Description
Air Transport Services Group Inc. 10% Owner WILLEM MESDAG bought 637,000 shares on 8-15-2012 at $ 4.71
BUSINESS OVERVIEW
Description of Business
The Company has two reportable segments,“ACMI Services" and "CAM." Due to the similarities among the Company's airline operations, the airline operations are aggregated into a single reportable segment, ACMI Services. The Company’s other business operations, including aircraft maintenance and modification services, aircraft part sales, equipment leasing and maintenance and mail handling for the USPS do not constitute reportable segments due to their size. Financial information about our segments and geographical revenues is presented in Note N to the accompanying consolidated financial statements.
CAM
CAM’s fleet consists of Boeing 767, Boeing 757, Boeing 727 and McDonnell Douglas DC-8 aircraft. CAM leases aircraft to ATSG airlines and to external customers, usually under multi-year contracts with a schedule of fixed monthly payments. Under a typical lease arrangement, the customer maintains the aircraft in serviceable condition at its own cost. At the end of the lease term, the customer typically is required to return the aircraft in approximately the same maintenance condition as it was in at the inception of the lease, as measured by airframe and engine time, until the next scheduled maintenance event. CAM examines the credit worthiness of potential customers, their short and long term growth prospects, their financial condition and backing, the experience of their management and the impact of governmental regulation when determining the lease rate that is offered to the customer. In addition, CAM monitors the customer’s business and financial status throughout the term of the lease.
Through CAM, we plan to expand the Company's combined fleet of aircraft. Information about the Company's commitments for aircraft expenditures is included in Note G to the accompanying consolidated financial statements.
ACMI Services
Through the Company's three airline subsidiaries, we provide airline operations to DHL, other airlines, freight forwarders and the U.S. Military. A typical operating agreement requires the ATSG airline to supply, at a specific rate per block hour and/or per month, the aircraft, crew, maintenance and insurance for specified cargo operations, while the customer is responsible for substantially all other aircraft operating expenses, including fuel, landing fees, parking fees and ground and cargo handling expenses. However, some charter agreements, including with the U.S. Military, require the airline to provide full service, including fuel and other operating expenses, in addition to aircraft, crew, maintenance and insurance for a fixed, all-inclusive price.
The Company, through ABX, has had long term contracts with DHL since August 16, 2003. Beginning in August 2003, ABX operated primarily under two commercial agreements with DHL; an aircraft, crew, maintenance and insurance agreement (“DHL ACMI agreement”) and a hub services agreement (“Hub Services agreement”), both of which had become effective in conjunction with DHL's acquisition of Airborne. Under these agreements, ABX and DHL generally operated under a cost-plus pricing structure. ABX provided staff to conduct package sorting, as well as airport, facilities and equipment maintenance services for DHL under the Hub Services agreement. In 2008, DHL began to restructure its U.S. operations due to continued losses. Pursuant to its restructuring plan, DHL discontinued intra-U.S. domestic pickup and delivery services and now provides only international services to and from the U.S. In the third quarter of 2009, ABX ceased all remaining sort operations for DHL and the Hub Services agreement expired. Additionally, in the third quarter of 2009, DHL assumed the management of aircraft fuel services for its U.S. network that were previously provided by ABX.
ABX continued to provide airlift for DHL’s international delivery services in the U.S. through ABX’s Boeing 767 aircraft under the DHL ACMI agreement until March 2010. At that point, the Company and DHL terminated the DHL ACMI agreement and executed new follow-on agreements, effective on March 31, 2010. Under the new agreements, DHL committed to lease 13 Boeing 767 freighter aircraft from CAM. ABX was separately contracted to operate those aircraft for DHL under a five year crew, maintenance and insurance agreement ("CMI agreement"). Since April 1, 2010, ABX's revenues under the CMI Agreement are reported under the ACMI Services segment and the aircraft lease revenues are reported under the CAM segment. As of December 31, 2011, DHL was leasing 13 aircraft from CAM, all of which ABX operates for DHL under the CMI agreement.
ATI provides airlift to the Air Mobility Command ("AMC"), which is organized under the U.S. Military. ATI contracts its unique fleet of McDonnell Douglas DC-8 "combi" aircraft to the AMC. The combi aircraft are capable of carrying passengers and cargo containers on the main flight deck. AMC awards flights to U.S. certificated airlines through annual contracts. For the U.S. Government's fiscal year 2011, AMC awarded ATI three international routes for combi aircraft. These routes are for destinations that are not within the areas of the Middle East conflicts. Additionally, ATI often operates temporary "expansion" routes for the AMC using its McDonnell Douglas DC-8 combi and freighter aircraft.
The Company has limited exposure to fluctuations in the price of aviation fuel under contracts with our customers. DHL, like most of our ACMI customers, procures the aircraft fuel and fueling services necessary for their flights. The charter agreements with the U.S. Military are based on a preset pegged fuel price and include a subsequent true-up to the actual fuel prices within two cents per gallon.
Aircraft Maintenance and Modification Services
The Company provides aircraft maintenance and modification services to other airlines through its ABX and AMES subsidiaries. ABX and AMES have technical expertise related to aircraft modifications as a result of ABX’s long history in aviation. They own many Supplemental Type Certificates (“STCs”). An STC is granted by the FAA and represents an ownership right, similar to an intellectual property right, which authorizes the alteration of an airframe, engine or component. ABX provides digital aircraft manuals for customers in conjunction with the modification of aircraft from passenger to cargo configuration.
AMES operates a Federal Aviation Administration (“FAA”) certificated 145 repair station, in Wilmington, Ohio, including hangars, a component shop and engineering capabilities. AMES is AS9100 quality certified for the aerospace industry. AMES markets its capabilities by identifying aviation-related maintenance and modification opportunities and matching them to its capabilities. AMES’ marketable capabilities include the installation of avionics systems and flat panel displays for Boeing 757 and Boeing 767 cockpits. The flat panel display modernizes aircraft avionics equipment and reduces maintenance costs by combining multiple display units into a single instrumentation panel. AMES has the capability to perform line maintenance and airframe maintenance on McDonnell Douglas DC-9, MD-80, Boeing 767, 757, 737 and 727 aircraft. AMES also has the capability to refurbish airframe components, including approximately 60% of the components for Boeing 767 aircraft.
DHL contracts with the Company to provide scheduled airframe maintenance for the 13 Boeing 767 aircraft that it leases from CAM. The Company also provides scheduled maintenance for four DHL-owned aircraft operated by ABX under the CMI agreement.
Aircraft Parts Sales and Brokerage
AMS is an Aviation Suppliers Association 100 Certified reseller and broker of aircraft parts. AMS carries an inventory of Boeing 767, DC-9 and DC-8 spare parts and also maintains inventory on consignment from original equipment manufacturers, resellers, lessors and other airlines. AMS' customers include the commercial air cargo industry, passenger airlines, aircraft manufacturers and contract maintenance companies serving the commercial aviation industry, as well as other resellers.
