacific, the growth with the Asiana and other customers overall. I'm not going to go through each customer. DGF also took a dedicated freighter as well. So, we certainly needed additional capacity first to serve our ACMI customers and we're having, and have consistently had, great performance in our charter market, which is both military, military cargo and passenger and the commercial charter market overall. So, we certainly needed additional capacity to take advantage of the growth and drive the results that we're talking about. In the 747-400s, given what was available in the market and the lease rates that we were able to obtain for those aircraft, it just made sense for us to lease the aircraft in on terms that kind of meet our business case and balance risk of how much we're buying in financing versus leasing in where and when it makes sense. So, going forward, on aircraft, if there's the right opportunity to acquire an aircraft, we would. We'd have to have really good visibility on to the long-term placement of the asset and the earnings that we'd generate from that. And we will balance that, of course, with leasing where and when appropriate.

[Kevin Sterling:]

Got you. No, makes sense. Are these six leases for one customer or is it multiple customers?

[Spencer Schwartz:]

Multiple customers, Kevin. And some of them – as I mentioned before, some of them will operate with the military. They'll operate for commercial charter. They'll certainly operate with ACMI customers. It's not always sort of one for one. They'll move around between customers.

[Kevin Sterling:]

Okay, thanks. And then, my last kind of follow up here. Bill, can you help us frame the big picture of what we're seeing now? How would you compare the airfreight market to previous cycles? I can remember coming out of the recession, the uptick we saw in airfreight, it was short-lived, but what we're seeing now seems like, to me, it has some legs to it. Would you agree with that assessment? Or am I off-base? And then, what we're seeing in January and February seems to be relatively strong to historical norms as well.

[William Flynn:]

Yeah. Well, you make the right point, Kevin. When coming out of probably the middle of 2009 and for a period of time, for a couple of years, we saw a good recovery after the 2008, first quarter 2009 downturn. And then, we didn't see a lot of growth for a couple of years. It was fairly flat. Capacity was still coming in. And there were a lot of questions how should we think about that. And it wasn't only airfreight. I think ocean container freight saw a pretty much similar phenomenon to that, almost that same period of time. And then, we talked about growth catalyzing in 2016. So, from the sources that we look at and the conversations we have with our customers as well because they are major actors in airfreight and express and e-commerce as well are looking towards a very strong 2018 and that continuing into 2019 and a good cycle of growth as we've talked about. I think e-commerce, the expectation that that has created for us as consumers and customers and companies no matter what industry that they're in, looking to further gain efficiencies and time-definite outcomes in their supply chain, all that favors air. And so, there is a new or a growing ingredient into – a growing component in the calculation around future growth, and I think this cycle could well be extended and continue to grow as a result of e-commerce.

[Kevin Sterling:]

Well, that's helpful, Bill. Thank you. And January and February would you say are off to a better start than historical seasonal patterns we've seen in the past couple of years.

[William Flynn:]

I think January February are off to a good start.

[Kevin Sterling:]

Okay. I really appreciate you time this morning. Thanks for all the color.

[William Flynn:]

Thanks, Kevin.

[Spencer Schwartz:]

Kevin, thanks.

[Operator:]

And your next question comes from the line of Helane Becker with Cowen. Please go ahead.

[Helane Becker:]

Thanks a lot, operator. Hi, everybody. Thank you so much for your time. I just have two questions. One point of clarification. I'm not sure whether it was Bill or Spencer who said in their prepared remarks about labor issues or – I don't remember how you referred to it. So, could you just refer to that again for me?

[Spencer Schwartz:]

Sure, Helane. It's Spencer. Just said that, during the fourth quarter, our ACMI and our charter results were also impacted by the operational disruptions that we saw.

[Helane Becker:]

Okay. So, with the injunction now, that should stop, right? Or has that stopped? Or can you just update us on that?

[William Flynn:]

Sure, Helane. I think a couple of things. We certainly think that the court made a sound and a well-reasoned decision in issuing the preliminary injunction overall. Right now, our negotiations continue with the pilot union under the terms and conditions in our contract. But I think our fourth-quarter results and the framework that we provided for 2018 should indicate our ability to manage our business and serve our customers.

