Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

Good morning. My name is Carol, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 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. Presenters at Atlas Air, you may begin your conference.

[Ed McGarvey:]

Thank you, Carol, and good morning everyone. I am Ed McGarvey, Vice President and Treasurer for Atlas Air Worldwide. Welcome to our third quarter 2015 results conference call. Today's call will be hosted by Bill Flynn, our President and Chief Executive Officer. Joining Bill is Spencer Schwartz, our Executive Vice President and Chief Financial Officer. As a reminder, today's call is complemented by a slide presentation that accompanies our remarks. If you have not already downloaded and printed a copy of our press release and slides, you may do so from our web site at atlasair.com. You may find the slides by clicking on the link to Presentations in the Investor Information section of the web site. As indicated on slide 2, we'd like to remind you that our discussion about the company's performance today include 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 the risk factors related to our business, please refer to our 2014 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. You can also find these on our web site at atlasair.com. During our question-and-answer period today, we'd like to ask participants to limit themselves to one principal question and one follow-up question, so that we may accommodate as many participants as possible. After we've gone through the queue, we'll be happy to answer any additional questions that you may have as time permits. At this point, I'd like to turn the call over to Bill Flynn.

[Bill Flynn:]

Thank you, Ed, and good morning everyone, and thank you for joining us today. Starting with slide 3, we are looking to a strong finish to a strong year in 2015. In line with our earnings framework, we expect to deliver significant growth in our full year adjusted EPS, and we are going into 2016 with a stronger balance sheet and a great portfolio of customers. We continue to see good demand for our aircraft and services, and we have pointed out before, many of our customers are outperforming the overall market. Our adjusted EPS in the third quarter totaled $1.23; that's up 12% compared with the third quarter of last year. Both our third quarter earnings and our outlook highlight, the impact of the initiatives we have taken to enhance our business mix, and our ability to leverage the scale and efficiencies in our operations. ACMI earnings during the quarter reflected increase in aircraft and block hour volumes. They also reflected higher crew training costs associated with our fleet growth initiatives. ACMI results were complemented by a sharp increase in charter contribution and the underlying strength in our dry leasing business. Charter earnings were driven by an improvement in yields, excluding fuel, and an increase in aircraft utilization. These are a product of our diversified global network, quality of service and ability to meet the differing needs of a wide variety of commercial charter customers. During the quarter, we used a portion of the proceeds from our convertible debt offering in June, to refinance higher finance EETC debt. This resulted in a charge for the early extinguishment of debt, which was primarily responsible for our reported net loss in the third quarter. As we have discussed previously, the benefits from this refinancing are significant, and will substantially improve our financial and operating flexibility. And so will our refinancing of term loans for two of our original 747-8s in late October, at substantially lower rates. Spencer will have more about the benefit of these transactions in his comments. During the quarter, we also acquired 1.7% of our outstanding common stock. Reflecting our commitment to shareholder value, we have now bought back more than 10% of our outstanding shares over the past three years. We have a remaining authority to repurchase up to $25 billion of our shares, and we will manage that authority with our desire to maintain a strong balance sheet and to invest in our business for the future. Moving to slide 4, we expect air freight to grow at a reasonable rate in 2015. As I audit reported yesterday, international air traffic, measured in freight ton kilometers, has grown at a 2.7% rate in the nine months through September. We anticipate a solid peak season, with a pickup in volumes and yields, driven by end of year air freight demand, supported by continued e-commerce growth. Slide 5 focuses on our framework for 2015. We are encouraged by our strong year-to-date performance. We are seeing good demand for our aircraft and services and we continue to anticipate significant growth in adjusted EPS this year. With a superior fleet and a diversified global network, we are well positioned for the peak season and for a typical sequential increase in our earnings in the fourth quarter. Consistent with our prior outlook, we expect adjusted fully diluted earnings per share of slightly over $1.50 for the quarter. Adjusted pre-tax earnings in the fourth quarter should increase, compared with the fourth quarter of 2014. We expect tax expense to be significantly higher than last year, due to a benefit of approximately $0.20 per share in 2014, primarily related to our Titan dry leasing business. In line with our prior outlook for 2015, we anticipate that our block hour volumes this year will increase approximately 10% compared with 2014, with more than 70% of the total in ACMI and the balance in charter. Our ACMI outlook reflects expected growth in both 747 freighter operations as well as CMI flying. Our charter outlook reflects the strong presence we have in the global charter market, and military demand that continues to hold up well, compared with 2014 levels. It also reflects the new 747-8 aircraft that joined our fleet today. We will use it charter for the peak season, then we expect it to be in ACMI in 2016. In dry leasing, our portfolio is expected to include two 767 converted freighters, one that will join the fleet in December, and one that will join in the first quarter of 2016. We will also begin CMI flying lease aircraft when they enter the fleet, so they will benefit the ACMI segment as well. Given expected flying levels, we continue to anticipate that aircraft maintenance expense will total approximately $190 million this year. In addition, depreciation expense should be approximately $130 million, while core capital expenditures, which are mainly for spare parts for our fleet, should total approximately $45 million for the year. Expenditure for aircraft and engines, including our new -8, the 767s we are converting and several engines are expected to be around $225 million. This is a good point to ask Spencer to provide you with some additional perspective on our third quarter. After Spencer, I will provide a few more thoughts, and then we will be happy to take your questions. Spencer?