Equipment and Facility Maintenance
LGSTX provides contract services for aviation support and facility services throughout the U.S. LGSTX has a large inventory of ground support equipment, such as power units, airstarts, deicers and pushback vehicles that it rents to airports, airlines and other customers. LGSTX is also licensed to resell aircraft fuel. LGSTX arranges fueling services for customers and can provide fuel for aircraft charter customers.
U.S. Postal Service
Since September 2004, we have provided mail sorting services under contracts with the USPS. Our subsidiary, LDS, manages USPS mail sort centers in Indianapolis, Dallas and Memphis. Under each of these three contracts, we are compensated at a firm price for fixed costs and an additional amount based on the volume of mail handled at each sort center. Each contract was renewed in 2010 and has a two-year term, with expiration dates in either September or October 2012. LDS is also operating two load consolidation centers for the USPS in Des Moines and Memphis under contracts that expire in June of 2012.
Flight Support
ABX is FAA-certificated to offer flight crew training to customers and rent usage of their flight simulators for outside training programs. ABX has three flight simulators in operation. ABX’s Boeing 767 and DC-9 flight simulators are level C certified. The level C flight simulators allow ABX to qualify flight crewmembers under FAA requirements without performing check flights in an aircraft. The DC-8 simulator is level B certified, which allows ABX to qualify flight crewmembers by performing a minimum number of flights in an aircraft.
The Company's GFS business provides aircraft dispatch and flight monitoring to supplemental air carriers.
Discontinued operations
Discontinued operations are a result of DHL's decision in 2008 to restructure its U.S. operations due to continued losses. Pursuant to its restructuring plan, DHL discontinued intra-U.S. domestic pickup and delivery services and now provides only international services to and from the U.S. In the third quarter of 2009, ABX ceased all remaining sort operations for DHL and the Hub Services agreement expired. Additionally, in the third quarter of 2009, DHL assumed management of aircraft fuel services for its U.S. network previously provided by ABX. Since that time, the results of the DHL hub services operations and the aircraft fuel operations are reported as discontinued operations. The results of discontinued operations for 2011 primarily reflect pension for the former hub employees and costs related to legal claims involving ABX's use of temporary workers in its hub services operation (See Item 3, Legal Proceedings).
Industry
The primary competitive factors in the air cargo industry are price, fuel efficiency, geographic coverage, aircraft range, flight frequency, aircraft reliability and capacity. Our airline subsidiaries compete for domestic cargo volume principally with other cargo airlines and passenger airlines which have substantial belly cargo capacity. Other cargo airlines include Amerijet International, Inc., Astar USA, LLC, Atlas Air Worldwide Holdings, Inc., National Air Cargo, Evergreen International, Inc. and World Airways, Inc. The industry is capital intensive and highly competitive.
Air cargo volumes correlate closely with general economic conditions and the level of commercial activity in a geographic area. Stronger general economic conditions and growth in a region typically increase the need for product transportation. Historically, the cargo industry has experienced higher volumes during the fourth calendar quarter of each year due to increased shipments during the holiday season. Generally, time-critical delivery needs, such as just-in-time inventory management, increase the demand for air cargo delivery, while higher costs of jet fuel generally reduces the demand for air delivery services. When jet fuel prices increase, shippers will consider using ground transportation if the delivery time allows.
The scheduled delivery industry is dominated by integrated door-to-door carriers including DHL, the USPS, FedEx Corporation, and United Parcel Service, Inc. Although the volume of our business is impacted by competition among these integrated carriers, we do not usually compete directly with them.
Competition for aircraft leasing is generally affected by aircraft type, aircraft availability and lease rates. We target our leases to cargo airlines and delivery companies seeking medium widebody airlift.
The aircraft maintenance industry is labor intensive and typically competes based on cost, capabilities and reputation for quality. U.S. airlines may contract for aircraft maintenance with maintenance and repair organizations ("MROs") in other countries or geographies with a lower labor wage base, making the industry highly cost competitive.
Airline Operations
Flight Operations and Control
Each of the Company's airline operations are conducted pursuant to authority granted to them by the FAA. Airline flight operations, including aircraft dispatching, flight tracking and crew scheduling, are planned and controlled by personnel within each airline. The Company staffs aircraft dispatching and flight tracking 24 hours per day, 7 days per week.
Aircraft Maintenance
Our airlines’ operations are regulated by the FAA for aircraft safety and maintenance. Each airline performs routine inspections and airframe maintenance, including Airworthiness Directive and Service Bulletin compliance on all of their aircraft. The airlines’ maintenance and engineering personnel coordinate routine and non-routine maintenance requirements. Each airline’s maintenance program includes tracking the maintenance status of each aircraft, consulting with manufacturers and suppliers about procedures to correct irregularities and training maintenance personnel on the requirements of its FAA-approved maintenance program. The airlines contract with MROs, including AMES, to perform heavy airframe maintenance on airframes and engines. Each airline owns and maintains an inventory of spare aircraft engines, auxiliary power units, aircraft parts and consumable items. The number of spare items maintained is based on the fleet size, engine type operated and the reliability history of the item types.
Insurance
Our airline subsidiaries are required by the Department of Transportation (“DOT”) to carry a minimum amount of aircraft liability insurance. Their aircraft leases, loan agreements and ACMI agreements also require them to carry such insurance. The Company currently maintains public liability and property damage insurance, and our airline subsidiaries currently maintain aircraft hull and liability insurance and war risk insurance for their respective aircraft fleets in amounts consistent with industry standards. CAM’s customers are also required to maintain similar insurance coverage.
Employees
As of December 31, 2011, ATSG and its subsidiaries had approximately 2,010 employees, including 1,770 full-time employees and 240 part-time employees. The Company employed approximately 595 flight crewmembers, 870 aircraft maintenance technicians and flight support personnel, 280 warehousing, sorting and logistics personnel, 70 employees for airport maintenance and logistics, 25 employees for sales and marketing and 170 employees for administrative functions. On December 31, 2010, the Company had approximately 2,065 employees.
Intellectual Property
The Company owns a small number of U.S. patents that have a nominal commercial value. The Company also owns many STCs issued by the FAA. The Company uses these STCs mainly in support of its own fleets; however, AMES has marketed certain STCs to other airlines.
Information Systems
The Company has invested significant management and financial resources in the development of information systems to facilitate flight and maintenance operations. The Company utilizes its systems to maintain records about the maintenance status and history of each major aircraft component, as required by FAA regulations. Using its systems, the Company tracks and controls inventories and costs associated with each maintenance task, including the personnel performing those tasks. In addition, the Company’s flight operations systems coordinate flight schedules and crew schedules. It has developed and procured systems to track crewmember flight and duty time, and crewmember training status.
Regulation
Our subsidiaries’ airline operations are generally regulated by the DOT, the FAA and the Transportation Security Administration (“TSA”). Those operations must comply with numerous security and environmental laws, ordinances and regulations. In addition, they must also comply with various other federal, state, local and foreign laws and regulations.