[Helane Becker:]

Yeah. No, I wasn't implying that you couldn't do that. I'm sorry if I did. I just wanted to be sure that the glitches that you may have experienced or kind of moved on from there. And then, just in terms of aircraft available, Bill, I think you mentioned that there weren't a lot of 7-4s available. Boeing is not making a whole lot of those. And the ones they are making are going to existing orders. And then, the 767-300, the issues there. Can you just talk about aircraft availability; and as you grow your client base, how that will develop for you if you're looking at new aircraft to get into? I don't know, how should we think about that, I guess?

[William Flynn:]

Well, I think you're right about aircraft availability. The 747-8 line is booked out through some number of years. I think the majority of those are going to be going directly into UPS. So, it will be into their internal networks and not capacity broadly deployed into the market. Our estimate is that there are only about eight 747s parked – 400s parked. And I'm not sure what condition they're in, but it will take some investment to bring those back into service. So, there's some certainly tight capacity in the market. We've identified a number of aircraft and leased them in. We think that was a prudent thing to do as we think about growing demand over the next couple of years and our ability to service that. We've sourced all of the aircraft that we need for Amazon and 12 are operating now as we talked about. Conversion slots are – and conversions are underway and we'll deliver the balance this year. There is – there are, I should say, additional six 7s in the market and we're looking at them as well. And at the same time, we're looking at fuel years further out, I think, which is the point of your question, as to what A330s – 330, 300 passenger to freighter conversions can provide in the mid wide-body market. I think there's only one currently deployed now just out of conversion in the market, but anxious to see what we learn, how that aircraft performs. And then, we'll go – we're continuing to study that as a potential kind of next freighter opportunity for us, but that's a couple years out.

[Helane Becker:]

Okay. That's really helpful. And then, just one last quick question. Did you take any aircraft for Amazon in the first quarter? Or can you say how many are getting in the first quarter?

[Spencer Schwartz:]

Helane, we had 12 at the end of the year and we still have 12 at this moment.

[Helane Becker:]

Okay.

[Spencer Schwartz:]

But we will get to 20 by the end of the year. So, approximately one a month.

[Helane Becker:]

One a month beginning now then –

[Spencer Schwartz:]

Yes.

[Helane Becker:]

– I guess is the answer.

[Spencer Schwartz:]

Approximately.

[Helane Becker:]

Since you said you didn't take any. Right.

[Spencer Schwartz:]

Approximately.

[Helane Becker:]

Since you haven't taken any year-to-date. Okay, all right. Got you. Thanks, guys.

[Spencer Schwartz:]

Thank you.

[Operator:]

And your next question comes from the line of David Ross with Stifel, Nicolaus. Please go ahead.

[David Ross:]

Yes. Good morning, gentlemen.

[Spencer Schwartz:]

Hi, Dave.

[William Flynn:]

Hi, David.

[David Ross:]

First question, just on the labor disruptions in the fourth quarter, can you talk about how quickly they ended after the court decision in late November? Did everything go back to normal immediately or is there a little bit of a tail? And then, do you have any estimates as to what it may have cost you in ACMI and charter in the quarter?

[William Flynn:]

Well, David, a couple of things. So, as you know, the pulmonary injunction was issued and we've talked to that and we issued a release to that effect. Under the injunction, the union has to comply with what the court ordered. And that's certainly their obligation to do so. As I also pointed out, we're under negotiations – continuing negotiations with our pilots. So, getting into a lot of detail around contracting and things that are related to contract, such as a PI is probably not best for us in a public forum. But, Spencer, do you have some additional thoughts you want to share?

[Spencer Schwartz:]

Just with regard to the quantification, we previously noted that it did have certainly an impact, but it would be inappropriate for us to discuss that further here, as Bill said, because we're in negotiations with the pilots' union. We're, obviously, quite pleased with the judge's order, with the preliminary injunction itself and you can see the results in the fourth quarter that we delivered and customers were happy with the peak performance.

[David Ross:]

As you moved into 2018, there hasn't been any tail to the labor disruptions? They went back to work and things are roughly running back normally. Is that a fair characterization?

[Spencer Schwartz:]

We're somewhat reluctant, Dave, to say much more because we're in the midst of negotiations. Again, we're quite pleased with the judge's order. You can see the results that we delivered in the first quarter. Customers are happy with our performance. I think that's really – those things should speak for themselves.