[Spencer Schwartz:]

Thank you, Bill, and hello everyone. Slide 6 highlights our third quarter results. Our adjusted net income totaled $30.7 million or $1.23 per share. Earnings in the third quarter were driven by our diverse business mix, including a sharp increase in charter segment contribution, and underlying strength in dry leasing. On a reported basis, results during the period reflected a net loss of $12.8 million or $0.51 per share, primarily due to a charge on the early extinguishment of debt, following the refinancing of higher cost debt with lower cost debt, which Bill noted, and I will talk about more in a moment. During the quarter, we generated free cash flow of more than $82 million or $3.33 per share, compared with $55 million or $2.17 per share last year. That brought free cash flow for the nine months of 2015 to $231 million or $9.27 per share, a large increase from $151 million or $5.98 per share in the first nine months of 2014. Reported results in the third quarter, also included an effective income tax rate benefit of 49.3%. That reflects the favorable resolution of an IRS exam, as well as our continued reinvestment of net earnings of certain foreign subsidiaries, outside of United States. Based on our current tax framework, we do not expect to pay any significant federal income tax until 2020 or later. Looking at slide 7; ACMI revenues during the quarter benefited from an increase in a number of aircraft compared with the third quarter of 2014. This impact was partially offset by a lower blended average rate per block hour, which reflected a mix effect, related to increases in 747-400 ACMI and 767 CMI flying. Average 747 cargo equivalents during the quarter rose 12% to 21.8 aircraft, while CMI aircraft equivalents increased 33% to 15.9 aircrafts. We expect to grow our CMI fleet, and enhance our business mix. Since we don't own these aircraft, the average block hour rate for these planes is less than the average rate for our other aircraft in the segment. The change in charter segment revenues in the third quarter was primarily driven by the impact of lower fuel prices. This impact was partially offset by an improvement in yields, excluding fuel. In dry leasing, revenues reflected a reduction in the number of segment aircraft, following our sale of a 737-800 passenger aircraft in the first quarter of this year. Looking ahead, dry leasing revenue should grow, with the two 767s that we will be adding to our portfolio. Moving to slide 8; segment contribution totaled $84 million in the third quarter, compared with $80 million in the third quarter of last year. ACMI results were affected by an increase in crew training costs, as we hired additional pilots, in connection with our fleet growth initiatives, and by higher maintenance expense. These were partially offset by a reduction in aircraft ownership costs, following the refinancing of higher cost debt related to several of our 747-400 cargo aircraft. Charter's strong contribution, was driven by an improvement in yields excluding fuel, higher aircraft utilization, and a reduction in aircraft ownership costs. Results in dry leasing reflected the sales of the 737-800 passenger aircraft that I previously noted. Turning to slide 9, and our balance sheet; we ended the third quarter of 2015 with cash, including cash equivalents, restricted cash and short term investments, totaling $390 million. That compared with $331 million at the end of last year. Our cash position at September 30, reflected net cash of $266 million provided by operating activities during the first nine months of 2015. Net cash of $182 million used for financing activities, which included $334 million of outflows for debt payments, as well as $20 million for share repurchases, and net cash of $6 million used for investing activities. Net cash used for investing activities in the first nine months of 2015, primarily related to the purchase of aircraft and engines, including our new -8, as well as ratable spare parts. These were partly offset by proceeds from investments and from the disposition of aircraft. Slide 10 highlights our recent refinancings of higher cost debt. During the quarter, we used approximately $113 million from our issuance of $224.5 million of convertible senior notes at 2.25% in June, to retire higher rate, enhanced equipment trust certificates related to five of our 747-400 freighters. The WTCs had a weighted average cash coupon of 8.1%. In addition to reducing our cost of debt, the refinancing reduces aircraft ownership costs, increases fleet flexibility and enhances cash flows. It's also immediately accretive to adjusted earnings per share beginning in the third quarter, which is being incorporated in our framework for the year. We expect similar benefits from the refinancing at higher rate debt, on two of the original 747-8s delivered to us in 2011. In October, we entered into new term loans that reduced the rates on those aircraft by 284 basis points, from 6.37% to 3.53%. As part of our effort, we will refinance only the remaining outstanding principal on these aircraft, and all other items remain the same. Slide 11 shows that at the end of the third quarter, our net leverage ratio, which includes capitalized rents was 4.8 times trailing 12 month EBITDA. That includes the benefit of our remaining investment in our outstanding WTCs. That's down from six times at the beginning of last year and 5.4 times at December 31st, primarily driven by the paydown of outstanding debt and an increase in earnings. In connection with the delivery of our new -8s, we have borrowed $125 million under a 12 year term loan, which will not have a significant impact on our leverage. With that, I would like to turn it back to Bill.