Environment
Under current federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or clean-up of hazardous or toxic substances on, under, or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of contamination from hazardous or toxic substances, or the failure to properly clean up such contaminated property, may adversely affect the ability of the owner of the property to use such property as collateral for a loan or to sell such property. Environmental laws also may impose restrictions on the manner in which a property may be used or transferred or in which a business located thereon may be operated and may impose remediation or compliance costs. Under its expired air park sublease with DHL, ABX and DHL are required to defend, indemnify and hold each other harmless from and against certain environmental claims associated with the Air Park in Wilmington, Ohio.
Our subsidiaries’ aircraft currently meet all known requirements for engine emission levels. However, under the Clean Air Act, individual states or the U.S. Environmental Protection Agency may adopt regulations requiring reductions in emissions for one or more localities based on the measured air quality at such localities. Such regulations may seek to limit or restrict emissions by restricting the use of emission-producing ground service equipment or aircraft auxiliary power units.
In addition, the European Commission has approved the extension of the European Union Emissions Trading Scheme ("ETS") for greenhouse gas emissions to the airline industry. Beginning in 2012, all Company airline subsidiary flights to and from any airport in any member state of the European Union are covered by the ETS requirements, and each year we are now required to submit emission allowances in an amount equal to the carbon dioxide emissions from such flights.
The federal government generally regulates aircraft engine noise at its source. However, local airport operators may, under certain circumstances, regulate airport operations based on aircraft noise considerations. The Airport Noise and Capacity Act of 1990 provides that, in the case of Stage 3 aircraft (all of our operating aircraft satisfy Stage 3 noise compliance requirements), an airport operator must obtain the carriers’ consent to, or the government’s approval of, the rule prior to its adoption. We believe the operation of our airline subsidiaries’ aircraft either complies with or is exempt from compliance with currently applicable local airport rules. However, some airport authorities have adopted local noise regulations, and, to the extent more stringent aircraft operating regulations are adopted on a widespread basis, our airline subsidiaries may be required to spend substantial funds, make schedule changes or take other actions to comply with such local rules.
The U.S. government, working through the International Civil Aviation Organization, has in the past adopted more stringent aircraft engine emissions regulations with regard to newly certificated engines and aircraft noise regulations applicable to newly certificated aircraft. Although these rules will not apply to any of our airline subsidiaries’ existing aircraft, additional rules could be adopted in the future that would either apply these more stringent noise and emissions standards to aircraft already in operation or require that some portion of the fleet be converted over time to comply with these new standards.
Department of Transportation
The DOT maintains authority over certain aspects of domestic air transportation, such as requiring a minimum level of insurance and the requirement that a person be “fit” to hold a certificate to engage in air transportation. In addition, the DOT continues to regulate many aspects of international aviation, including the award of international routes. The DOT has issued ABX a Domestic All-Cargo Air Service Certificate for air cargo transportation between all points within the U.S., the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. The DOT has issued ATI certificate authority to engage in scheduled interstate air transportation, which is currently limited to all-cargo operations, and certificate authority to engage in interstate and foreign charter air transportation of persons, property and mail. CCIA holds DOT certificate authority to engage in interstate all-cargo air transportation and DOT certificate authority to engage in foreign charter air transportation of property and mail. Additionally, the DOT has issued ABX, CCIA and ATI Certificates of Public Convenience and Necessity authorizing each of them to engage in scheduled foreign air transportation of cargo and mail between the U.S. and all current and future U.S. open-skies partner countries, which currently consists of over 100 foreign countries. ABX also holds exemption authorities issued by DOT to conduct scheduled all-cargo operations between the U.S. and certain foreign countries with which the U.S. does not have an open-skies air transportation agreement.
By maintaining these certificates, the Company, through its airline subsidiaries, can conduct all-cargo charter operations worldwide. Prior to issuing such certificates, and periodically thereafter, the DOT examines a company’s managerial competence, financial resources and plans, compliance, disposition and citizenship in order to determine whether the carrier is fit, willing and able to engage in the transportation services it has proposed to undertake.
The DOT has the authority to impose civil penalties, or to modify, suspend or revoke our certificates for cause, including failure to comply with federal laws or DOT regulations. A corporation holding either of the above-referenced certificates must qualify as a citizen of the United States, which, pursuant to federal law, requires that (1) it be organized under the laws of the U.S. or a state, territory or possession thereof, (2) that its president and at least two-thirds of its Board of Directors and other managing officers be U.S. citizens, (3) that less than 25% of its voting interest be owned or controlled by non-U.S. citizens, and (4) that it not otherwise be subject to foreign control. We believe we possess all necessary DOT-issued certificates and authorities to conduct our current operations and continue to qualify as a citizen of the United States.
Federal Aviation Administration
The FAA regulates aircraft safety and flight operations generally, including equipment, ground facilities, maintenance, flight dispatch, training, communications, the carriage of hazardous materials and other matters affecting air safety. The FAA issues operating certificates and operations specifications to carriers that possess the technical competence to conduct air carrier operations. In addition, the FAA issues certificates of airworthiness to each aircraft that meets the requirements for aircraft design and maintenance. ABX, CCIA and ATI believe they hold all airworthiness and other FAA certificates and authorities required for the conduct of their business and the operation of their aircraft, although the FAA has the power to suspend, modify or revoke such certificates for cause, or to impose civil penalties for any failure to comply with federal laws and FAA regulations.
The FAA has the authority to issue airworthiness directives and other mandatory orders relating to, among other things, the inspection and maintenance of aircraft and the replacement of aircraft structures, components and parts, based on the age of the aircraft and other factors. For example, the FAA has required ABX to perform inspections of its Boeing 767 aircraft to determine if certain of the aircraft structures and components meet all aircraft certification requirements. If the FAA were to determine that the aircraft structures or components are not adequate, it could order operators to take certain actions, including but not limited to, grounding aircraft, reducing cargo loads, strengthening any structure or component shown to be inadequate, or making other modifications to the aircraft. New mandatory directives could also be issued requiring the Company’s airline subsidiaries to inspect and replace aircraft components based on their age or condition. As a routine matter, the FAA issues airworthiness directives applicable to the aircraft operated by our airline subsidiaries, and our airlines comply, sometimes at considerable cost, as part of their aircraft maintenance program. In addition to the FAA practice of issuing Airworthiness Directives as conditions warrant, the FAA has adopted new policies to address issues involving older, but still economically viable, aircraft on a more systematic basis. FAA regulations mandate that aircraft manufacturers establish limits on aircraft flight cycles before which widespread fatigue damage might occur. The Boeing Company, has provided its recommendation to the FAA, which is reviewing those limits. Once these limits are approved by the FAA, carriers must then incorporate them into their maintenance programs over time. After the limits are reached, airlines will be unable to continue to operate the aircraft without the FAA first granting an extension of time to the operator. As the manufacturers have not yet set the new limits, the Company cannot yet estimate the impact of the new rule on any of its airline subsidiaries.