[William Flynn:]

And also, Spencer – and the framework we've provided for 2018, we're talking about almost 20% growth in operations and we're giving some perspective on earnings.

[David Ross:]

Okay. And then, just last question on CapEx. You gave the core CapEx number, which is increasing year-over-year presumably because there's airplanes in the fleet. Any guidance as to your preliminary thoughts on the rest of CapEx, the purchase deposit delivery payments number?

[Spencer Schwartz:]

Well, we have about approximately $90 million of spend remaining for aircraft to support the buildup for Amazon. So, to get to the full 20, we'll have about another approximately $90 million there. And then, we'll have engines and overhauls to perform related to those. In addition to that, we'll have some incremental engine purchases presumably as sort of normal part of our engine procurement process. Otherwise, those are really the big items. And then, as Bill said, we, obviously, have the leases that we talked about. And if we have an aircraft purchase, that would be for a long-term view with placing that with a customer.

[David Ross:]

Okay, thank you very much.

[Spencer Schwartz:]

Thank you.

[William Flynn:]

Thanks, David.

[Operator:]

Your next question comes from the line of Scott Group with Wolfe Research. Please go ahead.

[Scott Group:]

Hey, thanks. Morning, guys. Can you say the duration of the leases? And then, can you maybe share with us what the assumed fleet for ACMI and charter is just in terms of number of aircraft in 2018? And then, Spencer, I think you said that some of the planes are for ACMI. Are those contracts that you've already announced or are those contracts that are coming?

[William Flynn:]

Okay. So, I'll make a couple of comments there, I think. As far as the placement of the aircraft, some are with customers that we have already announced and some will be with other customers and some will be in ACMI and – sorry, some will be in charter with the military and with commercial charter. So, it's a bit of a mixture. We don't really have issues. We're very confident in how they will operate and where they will operate. I know we're not giving you the specificity that you would like, but we feel very confident and comfortable that those aircraft will be fully utilized. With regard to term, we're not going to provide real specifics there because these things are somewhat confidential and competitive in the marketplace. But they're short to medium-term. We're real comfortable with the terms that we achieved. Did I miss any more of your question, Scott?

[Scott Group:]

Yeah. Maybe if you could just share, within the guidance, what the kind of – how many planes you're assuming in ACMI and how many in charter for the year?

[Spencer Schwartz:]

Scott, we don't normally talk about that. I think that's a number somebody wanted to work into. We've said about 300,000 hours. We've said 25% in charter, 75% in ACMI. Some math on average utilization probably gives an indicative number. Overall, as I said, we're really excited about 2018 and beyond. And beyond just the underlying demand, the nature of our customer base, the new ACMI contracts that we've talked about with particularly our Asia-based customers where a large amount of the growth is have really positioned us for what we believe is going to be another exciting year in 2018.

[William Flynn:]

Scott, within our ACMI segment, we continue to add to the number of aircrafts that are placed in ACMI, including within the CMI portion of ACMI. They're both growing quite nicely.

[Scott Group:]

Okay, helpful. And then, last question. Can you just say – does the guidance assume that you get a labor deal done this year? And then, can you just clarify, are you accruing for wage increases or would that all happen if and when you get the labor deal done?

[Spencer Schwartz:]

Well, first of all, we can't really predict the timing of a new agreement. That just depends on the process and both parties' ability to get to a deal. So, we're certainly not positioned to predict the timing of that.

[Scott Group:]

That makes sense. But do you accrue for wage increases that you're sort of expecting or do you not do any of that; and then, once the deal happens, that's when you start to – meaning, if we get a labor deal done, let's say, July 1, do we need to update guidance because we now have a labor deal done? And I just want to understand the puts and takes there.

[William Flynn:]

If that were to happen, Scott, yes, then we would update guidance at that point.

[Scott Group:]

Okay.

[William Flynn:]

The guidance that we've provided we believe is the guidance for the full year.

[Scott Group:]

Got you. Okay. Thank you, guys. Appreciate it.

[Spencer Schwartz:]

Thank you.

[Operator:]

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

[Jack Atkins:]

Hey, good morning, everyone. Thanks for the time.

[William Flynn:]

Good morning, Jack.

[Spencer Schwartz:]

Hi, Jack.