[Bill Flynn:]

Thank you, Spencer. As I noted at the start and as reflected on slide 12, we are looking forward to a strong finish to a strong year in 2015. In line with our earnings framework, we expect significant growth in adjusted earnings per share in 2015, and with a stronger fleet, a stronger balance sheet, and a great portfolio of customers, we are confident about our business as we look to 2016. We continue to see good demand for our aircraft and services. We have a strong and dedicated team, and we are well prepared to leverage our competencies and market leadership, to capitalize on market opportunities and to continue our focus on longer term business growth. With that operator, may we have the first question please?

[Operator:]

Certainly. [Operator Instructions]. Your first question comes from the line of Jack Atkins from Stephens. Your line is open.

[Jack Atkins:]

Good morning guys and thanks for taking my questions.

[Bill Flynn:]

Hey Jack.

[Jack Atkins:]

You know, I guess if we could maybe start off with the ACMI segment, the direct contribution profit was a little bit softer there? You were, I think, down 13%, block hours were up 14% though. It sounds like you guys had some additional costs, as you were ramping the new aircraft. Could you maybe walk us through the puts and takes there, what was sort of going on in ACMI in the quarter, and would you expect that to continue?

[Spencer Schwartz:]

Sure Jack. It's Spencer. We think it's important. When you look at ACMI, that you can't really look at any one particular quarter, and make a determination about that segment. ACMI earnings are influenced by customer flying levels, the timing of when maintenance is required, crew costs including training and placements, etcetera. It's important, I think, to point out as you asked, and we expect both a sequential increase in ACMI direct contribution in the fourth quarter of this year, as well as an increase over the fourth quarter of the prior year. So we don't expect this trend to continue, I think is the important point. Crew training, as you pointed out Jack, you are exactly right. We have been growing our ACMI segment, as you know, and in order to achieve that growth, we needed to add more crew and so therefore, we incurred some crew training costs, generally at a short period of time, to catch that up. And so once operations start, there is crew training that's required. And so we saw the impact of that on ACMI. We also saw an increase in maintenance expense in the third quarter versus the third quarter of last year. So those things had an impact. But again, that happens from time to time. We don't expect that to continue.

[Jack Atkins:]

Okay, okay. Spencer, thank you for that additional color there. And then, Bill, you noted in your prepared comments, it was also interest he presentation, that you are confident about 2016. I guess, could you maybe give us a little bit more color on what that means for the directionality of earnings? There are some puts and takes this year. You had a very strong first quarter because of the West Coast ports, and then you have got planes coming in, at the back half of this year, which should be a bit of [indiscernible] for next year as well, interest expense. Could you may be walk us through some of the puts and takes which could be driving earnings next year?

[Bill Flynn:]

Yeah. Well thank you, Jack. So in terms of, kind of the detailed color that I think you are asking for, we will provide that on our full year earnings call, when we report in February. But a couple of things, I think its important first of all to step back and think about the model, and I will build on the comments that Spencer just described in the ACMI question you had. So our core business is ACMI, 70% of our flying -- ACMI and CMI. As we look forward, we think there are good opportunities to grow ACMI and CMI and that model performs very well and has performed well for us. If you take a look at our charter contribution in this quarter, there was a lot of negative sentiment about market yet. We had a very strong charter performance this year, in that market. And so I think, it should tell a story that we are able to take our assets, put them to work, identify the customers, build on solid long term relationships with the key freight forwarders and charter brokers, and drive a good solid result in charter. And then as you look to dry leasing, that has that annuity like performance to it. So our confidence really stems from that, Jack, that we have the right assets, that we can move our assets between ACMI and charter, as it makes sense, that we have a stronger fleet, we have that new -8, we have more CMI operations as we will take on two more at the end of the year, and as I said, there is growth available to us in both. And if they are the right opportunities in our Titan dry leasing business, we will do those. So I think it’s the platform we have built, the impact of the scale and efficiencies that we have, and as Spencer talked, there certainly is going to be the benefit of the lower financing costs, given the recent transactions that we have been able to enter into.

[Jack Atkins:]

Okay. Thanks again for the color and I will jump back in queue.

[Bill Flynn:]

Thank you.

[Operator:]

Your next question comes from the line of Helane Becker from Cowen. Your line is open.

[Helane Becker:]

Thanks very much operator. Hi guys. Thank you very much for the time. So my question is really with respect to -- on the peak shipping season, because you guys -- and maybe you just answered this. You guys seem to be seeing better results than your peer group, and I am just wondering if that's the strength of the fleet specifically, or how you are outperforming everybody else?