The FAA has adopted a policy regarding the proper application of airport rates and charges imposed on airlines. The policy provides greater flexibility to airport operators to impose charges that would expressly allow for the imposition of “congestion fees” rather than uniform airport fees. If airports in the U.S. seek to use the flexibility offered by this policy, it could have an impact on the cost of conducting our flight operations.
The FAA requires each of the airline subsidiaries to implement a drug and alcohol testing program with respect to all employees that engage in safety sensitive functions. Each of the airlines comply with these regulations.
Transportation Security Administration
The TSA, an administration within the Department of Homeland Security, is responsible for the screening of passengers, baggage and cargo and the security of aircraft and airports. Our airline subsidiaries comply with all applicable aircraft and cargo security requirements. The TSA has adopted cargo security-related rules that have imposed additional burdens on our airlines and our customers. Among other things, the TSA requires each airline to perform criminal history background checks on all employees. In addition, we may be required to reimburse the TSA for the cost of security services it may provide to the Company’s airline subsidiaries in the future.
CEO BACKGROUND
Jeffrey J. Vorholt, age 59, is an independent consultant and private investor. He was formerly a full-time faculty member at Miami University (Ohio) and concurrently an Adjunct Professor of Accountancy at Xavier University (Ohio), from 2001 to 2006. Mr. Vorholt, a CPA and attorney, was the Chief Financial Officer of Structural Dynamics Research Corporation from 1994 until its acquisition by EDS in 2001. Previously, he served as the Senior Vice President of Accounting and Information Systems for Cincinnati Bell Telephone Company and the Senior Vice President, Chief Financial Officer and Director for Cincinnati Bell Information Systems, which is now Convergys Corporation. Mr. Vorholt served as Director and Chairman of the Audit Committee for Softbrands, Inc., a global provider of enterprise-wide application software, from 2002 until its acquisition by Infor Global Solutions of Alpharetta, Georgia in 2009. Mr. Vorholt has been a Director of the Company since January 2004. He is the Chairman of the Audit Committee and is a member of the Compensation Committee. Among other qualifications, Mr. Vorholt has over thirty years of experience in accounting and financial management, and his knowledge and experience in that field make him a valuable asset to the Board of Directors, particularly through his service on the Audit Committee.
Joseph C. Hete, age 57, President and Chief Executive Officer of ATSG since October 2007 and Chief Executive Officer of ABX Air, Inc. since August 2003. He was the President of ABX Air, Inc. from January 2000 to February 2008 and the Chief Operating Officer of ABX Air, Inc. from January 2000 to August 2003. From 1997 until January 2000, he held the position of Senior Vice President and Chief Operating Officer of ABX Air, Inc. Mr. Hete served as Senior Vice President, Administration, of ABX Air, Inc. from 1991 to 1997, and Vice President, Administration, of ABX Air, Inc. from 1986 to 1991. He joined ABX Air, Inc. in 1980. Mr. Hete serves as a member of the Executive Committee. Among other qualifications, Mr. Hete brings to the Board a deep and extensive knowledge of the air cargo industry and the day-to-day operations of the Company through his years in various senior business leadership roles with the Company, including as Chief Executive Officer. He is able to keep the Board of Directors informed on the current state of the Company by serving as a director.
MANAGEMENT DISCUSSION FROM LATEST 10K
BACKGROUND
Air Transport Services Group, Inc. (the “Company”) is a holding company whose principal subsidiaries include three independently certificated airlines, ABX Air, Inc. (“ABX”), Capital Cargo International Airlines, Inc. (“CCIA”) and Air Transport International, LLC (“ATI”), and an aircraft leasing company, Cargo Aircraft Management, Inc. (“CAM”). At December 31, 2011, the Company's in-service aircraft fleet consisted of 52 owned aircraft, one of which is a passenger aircraft, and five leased cargo aircraft. Additionally, the Company owned four other aircraft that were being are modified to standard freighter aircraft and two more aircraft that were being modified into combi aircraft as of December 31, 2011. The Company has two reportable segments: ACMI Services, which primarily includes the cargo transportation operations of its three airlines and CAM, which includes the Company's aircraft leasing business. The Company's other business operations, which primarily provide support services to the transportation industry, include aircraft maintenance, aircraft part sales, ground equipment leasing and mail handling services. These operations do not constitute reportable segments due to their size.
The Company's largest customer is DHL Network Operations (USA), Inc. and its affiliates ("DHL"), which accounted for 36% of the Company's consolidated revenues in both 2011 and 2010 and 55% of the Company's consolidated revenues in 2009. The Company has had long term contracts with DHL since August of 2003. Commencing March 31, 2010, the Company and DHL executed new commercial agreements under which DHL committed to lease 13 Boeing 767 freighter aircraft from CAM and contracted with ABX to operate those aircraft under a separate crew, maintenance and insurance (“CMI”) agreement. The CMI agreement pricing is based on pre-defined fees, scaled for the number of aircraft operated and the number of flight crews provided to DHL for its U.S. network. The initial term of the CMI agreement is five years and the terms of the aircraft leases are seven years, with early termination provisions. Through December 31, 2011, CAM leased all 13 Boeing 767-200 aircraft to DHL. In addition to the 13 CAM-owned Boeing 767 aircraft, ABX also operates four DHL-owned Boeing 767 aircraft under the CMI agreement.
Prior to the CMI and DHL lease agreements, ABX provided flight crews, maintenance and aircraft to DHL under an aircraft, crew, maintenance and insurance agreement (“DHL ACMI agreement”) which compensated ABX on a cost-plus mark-up basis. The follow-on agreements separate CAM's lease of freighter aircraft to DHL from the maintenance and operation of those aircraft by ABX on behalf of DHL.
The U.S. Military comprised 12% , 14% and 10% of the Company's consolidated revenues in 2011, 2010 and 2009, respectively. The Company's airlines contract their services to the Air Mobility Command ("AMC"), which is organized under the U.S. Military. ATI contracts its unique fleet of McDonnell Douglas DC-8 "combi" aircraft to the AMC. The combi aircraft are capable of carrying passengers and cargo containers on the main flight deck.
A substantial portion of the Company’s revenues and cash flows have historically been derived from providing airlift in North America to BAX Global, Inc., an affiliate of DB Schenker ("BAX/Schenker"). BAX/Schenker is a specialized heavy weight, business to business shipper. Under their agreements with BAX/Schenker, ATI and CCIA had the right to be the exclusive providers of main deck freighter lift for BAX/Schenker in the U.S. The Company started 2011 with eight Boeing 727 and eight DC-8 aircraft dedicated to supporting the BAX/Schenker network in North America. However, on July 22, 2011, BAX/Schenker announced its plans to adopt a new operating model that phased out the dedicated air cargo network in North America supported by the Company. Instead of dedicated aircraft, BAX/Schenker now utilizes DHL and other delivery services for its air transportation delivery requirements. To execute the plan, on September 2, 2011, BAX/Schenker ceased air cargo operations at its air hub in Toledo, Ohio and began to conduct air operations from the Cincinnati/Northern Kentucky airport, utilizing DHL's U.S. air hub. The Company provided limited airlift directly to BAX/Schenker through the peak delivery season, until late December, 2011. Beginning in January 2012, the Company contracted with DHL to supplement its U.S. air network to service BAX/Schenker freight volumes on DHL's expanded air network without use of ATSG's DC-8 aircraft and with only limited use of Boeing 727 aircraft.