[Jack Atkins:]

So, I guess, let me just start with a question on the ACMI segment. This was the first quarter in maybe the last 12 or 13 quarters where revenue per block hour in ACMI actually was flat to up. So, I think that's – I'm just curious what drove that and is it the strength of the broader market? Is it maybe some of the mix issues that have been weighing on things in the last four or five quarters maybe getting behind you. Just sort of curious how we should be thinking about that. And I think as we look out into 2018, would you expect revenue per block hour in ACMI maybe to flatten out after seeing couple of years of fairly steep declines, I think, largely due to mix?

[William Flynn:]

So, I'll start with your last point, Jack. There, clearly, were mix issues, as we talked about. CMI has no aircraft component.

[Jack Atkins:]

Right.

[William Flynn:]

And so, the rate per watt hour is going to be different. I don't think of that as an issue. I just think that's a reality and we're glad to have the 40-plus aircraft we have in CMI.

[Jack Atkins:]

Of course.

[William Flynn:]

So, where we are in ACMI this quarter, yeah, we talked about the new placements with customers during our third quarter call. And you're seeing that impact in terms of the average rate per block hour in that segment. Spencer, you might have some additional color on that.

[Spencer Schwartz:]

I think you got it right. So, Jack, as you know, as we've talked about, we've placed aircraft in ACMI. That, of course, generally increases the rate per block hour. And then, we have CMI placements and that generally decreases the rate per block hour because, as Bill said, it doesn't have the A component. So, that's what you saw. We had more sort of traditional ACMI placements than we had for a while because we are ramping up CMI so much. So, it's really just a mix issue. That's all.

[Jack Atkins:]

Okay. Okay. Makes sense. And then, just a question on the operating expense side, Spencer, can you help us think through how aircraft rents should flow this year given the timing of the dash-400s coming into the fleet. And then, you know the depreciation and amortization step up this year versus 2017, how much of that is tied to the new 767-300s coming into the fleet for Amazon and what would make up the rest of that stuff? It seems like it's a pretty significant increase on a year-over-year basis.

[Spencer Schwartz:]

Sure, Jack. So, with regard to aircraft rentals, during the fourth quarter, it was just under about $40 million for the quarter. For this year, you should expect to see that increase a little bit per quarter as the year progresses.

[Jack Atkins:]

Okay.

[William Flynn:]

As we said, the new aircraft that we're adding, we'll be adding throughout the year. So, you'll see that over time. With regard to depreciation, you're right. We have more aircraft certainly than we've had before. The aircraft that we placed for Amazon last year, 11 aircraft put in service last year, throughout the year, so then you have a full year of depreciation for those 11 and then we'll have eight more this year. And so, you have a partial year of that. So, with regard to depreciation, you should expect to see that increase gradually throughout this year as well. The fourth quarter, we had depreciation and amortization of about $46 million. And then, for this year, there should be a little step up each quarter as the year progresses.

[Jack Atkins:]

Okay, great. One last question if I could sneak it in here. With regard to airport fees, we've been seeing some higher airport fees creep up with the passenger airlines. Are you all seeing inflation in that line as well this year?

[William Flynn:]

That's hard to say, Jack. We're only paying the landing fees when it's in commercial charter.

[Jack Atkins:]

Yeah.

[William Flynn:]

Fees, in the ACMI and CMI, are for the account of customers. So, I think in terms of our landing fees, it's right now more a function of mix – what country our charter operations are flying out of and into more than any kind of concerted fee increase across the board.

[Jack Atkins:]

Okay. Okay, great. Thank you again for the time.

[Spencer Schwartz:]

Thank you, Jack.

[William Flynn:]

Thanks, Jack.

[Operator:]

And your next question comes from the line of David Campbell with Thompson, Davis & Company. Please go ahead.

[David Campbell:]

Yeah. Hi, Bill. Hi, Spencer. Glad to hear you answer these questions. I really appreciate it. January and February, you said, are off to a good start, market-wise, cargo growth, et cetera But how do you know? Because the Chinese New Year, as usual, distorts the numbers substantially both month-to-month and year-to-year. And so, how do we know it's off to a good start? And if you don't know, what sort of indications do you have for the month of March, which will be the first normal month in comparisons for several months?