[Bill Flynn:]

Well, thank you Helane. So a couple of things; when we look at the charter market, revenues appear somewhat off compared to prior year, but we really need to think about fuel, because there is an offset in fuel as Spencer talked about. So far this year, when we net out that fuel difference in our charter business, we are seeing rates that are equal to or slightly better than prior year. So the question then is, as you are looking forward into the fourth quarter is, what's our sense of how that's going to be in the fourth quarter. We are now into November, and so we have October behind us. And where we are, with our charter fleet, with our charter customers, we are essentially sold out for the year. We have reserved some capacity that we -- we feel confident we can sell, but we wanted to see how much more yields might be out there, available to us coming in through OCTOBER, our net yield, 2015 over 2014 is, equal to or better than. So we think we are well positioned for this peak. And if like anything, as we have talked about our portfolio of customers, if certainly our ACMI and CMI customers, but it's also our freight forwarded and charter broker customers. We have program charters in place, we have long term relationships with them, and so we are -- you saw the numbers that we talked about we are looking to, slightly better than $1.54 for the quarter, and somewhat in the face of that $0.20 tax headwind expense we talked about.

[Helane Becker:]

Right. Okay. Thank you. And then I just had one other question; with respect to pilot crew training; so is that behind you now, so that headwinds will be there in the fourth quarter, or does that still continue into next year?

[Bill Flynn:]

So you know, we always do recurrent pilot trainings, so our pilots come back to the school house, for their currency [ph]. But in this context, we have had to hire increased pilot work force, because we have taken on more aircraft. We had a hire in advance of the delivery of the -8, we need to hire in advance and train in the context of the two 767 CMIs, and we have been operating at a higher ops tempo or higher daily utilization than we had before. And so, we needed to hire additional pilots for our existing fleet, over and above the ones that are -- the deliveries, just because of the higher ops tempo that we are experiencing in the fleet. And that can be lumpy, when the aircraft come in, as three aircraft are coming in roughly about the same time, that's a bit lumpy, and so did have to bump up crew training. But that will normalize going forward.

[Helane Becker:]

Okay. Great. Okay, well thank you for your help. I appreciate it.

[Bill Flynn:]

Thank you, Helane.

[Operator:]

Your next question comes from the line of Scott Group from Wolfe Research. Your line is open.

[Scott Group:]

Yeah hi. Thanks. Good morning guys.

[Bill Flynn:]

Good morning Scott.

[Scott Group:]

So I know you gave some initial kind of color, about 2016, but so I wanted to ask you a couple of other additional items. Any initial view on how we should think about maintenance expense next year, just given the bigger fleet? And then, when do you think is a realistic timeline to have the -8 placed in an ACMI service?

[Spencer Schwartz:]

Sure Scott. So with regard to 2016, as Bill said, we will provide a more detailed outlook and framework as we typically do during our February call. At this time of the year, we are still going through finalizing everything for 2016. So we are not in a position yet to talk about maintenance for next year, that is obviously one of the big variables for next year. But as Bill pointed out, we are confident about 2016. We will have an additional -8. We will have two more 76es, we will have lower financing costs, we added a 747-400 during the year, so we will have a full year of that next year. So we are feeling good, as we go into 2016. So I haven't really answered your maintenance question; we need to do that during our February call. And the second part of your question, I am sorry, was?

[Scott Group:]

Just when you expect to have the -8 in ACMI?

[Spencer Schwartz:]

Sure. Sorry. So the -8, we took delivery today, and so that -8 will operate for us in our charter segment initially. And there aren't many -8s operating the way we do in our charter segment, so that aircraft does really well for us. So we are excited about placing that -8 in charter. We will take advantage of that. We expect longer term, that the aircraft, some time during 2016, will replace in ACMI. But we are not a lot concerned about it. Its going to do really well in charter, and then it will find a home, like all of our other -8s, all nine of them placed very profitably with long term customers in ACMI, so will this [ph] -8.

[Scott Group:]

Okay, perfect. And just last question, just want to make sure I understand the commentary on the fourth quarter guidance. So ACMI profitability should be improved year-over-year. Charter, it sounds like -- with yields that are flat to up ex fuel and just lower fuel; charter contribution should be positive year-over-year, and we have the lower interest expense and kind of the only offset there is just the higher tax rate. Are there any other kind of big moving parts we should be thinking about, that explains kind of the slight drop in earnings that you guys are talking about? Is it just a tax rate, or is there anything else there?