Triggered by BAX/Schenker's July decision, we tested the carrying value of the Company's aircraft, engines, aircraft spare parts, goodwill and other intangibles during the third quarter of 2011. During the third quarter of 2011, we recorded pre-tax impairment charges totaling $27.1 million to reduce the carrying values of the Company's Boeing 727 and DC-8 freighters, goodwill and customer relationship intangible assets to their individual fair values. The lower fair value of these aircraft and BAX/Schenker's July decision to terminate its dedicated air network are the result of prolonged recessionary conditions and trends toward higher fuel prices. Demand for Boeing 727 and DC-8 aircraft has diminished in recent years, because these older aircraft are less fuel efficient and generally not as reliable as more modern aircraft.
The Company's revenues from the services performed for BAX/Schenker, derived primarily by providing Boeing 727 and DC-8 airlift, were $187.0 million , $194.3 million and $160.2 million for the years ended December 31, 2011 , 2010 and 2009, respectively. The Company's revenues from BAX/Schenker comprised approximately 26% , 29% and 19% of the Company's total revenues during the years ended December 31, 2011, 2010 and 2009, respectively ( 15% , 18% and 14% of total revenues excluding directly reimbursable revenues, respectively).
RESULTS OF OPERATIONS
Summary
The consolidated net earnings from continuing operations were $23.9 million and $39.9 million for 2011 and 2010, respectively. The pre-tax earnings from continuing operations for 2011 were $40.9 million , inclusive of asset impairment charges and interest rate derivative losses during 2011, compared to pre-tax earnings of $63.3 million in 2010, in which no impairment charges or derivative losses were recorded. The decline in earnings from continuing operations in 2011 as compared to 2010 resulted primarily from the recognition of asset impairment charges of $27.1 million , interest rate derivative losses of $4.9 million and the write-off of $2.9 million of unamortized debt issuance costs related to the refinancing of the Company's debt in 2011. Adjusted pre-tax earnings from continuing operations, a non-GAAP measure (see reconciliation table below), after removing impairment charges, net derivative losses and charges related to debt refinancing was $75.8 million for 2011 compared to $59.8 million for 2010 after removing pre-tax earnings related to DHL's restructuring. This improved earnings, as adjusted, over 2010, was driven primarily by CAM, which placed five additional aircraft under external customer leases since December 31, 2010.
The Company's impairment charges stemming from BAX/Schenker's transition to a new U.S. business model are described below:
- $22.1 million ($13.7 million after income tax benefit) to write-down Boeing 727 and DC-8 freighters, engines and related parts to their appraised fair values. In light of BAX/Schenker's decision to phase-out its dedicated air network in the U.S. and after evaluating business prospects for these aircraft, management has decided to discontinue the service of Boeing 727 and DC-8 freighters sooner than previously expected.
- $2.3 million ($1.4 million after income tax benefit) to write-down customer relationship intangible assets, reflecting the closure of BAX/Schenker's dedicated air network.
- $2.8 million ($2.8 million after income tax benefit) to write-down goodwill acquired when the Company purchased ATI, which operated the DC-8 aircraft for BAX/Schenker. The write-down reflects the lower forecasted cash flows in the near term as ATI re-fleets by replacing the DC-8 aircraft operated for BAX/Schenker with more efficient Boeing 767 and 757 aircraft to be operated for other customers.
During 2011, the Company executed a new credit facility with a consortium of banks ("Credit Facility"). The new Credit Facility refinanced the Company's previous term loan and provides liquidity to expand the Company's aircraft fleet through April 2016. The new Credit Facility includes a term loan of $150 million and a $175 million revolving credit facility, of which the Company has drawn $106 million, net of repayments. In conjunction with the execution of the new Credit Facility, the Company terminated its previous credit agreement, which resulted in the write-off of $2.9 million of unamortized debt issuance costs associated with that credit agreement and the recognition of $3.9 million of losses for certain interest rate swaps previously designated as cash flow hedges of interest payments stemming from the former term loan. These charges, which totaled $6.8 million before income tax effects, were recorded in March 2011.
Customer revenues from continuing operations increased by $62.8 million to $730.1 million during 2011 compared to 2010. Excluding directly reimbursed revenues, customer revenues increased by $45.4 million during 2011 compared to 2010. Revenue growth during 2011 compared to 2010 reflects additional external aircraft leases by CAM, up $24.5 million, additional Boeing 767 aircraft operations being performed under the ACMI Services segment, up $12.7 million, and increased aircraft maintenance services, up $9.9 million, which is reflected under other activities. Revenue growth comparisons to 2010 are affected by the termination of the DHL ACMI agreement and the termination of the severance and retention agreement ("S&R agreement") with DHL in March 2010. Under the S&R agreement, DHL compensated and reimbursed ABX for its management and costs associated with DHL's network restructuring starting in May 2008 and continuing through March 2010. Revenues from the S&R agreement were $4.0 million in the first quarter of 2010.
CAM
The Company offers aircraft leasing through its CAM subsidiary. Aircraft leases normally cover a term of five to seven years. In a typical leasing agreement, customers pay rent and a maintenance deposit on a monthly basis.
CAM's revenues for 2011 grew to $140.5 million compared to $101.4 million during 2010. Revenues from external customers accounted for $24.5 million of the increased revenue for 2011. Since December 31, 2010, CAM has leased five more Boeing 767-200 aircraft to external customers. CAM's revenues from the Company's airlines totaled $72.7 million during 2011, compared to $58.1 million for 2010.
As of December 31, 2011 , CAM had 52 aircraft that were under lease, 31 of them internally to ATSG airlines. CAM's pre-tax earnings, inclusive of an interest expense allocation and $6.8 million for aircraft impairment charges, were $53.2 million and $41.6 million , during 2011 and 2010, respectively. CAM's pre-tax earnings, excluding the aircraft impairment charges, increased by $18.4 million for 2011 compared to 2010. Improved earnings reflected five more Boeing 767 freighter aircraft under lease since December 31, 2010. During 2011, CAM completed the freighter modification of two Boeing 767-200 aircraft and leased them to a Brazilian airline under long term leases. Also during 2011, CAM leased two additional Boeing 767-200 aircraft to DHL, fulfilling its commitment from March of 2010 to lease 13 aircraft to DHL under long term leases. CAM also leased one additional Boeing 767-200 freighter aircraft to a Miami, Florida, based operator in 2011. During 2011, CAM completed the modification of its first two Boeing 767-300 freighter aircraft and leased the aircraft internally to its affiliate, ATI, which began to operate the aircraft for customers under ACMI agreements.