[William Flynn:]

Right. So, you raise a good point, David, about Lunar New Year. And so, when we look to compare, we combine Jan and Feb and then look at the two compared to prior year. And if we're looking for a longer perspective, we'll look at Jan, Feb over – combined over a over couple of years. So, we look at both. We look at the market. And then, what's near and dear our heart is our customers and what they're telling us and what kind of schedule they're giving to us to operate on their behalf. So, I would say that, when you combine the two, Jan and Feb, in the market, generally, we're off to a good start. The market has got good demand across all the major trade lines. But you had good levels of operations for our customers from the beginning of the year through the Lunar New Year. And based on our review of what they're telling us, we've factored all of that and then provided the framework that we did around our first quarter, where we're – I think our words were approximately double adjusted net income for last year and about $90 million of EBITDA. So, I think the market is good. And that's a conversation we're having with our customers. And, certainly, we've got a good handle on what our operations and the level of flying is going to be for us.

[Spencer Schwartz:]

And, David, it's Spencer. There continues to be a sort of scarcity of assets, scarcity of freighter assets. And so, some of it is based on that. It's our customers looking for capacity and reaching out to us to try to shore up their networks.

[David Campbell:]

Okay. Second question is, on a longer-term basis, you, obviously, have a lot of growth potential this year from aircraft orders and aircraft you are putting in place for Amazon. But beyond this year – 2019, 2020 – what kind of visibility do you have for growth? Next year, you'll have full year of the – all of the Amazon aircraft, but there's no other aircraft deliveries scheduled that I know of, I think. And so, where is the growth going to come from in 2019 and 2020, particularly given the shortage of aircraft capacity?

[William Flynn:]

So, a couple of things. You're right. We'll have the full year effect of having all 20 aircraft in service for Amazon as we deliberate more this year. We'll have the full year effect of the four aircraft that we're adding from the lease-ins that we're talking about so far. I think, in charter, if we assume that market is going to continue to grow and have a nice a growth path forward, there's certainly pricing opportunities for us in charter. We haven't talked about military yet, but military will – we did, I think, in our last call because it's FY, not calendar year. We said we're going to have good levels of military operations in cargo and passenger in FY 2018 and I think that will certainly carry through into the first quarter of FY 2019, our fourth calendar quarter, as you know. And while there are constraints on capacity, that doesn't mean there isn't capacity available to us. And so, based on our estimate of the market and what our customers are telling us, if we needed additional capacity, I believe we could find it, but we wouldn't be overly speculative in taking that capacity in. That's how we've really managed the company over the last several years once we completed the initial delivery of the dash-8s.

[Spencer Schwartz:]

David, we expect – said simply, we expect to continue to grow the business in 2019 and 2020.

[David Campbell:]

Okay, thank you very much. I appreciate it.

[Spencer Schwartz:]

Thanks, David.

[Operator:]

Your next question comes from the line of Stephen O'Hara with Sidoti & Company. Please go ahead.

[Stephen O'Hara:]

Hi, good morning.

[William Flynn:]

Good morning, Steve

[Spencer Schwartz:]

Good morning, Steve.

[Stephen O'Hara:]

Hi. I was just curious about the depreciation as well. It looks like op margins will be down a little bit in 2018. I would've expected that maybe the revenue, as those aircraft come on, would kind of offset that higher depreciation. Is it – so, maintenance, it's flowing in. That was capitalized. That needs to be sped up or something. And you expect that maybe rebound in 2019 as these – does op margin maybe rebound, all else being equal, in 2019 as you get the full benefit of these aircraft? Thank you.

[Spencer Schwartz:]

Not sure I completely understand your question, Steve. We're placing incremental aircraft in service, and so, therefore, the depreciation on that is higher. We do have some capitalized maintenance, and that maintenance then is amortized and so we're seeing that as well. But margins are looking pretty strong.

[Stephen O'Hara:]

I guess the implication – I guess I'm surprised. It seems like the op margin goes down a little bit in 2018 based on the revenue and EBITDA guidance using the depreciation estimate that you gave. I'm just wondering why did we go down in 2018, given the improvement – assuming improvement from the union side and then the continued integration of the Amazon contract?

[Spencer Schwartz:]

So, it may just be your model or it may be because we used the word approximately or something like that. But we don't see margins coming down the way you're seeing.