[Spencer Schwartz:]

Sure. Good question. As Bill talked about earlier, we expect pre-tax income will be greater in the fourth quarter of this year than the fourth quarter of last year. So all of our segments -- the earnings should be improved over the prior year, so on a pre-tax basis. So that's a thing to focus on, that's a great thing. We expect ACMI will be up, as I said, I agree with you. We expect to see charter up; dry leasing, it will be pretty similar, but perhaps could be slightly up. We have the $0.20 tax item that we have talked about, and that really relates to a benefit that we recorded in the fourth quarter of last year, related to our Titan dry leasing business. We got a lower tax rate in Singapore, it went from 17% to 10%, and so that was kind of a one time benefit to catch up with that rate. We obviously won't be seeing that in the fourth quarter of this year. I think that the key things for the fourth quarter of this year is, last year during the fourth quarter, we had a bit of an impact from the start of the West Coast disruption, so prices were starting to increase, as a result of that. Maintenance expense should be lower in the fourth quarter of this year. We expect that volumes should be up during the fourth quarter of this year, and we are placing the 10th -8 in service, and we have the additional 400 that we talked about. Fuel decreased towards the end of the last year, but is decreasing during the fourth quarter of this year as well. And so, you sort of put all that together. Pre-tax income we think will be higher. We certainly expect pre-tax income will be higher. We are harmed a bit by the tax benefit that we enjoyed in the fourth quarter last year.

[Scott Group:]

Okay. Thank you guys.

[Spencer Schwartz:]

Thank you.

[Bill Flynn:]

Thank you.

[Operator:]

Your next question comes from the line of Bob Labick from CJS Securities. Your line is open.

[Bob Labick:]

Good morning.

[Bill Flynn:]

Welcome back Bob.

[Bob Labick:]

Thanks. Happy to be back. Wanted to focus a little on ACMI; you mentioned earlier that revenue for block hour was shifted by a mix towards CMI, which obviously helps return on assets and things like that. But just on a going forward basis, can you give us a sense of -- is this the normal mix going forward, or how should we think about revenue per block hour as additional fleet moves happen over the next few quarters?

[Bill Flynn:]

Sure Bob. Looking at the rate per block hour during the third quarter; as you said, there was a change in mix. We had increased CMI flying. Our aircraft equivalents were up, 4 aircraft over 30% above the third quarter of 2014. So we went from a little over 12 to a little over 16. We have been growing our CMI business, which naturally, has a lower rate per block hour, because we don't own the aircraft. We continued to grow that, and the rate per block hour is also highest for -8s. So in periods when we had more -8s than other smaller aircraft type, the rate per block hour generally goes up, than in periods when we had more 400s and 767s. In periods when more of those were added to ACMI, the rate per block hour generally goes down. So it really is -- it’s a mix effect and it depends what's happening during any particular quarter. We are not all that concerned about it, because we understand the mix impact. But I know its something that you all look at. But again, we are adding four aircraft, growing our CMI business by 30% in a particular quarter, that's something we expect to see.

[Bob Labick:]

Okay. Great. And then just maybe shifting to capital allocation; obviously you bought some stock during the quarter, you have some very substantial free cash flow. Can you talk about medium term capital allocation goals, and the balance between repurchases, more aircraft, and then the desire to continue to grow CMI at the same time? Which doesn't require as much capital?

[Spencer Schwartz:]

So when it comes to capital allocation, Bob, we try very hard to have a balanced approach. Our cash prioritization continues to be three primary areas. We want to maintain a strong balance sheet and have a strong cash balance. We want to continue to invest in assets that our customers want, that are modern efficient aircraft that our customers want, and then we also want to be able to return capital to our shareholders. So we have really been focused on trying to do all of those, and we know it's very difficult to please everyone. But we have been trying to do all those things. Our cash balance is very-very strong. We have been paying off debt, and so our net leverage ratio has been declining. We have recently purchased, we just added a -8 today. We are adding two 767s, that will soon come out of conversion. We continue to look at additional other aircraft, if they make sense, for our business, and as we talked about and as you just said, we have repurchased over 10% of our company back in the last few years. So from our viewpoint, we think we are being very balanced when it comes to capital allocation.

[Bob Labick:]

Great. All right. Thank you.

[Bill Flynn:]

Thank you.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Jack Atkins from Stephens. Your line is open.

[Jack Atkins:]

Great. Thanks for taking my follow-up guys. I was curious about the military business and your outlook for that over the next 12 months, and the new military fiscal year just started. Can you give us some insight into your expectations there?

[Bill Flynn:]

Yeah sure Jack. This is Bill. So as we talked about at the -- I guess, one or two of the calls before that we saw military demand stabilizing, and that's essentially as we see it today, the hours of share [ph] will meet our expectations, which is a high rate of flying, than we had in 2014. And we think the level that we are at now, in 2015, will continue through 2016 at least.

[Jack Atkins:]

Okay. Okay Bill. Thank you for that. And then just on the housekeeping side, Spencer, what exactly should we be modeling for a tax rate in the fourth quarter, just so we have that number?

[Spencer Schwartz:]

I can give you the -- what we expect for the full year?

[Jack Atkins:]

Well just -- what's assumed in the fourth quarter guidance, I guess?