During 2012, we plan to further invest in the modification of Boeing 767-300 and 757-200 aircraft. The fuel efficiency, cubic capacity, payload and operating costs of the Boeing 767-300, make it a desirable freighter aircraft in medium-range international air cargo markets and in certain transcontinental routes. Additionally, existing customers have requested Boeing 757-200 aircraft. As these aircraft are modified, we plan to place them into service under dry leasing arrangements to external customers or ACMI operations using our airlines, depending on which alternative provides the best long term return and considering other factors, including geographical placement and customer diversification. Additional information about our aircraft acquisition and modifications plans can be found below under Commitments.
ACMI Services Segment
As of December 31, 2011 , ACMI Services included 49 in-service aircraft, including 31 leased internally from CAM, five leased from external providers and 13 CAM-owned freighter aircraft which were under lease to DHL and operated by ABX under the CMI agreement. During 2011, ABX began to lease and operate two more DHL-owned aircraft, bringing to four the number of DHL-owned aircraft that ABX leases from DHL and operates under the CMI agreement. During 2011, ATI leased two Boeing 767-300 aircraft from CAM and began to operate the aircraft under ACMI agreements. Also in December 2011, CCIA began to operate a Boeing 757 aircraft under an ACMI agreement.
ACMI Services revenues were $605.5 million and $579.4 million during 2011 and 2010, respectively. Revenues from airline services increased 3% during 2011 compared to 2010, driven by higher block hours flown for customers. Aircraft block hours flown for customers increased 2% during the year, however, block hours for customers other than BAX/Schenker increased 11% in 2011 compared to 2010. This increase in block hours reflects the additional Boeing 767 aircraft placed into service during 2011, as described above. Reimbursable revenues increased $17.4 million during 2011, compared to 2010. The comparison of airline services revenues and reimbursable revenues to 2010 reflects the new commercial agreements between ABX and DHL which became effective in April 2010. Airline services revenues for the first quarter of 2010 included compensation based on aircraft depreciation and certain maintenance expenses under the former cost-plus DHL ACMI agreement. Beginning in April 2010, lease revenues for the DHL network aircraft have been reflected in CAM's revenues, while compensation for certain aircraft related maintenance costs have been reflected as reimbursable revenues. Revenues from activities under the S&R agreement declined by $4.0 million during 2011 compared to 2010, due to the termination of the S&R agreement in March 2010.
ACMI Services incurred a pre-tax loss of $13.8 million during 2011 due to asset impairment charges of $20.4 million . The pre-tax earnings for ACMI Services, excluding asset impairment charges, were $6.6 million from airline services for 2011 compared to $17.3 million from airline services during 2010. Operating results during 2011 were negatively impacted by the phase-out of BAX/Schenker's North American air network, unscheduled aircraft downtime, start-up costs for new Boeing 767 passenger operations and reductions in revenues from U.S. Military charters. As a result of unscheduled aircraft maintenance events, revenue flights were missed and higher operating expenses were incurred during the aircraft downtime. Some of the downtime affected DC-8 combi aircraft and Boeing 767 freighters operating in remote regions that were difficult to service. Revenues from the U.S. Military declined $2.6 million during 2011 compared to 2010 due to maintenance related cancellations and contractual rate reductions. The results for 2011 were impacted by start-up costs incurred by ATI in order for it to gain passenger authority and operate passenger routes under an ACMI agreement with a tourist operator beginning in April 2011. This agreement was primarily for the purpose of allowing ATI to build 12 months of passenger operating experience on the Boeing 767 aircraft, which is required in order to transport passengers for the U.S. Military on such aircraft. Additionally, ATI incurred higher crew preparation costs in 2011 to support the addition of its first two Boeing 767-300 aircraft during the year and transition DC-8 crews to the Boeing 767 aircraft.
Revenues from DHL, BAX/Schenker and other customers included the reimbursement of certain expenses. Excluding these reimbursable revenues, DHL, BAX/Schenker and the U.S. Military accounted for 37% , 19% and 20% , respectively, of ACMI Services revenues during 2011. Excluding reimbursable revenues, DHL, BAX/Schenker and the U.S. Military accounted for 39% , 22% and 21% of ACMI Services revenues for 2010.
Future earnings from ACMI Services will be impacted by the timing of aircraft modifications and aircraft utilization levels which is affected by customer demand and our ability to maintain the aircraft at reliability levels expected by our customers. Customer demand for our services will depend on the cost competitiveness of the airlines and market preferences for the type of aircraft that we operate. In June of 2012, our award to fly three DC-8 combi aircraft for the U.S. Military will expire. The U.S. Military has expressed its preference to replace the DC-8 combi aircraft that it utilizes with a more modern aircraft type, such as the Boeing 757. We expect the U.S. Military to begin a solicitation process for a contract to replace the DC-8 combi aircraft. We plan to bid on such a contract using our Boeing 757 combi aircraft, which will be ready for service in the second half of 2012. New customer agreements typically involve start-up expenses, including those for route authorities, overfly rights, travel and other activities, and may impact future operating results. Revenue-generating service may begin sometime later; however, depending on satisfaction of a number of conditions, including international regulations and laws, contract negotiations, flight crew availability, and arranging resources for aircraft handling.
The Company's earnings may fluctuate due to the costs of aircraft repairs and maintenance and the timing of scheduled heavy maintenance which, under ABX’s policy are expensed as maintenance is performed. During 2012, pension expense for continuing operations will increase by approximately $5.7 million due primarily to the effects of lower discount rates used to actuarially calculate the Company's annual pension expense for 2012.
As noted above, during 2011 ACMI Services included the operation of Boeing 727 and DC-8 aircraft in BAX/Schenker's North American network which was phased-out in 2011. The Company has begun to market these aircraft, engines and related parts to other airlines and parts dealers. Operations using the Boeing 727 and DC-8 freighters will be limited while the aircraft are marketed.
Other Activities
The Company sells aircraft parts and provides aircraft maintenance and modification services to other airlines. The Company also operates five U.S. Postal Service (“USPS”) sorting facilities. The Company provides ground equipment leasing and facility maintenance including fuel services. Other activities also include the management of workers' compensation claims under an agreement with DHL and gains from the reduction in employee post-retirement obligations.
External customer revenues from all other activities were $57.4 million and $45.9 million for 2011 and 2010, respectively. The increase in other revenues during 2011 primarily reflects additional aircraft maintenance projects and additional services provided to the USPS beginning in April 2011.
The pre-tax earnings from other activities were $11.3 million and $8.0 million in 2011 and 2010, respectively. The increase of $3.3 million in pre-tax earnings for 2011 compared to 2010 reflects increased aircraft maintenance projects completed during 2011 and additional business with the USPS, offset by higher facility expenses for the other business segments, additional corporate expenses to support the subsidiaries and additional business development expenses to support the Company's growth.