[Stephen O'Hara:]

Okay, all right. No, that's helpful. And then, I guess, can you just talk about maybe your willingness or desire to purchase additional dash-8s? And was that a consideration when looking at these shorter-term leases? Thank you.

[William Flynn:]

Well, as we said, the dash-8 has really developed into being a great aircraft that works well for customers. And I think UPS moving forward with 28 of them probably underscores that – certainly underscores that comment. There are not dash-8s available in the near-term. The 400, particularly in the fuel environment we're in, which I would say $60 to $80 – I'm not predicting where fuel rates are going to be, but in that range – the 747-400 freighter delivers a great cost per kilo in terms of operations on behalf of the customers and for our customers. So, could we be interested in additional dash-8s? Yes. And I've said that before. In the near-term and with the kind of terms and conditions and tenure on these lease contracts, the 400s made sense to us.

[Stephen O'Hara:]

Okay, all right. Thank you very much.

[William Flynn:]

Thank you.

[Spencer Schwartz:]

Thank you.

[Operator:]

Your next question comes from the line of Chris Stathoulopoulos with Susquehanna. Please go ahead.

[Christopher Stathoulopoulos:]

Good morning and thanks for taking my question. I was wondering if you could give pilot and total headcount, where we finished for 2017, and then your outlook for this year?

[Spencer Schwartz:]

Sure. For 2017, I think our total employee count was just under 2,900 employees and about two-thirds of those are pilots and the rest is ground staff. For 2018, we continue to hire as we're adding more aircraft. And so, you should expect to see those numbers increase. But we typically don't provide specifics on a number of employees until it actually happens. But, clearly, we're adding a lot more aircraft. We will be continuing to add employees as well.

[Christopher Stathoulopoulos:]

Okay. Just looking at your fleet count, where it ended for the year, and if we just build up on the guidance that you gave, is it – and assume, like, let's say, 22 to 23 heads per aircraft, is it fair to assume kind of like a low to mid-single digit pilot headcount growth for the year?

[Spencer Schwartz:]

I think with regard to headcount, I think we've said what we're going to say on that. We continue to add both pilots and ground staff to support new flying, new aircraft, new stations. And I think you'll see that throughout the year.

[Christopher Stathoulopoulos:]

Okay, okay. And then, just to follow-up on an earlier question. I think it was from Scott. You had said that, if you guys were to settle with any of the open CBAs, that would perhaps update guidance. And I'm guessing that there's some type of inflation factor in these contracts. But if they come in significantly above these, is there an opportunity to revisit the terms of the ACMI and CMI contracts sort of midway?

[William Flynn:]

I think a couple of things without getting into the details of the negotiation and where we are. So, as Spencer said, when we do the contract, we'll, obviously, need to provide information. The market will generally understand it because it's just a ratification and everything else around that. So, there'll be pretty good visibility on that when it happens. We'll have to update guidance or we will update guidance if we believe we need to at that time.

[Christopher Stathoulopoulos:]

But I'm saying, would you be able to sit down with someone like an Amazon or a DHL midway through the term and revisit some of them or…?

[William Flynn:]

I'm sorry. Without getting into any customer specifics, clearly, part of our strategy has to be that, when we take increases, we work with our customers on those increases.

[Christopher Stathoulopoulos:]

Okay. Okay. And then longer-term, and I realize there's a lot of different things going on in terms of the margin profiles, with ACMI, charter and dry lease, but with the gradual mix shift towards ACMI, I realize also you have the curveball – fuel – in there, but how should we think about perhaps operating or EBITDA margins, let's say, two, three years out? Could you get to someplace in mid-teens or – I'm just trying to figure out, again, with all the different pieces on the margin profiles of the business and certainly how we should think about incremental margins and what is able to fall to the bottom line here?

[Spencer Schwartz:]

Sure, Chris. Our adjusted EBITDA margin for the full year of 2017 is about 20%. And as we mentioned earlier, we expect that to continue or perhaps increase in 2018. And so, those are very healthy margins and we're quite comfortable with those.

[Christopher Stathoulopoulos:]

Okay, that's it for me. Thanks.

[Spencer Schwartz:]

Thank you.

[Operator:]

And your final question comes from the line of Jack Atkins with Stephens. Please go ahead.