[Spencer Schwartz:]

I don't have that on my fingertips. For the full year on adjusted basis, we expect a 28% tax rate. You could back in or I could back in for the fourth quarter --

[Jack Atkins:]

No, that's fine. We can back into that, that's fine. And then, in the dry leasing business, it looks like with the 767s, you are going to have dry lease through Titan, and then you are going to have the CMI and the ACMI segment. Why kind of break it out that way, versus having it all just in the ACMI segment, what you guys do for the 747s?

[Bill Flynn:]

Sure. Thanks Jack. So two things, it’s a point to bear in mind, of the two that are delivering, one will be fairly late December and one will be January. So in terms of the impact, the majority of that impact or that impact really is a 2016 level.

[Jack Atkins:]

Sure.

[Bill Flynn:]

The reason we have bifurcated the two here, is because they are two different contracts. And the contract on the aircraft in Titan is much longer term, and the CMI is a shorter term contract.

[Jack Atkins:]

Okay. Makes sense. Thanks again for the time guys.

[Bill Flynn:]

Thank you, Jack.

[Operator:]

Your next question comes from the line of Scott Group from Wolfe Research. Your line is open.

[Scott Group:]

Hey guys. Thanks also for taking the follow-up. Just a couple of things Spencer, just sort of model. With the latest round of financing, how should we think about interest expense and the capitalized interest lines going forward?

[Spencer Schwartz:]

Sure Scott. Well capitalized interest, we really don't have very much of that any more, and so that's very-very minimal. I mean, there is a tiny amount here and there, sometimes for capitalized engines and that sort of thing. But otherwise, that's really gone away. It was a much bigger item when we had the big -8 order coming. But with regard to interest expense and interest income, we paid down higher yielding debt, about $155 million that had an effective interest rate. A book interest rate of about 13%, a cash coupon rate of about 8%, and so basically, that interest goes away, which is terrific. We took on the convertible, and so that's $224.5 million that has a rate of 2.25%, and so we will add that interest expense. And then the pass-through certificates that we had, so some of those got paid off, as a result of us paying off the EETCs, and that was approximately $90 million, and so we lose that interest income. And so, all of that sort of nets to approximately, for 2016, about an $0.18 benefit to earnings, after tax.

[Scott Group:]

Okay.

[Bill Flynn:]

We can take that later if you'd like --

[Scott Group:]

No, no, that's helpful. Okay. Under the military question that Jack just asked, did your team share change at all in the new fiscal year?

[Bill Flynn:]

So we are actually not in the new fiscal year yet. Even though, we are -- even though you would think we are the -- the FY 2015 contract was extended through the end of this calendar year Scott. So the FY 2016 military contracts, only going to be nine months, Jan 1 to October 30, and that has to do with some different considerations that the military had. We are at about a 58% entitlement for both cargo and pack, so that's pretty stable to where we were. That hasn't really moved very much this year, nor next. But it did 2014 into 2015.

[Scott Group:]

Okay. Perfect. And then lastly is -- as we think about 2016, is that a normal year from a - just typical placement in ACMI or higher than normal, lower than normal?

[Bill Flynn:]

It’s a normal year Scott.

[Scott Group:]

Okay, perfect. Thank you guys.

[Bill Flynn:]

Thank you.

[Operator:]

Your next question comes from the line of Nathan Hong for Morgan Stanley. Your line is open.

[Nathan Hong:]

Hi guys. Thanks for taking the question. I kind of just wanted to ask you about Asia, I guess, more specifically on China. Clearly, I think we are still seeing growth in the region, though of course at a slower pace. And so I am wondering, how Atlas is positioned from that perspective? Can you actually talk about, if there has been any changes as to how you are flying across your network, in response to the slower growth out of Asia?

[Bill Flynn:]

So a couple of things; in terms of our ACMI customers, because that's their networks; their networks continue to operate, as they think makes best sense for them. DHL, our largest customer, has increased its capacity in and out of China, increased its capacity on ACMI operation that we operate for them, in both trans-Pacific and into Asia, and DHL continues to have very strong volume and earnings growth and [indiscernible], and I am sure they will talk about that, when they provide their next call. Qantas has talked about growth in their cargo business, and we operate a trans-Pacific network for Qantas, from the U.S. into Australia, north to China, then trans-Pacific eastbound network for them. Etihad has talked about growth in their business, and their business and the networks that we fly for them under ACMI certainly include Hong Kong and China. And BST, who is a Chinese freight forwarder, and for whom we operated -8, while not publicly traded is certainly growing, and expects to continue to do so in this export-led economy. Our charter growth in this quarter -- our third quarter charter growth, our military contribution was stable year-over-year, and so the growth in charter was commercial, and that was predominantly Asia; and when we say Asia, we mean Hong Kong and China, for the most part. So I think we are very well positioned. We are positioned with our ACMI customers. While some are public and they talk about what they are doing and how they are growing and how they are positioning, and then of course, our charter numbers are not exclusively in and out of Hong Kong and China, but largely, because that's where the largest freight market is.