The Company's aircraft maintenance and repair business, Airborne Maintenance and Engineering Services, Inc.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
BACKGROUND
Air Transport Services Group, Inc. (the “Company”) provides airline operations, aircraft leases, aircraft maintenance and other support services primarily to the cargo transportation and package delivery industries. Through the Company's subsidiaries, it offers a range of complementary services to delivery companies, freight forwarders, airlines and government customers. The Company's principal subsidiaries include three independently certificated airlines, ABX Air, Inc. (“ABX”), Capital Cargo International Airlines, Inc. (“CCIA”) and Air Transport International, LLC (“ATI”), and an aircraft leasing company, Cargo Aircraft Management, Inc. (“CAM”).
At June 30, 2012, the Company’s subsidiaries owned 54 aircraft in service condition consisting of 21 Boeing 767-200 standard freighter aircraft leased to external customers, 32 freighter aircraft operated by the Company's airlines and one Boeing 767 passenger aircraft. The 32 freighter aircraft operated by the Company's airlines consisted of 15 Boeing 767-200, four Boeing 767-300, three Boeing 757, four Boeing 727, two McDonnell Douglas DC-8 freighter aircraft and four McDonnell Douglas DC-8 "combi" aircraft. The combi aircraft are capable of simultaneously carrying passengers and cargo containers on the main flight deck. The Company's subsidiaries also leased four Boeing 767-200 freighter aircraft and two Boeing 767-300 freighter aircraft as of June 30, 2012. Additionally, as of June 30, 2012, the Company had three Boeing 767-300 aircraft undergoing freighter modification, one Boeing 757 aircraft undergoing freighter modification and one Boeing 757 aircraft undergoing combi modification.
The Company has two reportable segments: ACMI Services, which primarily includes the cargo transportation operations of its three airlines and the CAM segment, which includes the Company's aircraft leasing business. The Company's other business operations, which primarily provide support services to the transportation industry, include aircraft maintenance, aircraft part sales, ground equipment leasing and mail handling services. These operations do not constitute reportable segments due to their size.
The Company's largest customer is DHL Network Operations (USA), Inc. and its affiliates ("DHL"), which accounted for 52% and 35% of the Company's consolidated revenues for the six month periods ending June 30, 2012 and 2011, respectively. The Company has had long term contracts with DHL since August of 2003. Commencing March 31, 2010, the Company and DHL executed commercial agreements under which DHL leases 13 Boeing 767 freighter aircraft from CAM and contracted with ABX to operate those aircraft under a separate crew, maintenance and insurance (“CMI”) agreement. The CMI agreement pricing is based on pre-defined fees, scaled for the number of aircraft operated and the number of flight crews provided to DHL for its U.S. network. The initial term of the CMI agreement is five years and the terms of the aircraft leases are seven years, with early termination provisions. In addition to the 13 CAM-owned Boeing 767 aircraft, ABX also operates four DHL-owned Boeing 767 aircraft under the CMI agreement. Additionally, the Company's airlines are providing seven other Boeing 767 aircraft, four Boeing 727 aircraft and one Boeing 757 aircraft to DHL under other contracts having durations of one year or less and two Boeing 757 aircraft under multi-year contracts.
The U.S. Military comprised 16% and 11% of the Company's consolidated revenues for the six month periods ended June 30, 2012 and 2011, respectively. The Company's airlines contract their services to the Air Mobility Command ("AMC"), which is organized under the U.S. Military. ATI contracts its unique fleet of McDonnell Douglas DC-8 combi aircraft to the AMC.
A substantial portion of the Company’s revenues and cash flows have historically been derived from providing airlift in North America to BAX Global, Inc., an affiliate of DB Schenker ("BAX/Schenker"). BAX/Schenker is a specialized heavy weight, business to business shipper. In July 2011, BAX/Schenker announced its plans to adopt a new operating model that phased out the dedicated air cargo network in North America supported by the Company. In September 2011, BAX/Schenker ceased air cargo operations at its air hub in Toledo, Ohio and began to conduct air operations from the Cincinnati/Northern Kentucky airport, utilizing DHL's U.S. air hub. Instead of dedicated aircraft, BAX/Schenker now utilizes DHL and other delivery services for its air transportation delivery requirements.
The Company provided limited airlift directly to BAX/Schenker through the peak delivery season, until late December 2011. Beginning in January 2012, DHL contracted with the Company's airlines to supplement DHL's U.S. air network to service BAX/Schenker freight volumes on its expanded air network without use of the Company's DC-8 aircraft and with only limited use of Boeing 727 aircraft.
The Company ceased providing services to BAX/Schenker as of the end of 2011. The Company's revenues from the services performed for BAX/Schenker, derived primarily by providing Boeing 727 and DC-8 airlift, were $60.3 million and $116.3 million for the three and six month periods ended June 30, 2011, respectively. The Company's revenues from BAX/Schenker comprised approximately 31% and 32% of the Company's total revenues during the three and six months ended June 30, 2011 ( 17% and 18% of total revenues excluding directly reimbursable revenues).
RESULTS OF OPERATIONS
Summary
The consolidated net earnings from continuing operations were $11.2 million and $17.9 million for the three and six months periods ended June 30, 2012, respectively, compared to $12.3 million and $15.2 million for the corresponding periods of 2011. Pre-tax earnings from continuing operations were $18.2 million and $28.9 million for the three and six months periods ended June 30, 2012, respectively, compared to $19.7 million and $24.2 million for the corresponding periods of 2011.
Earnings during the first six months of 2011 were impacted by pre-tax charges totaling $6.8 million stemming from the refinancing of the Company's former credit agreement. After removing the charges related to debt refinancing and the effects of interest rate derivatives, adjusted pre-tax earnings from continuing operations, a non-GAAP measure, were $18.0 million and $28.3 million for the three and six month periods ended June 30, 2012 compared to $19.3 million and $30.7 million for the corresponding periods of 2011. (A definition and reconciliation of adjusted pre-tax earnings is shown below.) Adjusted pre-tax earnings from continuing operations during the three and six month periods ending June 30, 2012 compared to the corresponding periods of 2011 were bolstered by additional external aircraft leases and increased operations for the Company's Boeing 767 and Boeing 757 aircraft, but were negatively impacted by the discontinuation of the BAX/Schenker North American air network in the fourth quarter of 2011.
Total customer revenues from continuing operations decreased by $39.5 million to $153.6 million during the second quarter of 2012 and by $69.1 million to $299.1 million for the first six months of 2012 compared to the corresponding periods of 2011. The declines reflect $60.3 million and $116.3 million of revenues during the three and six month periods ending June 30, 2011, respectively, from services for the BAX/Schenker air network which was discontinued. Revenues from reimbursed fuel and other reimbursed operating expenses declined $29.3 million and $56.7 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. These declines were also primarily due to the discontinuation of the BAX/Schenker air network. Excluding directly reimbursed revenues, customer revenues decreased by $10.2 million and $12.4 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. Revenue growth during 2012, driven by additional external aircraft leases by CAM and additional Boeing 767 and Boeing 757 aircraft operations by ACMI Services, was offset by the revenue decline from the discontinuation of the BAX/Schenker air network.