[Jack Atkins:]

Great. Thanks for letting me squeeze in a couple of follow-up questions here, guys. So, I guess, first, going back to Steve's question around the margins, a moment ago, and maybe it's an issue of my model too. But I've got operating margins – when you look at your guidance sort of coming in by 80 basis points to 90 basis points on a year-over-year basis, just given the revenue growth that's implied versus the operating income growth that's implied. I guess his question is a good one. Is it a function of fuel, which I know flows to revenue, but doesn't necessarily drive any sort of change in operating income? Or is it flying with these operating leases, the incremental depreciation associated with the Amazon flying? Just trying to think through that.

[Spencer Schwartz:]

Sure, Jack. You're absolutely right. Fuel, clearly, has an impact. As fuel increases, it really doesn't impact our bottom line very much, doesn't impact cash flows, but does have an impact on margins. So, there is – you certainly see that impact in our charter business. And there are other little things that impact it. There are times when we have bill-backs to customers for various things. And sometimes, instead of having bill back that way, sometimes we'll increase the revenue that we receive from the customer, and then we don't have to bill them back for every little thing, and that impacts margins, but really has no impact on the bottom line. So, there are things like that that impact margins to some extent, but not materially. So, some of that may be bleeding into the calculations as well.

[Jack Atkins:]

Okay. Okay. Thank you for that, Spencer. And then, the last one for me. Just on cash flow, it seems like this year, if I heard your comments correctly, around CapEx, it doesn't sound like you guys have a large CapEx requirement this year. When you combine your maintenance CapEx with potential fleet additions, given that you're doing it really in an off-balance sheet way this year. So, when we think about sort of your true free cash flow this year, is it right to think that you guys could be generating $100 million to $150 million in free cash flow? And if so, sort of what would be the priority be for that cash?

[Spencer Schwartz:]

Sure. I always look at free cash flow – I think I look at it a little differently from some others. But, for us, we look at our operating cash flows less our core capital expenditures, and that's how we calculate the free cash flow. And then, how we utilize that cash flow, we may use that cash flow for incremental capacity or to purchase aircraft or engines or those types of things. So, we look at it, I think, a little differently. For the full year of 2017, free cash flow was about $237 million, something like a 30% increase over the prior year. And the good thing about that is it's mainly driven by operating cash flows, which is great. For 2018, we expect to continue to see operating cash flows increase. We talked about the increase in core capital expenditures, but free cash flow, we think, should increase. With regard to capital allocation, I think we've been incredibly balanced with regard to our capital allocation strategy. We continue to focus on ensuring that we have a strong balance sheet. We want to continue to invest in the business and make sure that we have the assets that customers want. And as you know, from 2013 through 2015, we bought back 10% of the company through share repurchases. Those shares have appreciated nearly 40% since that time. 2015 through 2017, we acquired Southern Air, we acquired and converted 20 aircraft to support the Amazon ramp up. We acquired a tenth dash-8 and on and on. And we've improved our balance sheet. So, we've been really balanced. It's been an approach that we believe has worked quite well. And I would expect more of the same as we move forward.

[Jack Atkins:]

Okay, great. Thank you for that color, Spencer.

[Spencer Schwartz:]

Thank you.

[William Flynn:]

Heidi?

[Operator:]

You have a question from the line of Scott Group with Wolfe Research. Your line is open.

[Scott Group:]

Hey, guys. Thanks for the quick follow-up. Just – one last just thing on the fleet. So, if I look in fourth quarter, the less dash-8s in ACMI and more in charter, was that just a seasonal fourth-quarter thing. Was there any change there? I'm just looking at aircraft equivalent. And the dash-8s are 8.7 equivalent in fourth quarter, I think, and like 9.5 in the third.

[Spencer Schwartz:]

I think it was just that we had aircraft that moved from charter to ACMI, and so it's just the impact of that. We placed two dash-8s, as you know, with Cathay Pacific. And so, I think it's just the timing of that movement.

[Scott Group:]

Okay, helpful. Thank you, guys.

[Spencer Schwartz:]

Thank you.

[Operator:]

There are no further questions at this time. I will now turn the call back over to the presenters.

[William Flynn:]

Okay. Well, thank you, Heidi. Spencer and I would like to thank all of you for sharing your time with us today, your interest in our company and certainly your questions. And we look forward to speaking with you all again soon. Thank you.

[Operator:]

This concludes today's conference call. You may now disconnect.