[Nathan Hong:]

That's great color. And maybe for Spencer, just a quick question on your leverage ratio. Obviously, you guys have done a great job at taking that down over the years. I am just wondering, if you could give us your updated thoughts on where you think leverage can kind of go going forward, and whether or not, you guys have a target out there? Thanks.

[Spencer Schwartz:]

Sure Nate. So I guess, perhaps selfishly, I just want to point out that not all debt is created equal. And so -- in looking at our debt, its really-really low rate debt. It's generally collateralized by a modern efficient aircraft, and so, I understand that we all -- sort of financial people, are focused on these things. But just want to point out, our -8 are financed; all ten of them have a combined rate of about 2.8%. That's a debt that you and I would take any day of the week. That we continue to unencumber our 747-400s, as you know, with the big paydown. We took on 2.25% debt to do that, I think that's really a very smart transaction, and so I stand behind that. So I realize, it’s a little selfish and biased, but not all debt is created the same, and we have continued to lower our net leverage ratio. So for us, it really depends on what makes sense for the business. We will take on additional aircraft, we will take on debt associated with additional aircraft, when and if it makes sense for our business, and when we think that there is an appropriate business case to take on the additional aircraft. We have been very fortunate that the financing markets really understand the strength and the quality of our business and our earnings and the credit that we are. I think that shows through, and all the recent financings that we have done. So we are comfortable with our leverage, and we look at it on a plane by plane basis. We don't have kind of a target. We look at it on an acquisition by acquisition basis. We look at the NPV and the IRR for a particular aircraft. Will be accretive to EPS. Who is the customer? Is it a good investment, and does it contribute towards our overall strategic goals? And those are the kinds of things that we look at. I know it’s a long winded answer, but we don't have a sort of specific target.

[Nathan Hong:]

Okay, that's great color. Definitely appreciate your time. Thanks.

[Spencer Schwartz:]

Thank you.

[Operator:]

Your next question comes from the line of David Campbell from Thompson Davis and Company. Your line is open.

[David Campbell:]

Hi Spencer, Bill. I am a little behind, because I was late getting on the call, and then I got disconnected. Also, I have been on and off the call. I was just wondering -- there is a couple of things I wanted to know, first of all how the seasonal peak in your opinion, is it as strong as a year ago, beginning in late September?

[Bill Flynn:]

So we are definitely in peak season, David, and we talk a bit about yields leading up to kind of where we are now. Early on the call, maybe you heard it or not. But when we strip out the fuel impact, the yields that we have been experiencing, so far, are equal to or better than last year. That's Atlas, that's what we are talking about. We expect that to continue through the balance of the peak for Atlas. There is a peak. We are certainly experiencing a peak. Others may not or haven't felt it yet, but we are. And net of fuel, we are seeing yields at equal to or better. Maybe a little bit of tapering at December, and that tapering on a year-over-year basis, would only be a result of that -- when the west coast port stoppages first started to be felt, and fueled with dropping, as a result of that, yields were a bit higher I think. But overall, we are in peak, and that's informed the kind of earnings framework of slightly better than $1.50 that we have put out there.

[David Campbell:]

The $1.50 includes a higher tax rate, which is -- what's the tax rate expected in the fourth quarter?

[Spencer Schwartz:]

Sorry David. I don't know -- I think someone else asked the same question. I will tell you the adjusted tax rate that we expect for the full year is about 28% for the full year.

[David Campbell:]

28%? Okay.

[Bill Flynn:]

I think on a quarter-over-quarter basis, you have talked about a $0.20 per share benefit that we had in Titan last year. So that's part of that tax headwind.

[David Campbell:]

And I take that you are getting a new -8, is that an -8 -- that you bought from somebody else?

[Bill Flynn:]

No. That's a new -8 that delivered this morning from Boeing.

[David Campbell:]

And that's going -- that's in ACMI?

[Bill Flynn:]

We said that -- we are putting it in at the charter right now; because very strong yields. We are going -- we will end up with [ph] very strong yields on that -8 in charter. And then next year, we will put it into ACMI, as we have all of the other nine aircraft. And the [indiscernible] here is to use it in charter right now.

[David Campbell:]

Sure. This is the time to use. Definitely the time to use it now. Okay. And that's a very good use of the plane. And Spencer, you mentioned something that I missed, if you could run, $250 million of new debt -- new convertible debt. Is it -- I must have misunderstood that?

[Spencer Schwartz:]

Yeah David, in June, we issued $224.5 million of convertible debt, 2.25%. We will use the vast majority of the proceeds of that issuance to pay down EETC debt. We refinanced 8.1% debt with 2.25% debt.

[David Campbell:]

I remember that now. I remember that. What is the -- can you give me the estimated interest expense for the fourth quarter?

[Spencer Schwartz:]

I took Scott Group earlier through that map. I can take you through it later. I don't want to take everyone's time on that. But I went through the puts and takes earlier with Scott.

[David Campbell:]

Okay. I was in and out of the conference call.

[Spencer Schwartz:]

That's okay. I could deal with you later.

[David Campbell:]

I am going to let somebody else have it. Thank you.

[Bill Flynn:]

Thank you, David.

[Spencer Schwartz:]

Thanks David. Hope you are feeling better.

[David Campbell:]

I am feeling better. Thank you very much.

[Operator:]

Your next question comes from the line of Steve O'Hara from Sidoti and Company. Your line is open.

[Steve O'Hara:]

Hi. Good morning.

[Bill Flynn:]

Good morning Steve.

[Steve O'Hara:]

I am joining the call late as well, so if somebody has asked this already, I apologize. But just maybe on the free cash flow outlook for 2016, based on deliveries you have currently planned, it would seem, I believe which is minimal at this point, besides from maybe the 767, but I think that was actually purchased. What -- I mean, it would seem like you have a pretty good free cash flow run rate going into 2016, even if you have, maybe a tougher comp in 2015. Is that kind of the right way to think about it?

[Bill Flynn:]

Sure. We will obviously talk more about 2016 during our next earnings call. But the types of things I think that will play into that, if you take a look at our free cash flow for the nine months this year, I mean, its up tremendously as we mentioned earlier over the prior year. Its 9.27 year-to-date versus 5.98 year-to-date this time last year. So its growing tremendously. I think some of the things to think about, as we go into 2016, and we will obviously talk more about it during our next call. Lunar New Year is a bit earlier next year, see what impact that has. We have an additional -8 which we have talked about, we are taking delivery of today, and so we will have a full year of enjoyment with that aircraft next year. We are taking on two 767s that we will have both being dry leased, as well as operating in CMI, so those are additions for next year. We have the lower financing costs that we have talked about. We have brought back a 747-400 during this year, and so that will operate for a full year next year. We don't have the benefit of the West Coast port congestion in 2016, presumably, and we had some tightened return conditions that we enjoyed this year, that presumably we will not have next year. And then maintenance, we will see how that plays out. We are in the process now, as I mentioned earlier. We are in the process now of determining what we think maintenance will look like next year. And so we don't have a number on that yet. So those are the types of things to think about it. I think as we head into next year, when it comes to free cash flow, I think we have been pretty pleased with what we are generating.

[Steve O'Hara:]

Okay. So I mean, it sounds like 2016, let's say headwinds are more or at least, thus far that you are kind of willing to go into or more benefits that happen in 2015 rather than, I guess, issues with 2016.

[Spencer Schwartz:]

Absolutely. Yes. We completely agree with that Steve.

[Steve O'Hara:]

And then just -- I don't know if you talked about this, you did just -- I will wait for the transcript. But on the 747-400s versus the -8s, did you talk about maybe your plans in regards to the fleet flexibility, the newfound fleet flexibility, and maybe your desire over the next few years to transition the fleet? Thank you.

[Bill Flynn:]

Sure Steve. This is Bill. So we are taking the chance. We are really excited to have the aircraft performing very well for us, which means they are performing very well for our customers. Even in a period of much lower fuel costs, frankly that really tees up to -8 very well for our customers. We believe we have growth in our ACMI business, and that means growth with the 747-400 pure [indiscernible]. Over time, if we continue and as we would continue to take on more -8s, there is a inflection point where we would begin to move 400s out of the fleet, if not one for one, if not always an additional add. This flexibility with the EETCs or the convertible debt and the retirement of these EETCs, greatly enhances our ability to do that, where and when it makes sense. And then just another aspect of fleet flexibility we didn't talk about. I think there was some concern when brought back one of our BCFs from parking, and then we shed another BCF, but brought one back at the same time under much more flexible terms. Those have been a key part of driving the results that we have had in our charter segment. BCFs go in the charter. They are very flexible. We could park if we need to. We can return if we want to. But that has been a key part about having that capacity available to us in this quarter, and -- sorry this past quarter the third, this current the third. And we will manage that, and we are flexing our fleet as well. So there is kind of a short term flex around these two BCFs which are very good for charter. And then the mid-term flex around the 400s now that we have addressed the EETC overhang, if we want to call it that. And it gives us just better options to think about the fleet going forward.

[Steve O'Hara:]

Okay. Thank you very much.

[Spencer Schwartz:]

Thank you, Steve

[Operator:]

And presenters, we have no further questions at this time. I will turn the call back to you for any closing remarks.

[Bill Flynn:]

Okay. Well thank you Carol. And Spence and I would like to thank all of you who are on the call today for your interest in our company and for your questions. We very much appreciate you sharing time with us today. And we look forward to speaking with you again soon. Thanks.

[Operator:]

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