During 2011, the Company executed a new credit facility ("Senior Credit Agreement") with a consortium of banks to expand and extend its borrowing capacity to support growth of the Boeing 767 and 757 aircraft fleet. The Senior Credit Agreement refinanced the Company's previous term and revolving credit loan. In conjunction with the execution of the Senior Credit Agreement, the Company terminated its previous credit agreement, which resulted in the write-off of $2.9 million of unamortized debt issuance costs associated with that credit agreement and the recognition of $3.9 million of losses for certain interest rate swaps previously designated as cash flow hedges of interest payments stemming from the former term loan during the first quarter of 2011.
CAM
Through the CAM subsidiary, the Company offers aircraft leasing to external customers and leases aircraft internally to the Company's airlines. Aircraft leases normally cover a term of five to seven years. In a typical leasing agreement, customers pay rent and maintenance deposits on a monthly basis.
As of June 30, 2012 , CAM had 54 aircraft in service condition, 32 of them leased internally to the Company's airlines. CAM's revenues grew $5.3 million and $11.0 million for the three and six months periods ended June 30, 2012, respectively, compared to the corresponding periods of 2011, as a result of additional aircraft leases. Since June 30, 2011, CAM has completed the modification from passenger to freighter of four Boeing 767-200 aircraft, three Boeing 767-300 aircraft and one Boeing 757 aircraft, and placed those aircraft under leases with internal and external customers. Revenues from external customers accounted for $2.8 million and $8.1 million of the increased revenue for the three and six months periods ended June 30, 2012, respectively, driven by two additional aircraft leases placed with external customers since June 2011. CAM's revenues from internal leases of Boeing 727 and DC-8 freighter aircraft for the three and six months periods ended June 30, 2012 declined $4.8 million and $10.0 million, respectively, compared to the corresponding periods of 2011 due to the retirement of Boeing 727 and DC-8 aircraft previously operated for BAX/Schenker, but the decline was more than offset by additional Boeing 767 and 757 aircraft leases.
CAM's pre-tax earnings, inclusive of an interest expense allocation, increased $3.0 million and $6.4 million for the three and six months periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. Improved earnings reflected eight additional Boeing 767 and 757 aircraft under lease since June 30, 2011. CAM's pre-tax earnings for the second quarter of 2012 does not reflect $0.7 million of unpaid rents related to a Boeing 767 aircraft under lease with a regional airline. Management and the lessee are discussing the timing of future payments which could result in the early return of the leased aircraft.
During 2012, CAM completed the modification from passenger to freighter configuration of one Boeing 767-200 and two Boeing 767-300 aircraft and leased those aircraft internally to a Company airline. CAM has five other passenger Boeing 767-300 and 757-200 aircraft, as discussed further below, that are being modified for future deployment.
ACMI Services Segment
The ACMI Services segment provides airline operations to its customers, typically under contracts providing for a combination of aircraft, crews, maintenance and insurance ("ACMI"). Our customers are usually responsible for supplying the necessary aviation fuel and cargo handling services and reimbursing our airline for other operating expenses, such as landing fees, ramp expenses and certain aircraft maintenance expenses. Aircraft charter agreements, including those for the U.S. Military, usually require the airline to provide full service, including fuel and other operating expenses for a fixed, all-inclusive price. As of June 30, 2012 , ACMI Services included 51 in-service aircraft, including 32 leased internally from CAM, six leased from external providers and 13 CAM-owned freighter aircraft which are under lease to DHL and operated by ABX under the CMI agreement.
Revenues from ACMI Services decreased 26% and 25% during the three and six months periods ended June 30, 2012, respectively, compared to corresponding periods of 2011 as a result of the discontinuation of services for BAX/Schenker's North American air network. Since June 30, 2011, ACMI Services has retired seven Boeing 727 and eight DC-8 freighter aircraft in response to the discontinuation of BAX/Schenker's North American air network in 2011. During the three and six month periods ended June 30, 2011, ACMI Services revenues included $35.0 million and $66.5 million for the reimbursement of fuel and other operating expenses for the BAX/Schenker air network. Airline services revenues, which do not include revenues for the reimbursement of fuel and certain operating expenses, declined 12% and 9%, reflecting the loss of BAX/Schenker revenues of $25.0 million and $49.6 million during the three and six month periods ended June 30, 2011, respectively.
Revenue declines from BAX/Schenker were offset by revenues from additional Boeing 767 and Boeing 757 aircraft added to the ACMI Services fleet since June 2011. Since June 30, 2011, ACMI Services has added two Boeing 767-200, four Boeing 767-300 and one Boeing 757 aircraft into the operating fleet. Airline service revenues, excluding those from BAX/Schenker, increased $11.3 million and $29.7 million during the three and six month periods ended June 30, 2012, respectively, compared to the corresponding periods of 2011, driven by these additional Boeing 767 and 757 aircraft. Aircraft block hours flown for customers other than BAX/Schenker increased 15% during the three and six months periods ending June 30, 2012, compared to the corresponding periods of 2011.
ACMI Services incurred pre-tax losses of $1.6 million and $9.8 million during the three and six months periods ending June 30, 2012, respectively, compared to pre-tax earnings of $4.6 million and $2.1 million for the corresponding periods of 2011. Operating results during 2012 were negatively impacted by the discontinuation of BAX/Schenker's North American air network, the cost of training flight crew members for the Boeing 767 aircraft, increased pension expenses, higher engine maintenance expenses and delays in placing aircraft into revenue service. During the second quarter of 2012, ABX added three Boeing 767-300 aircraft into its in-service fleet. Delays in placing two of the recently deployed Boeing 767-300 aircraft into incremental revenue generating services adversely impacted operating results during the second quarter of 2012. While ATI and CCIA have reduced the number of crew members and other employees in the ACMI Services segment due to the termination of the BAX/Schenker network, salaries and benefits expenses during 2012, included the cost of training senior, former DC-8 crewmembers for the Boeing 767 aircraft.
To further streamline the operations impacted by the loss of the BAX/Schenker business, we intend to effect a corporate reorganization pursuant to which the airline operations of ATI and CCIA will be merged near the end of 2012. In May 2012, ATI and CCIA reached a tentative agreement with their respective flight crewmembers, as represented by the Air Line Pilots Association International ("ALPA"). The tentative agreement sets out the essential terms under which the parties intend to pursue a joint collective bargaining agreement and merge their flight crewmember seniority lists. The airlines and ALPA intend to have the definitive agreement in place and complete the integration of the seniority lists by the end of 2012.
Continued stagnant economic conditions may slow the pace by which we deploy aircraft into incremental revenue operations. We may further reduce staff levels as required to match with customer demand and aircraft utilization levels. Additionally, customer demand for air cargo services depends on the cost competitiveness of the airlines, aircraft reliability and market preferences for the type of aircraft that we operate. New customer agreements typically involve start-up expenses, including those for proving flights, route authorities, overfly rights, travel and other activities, and may impact future operating results. Revenue-generating service may begin sometime later; however, depending on the satisfaction of a number of conditions, including international regulations and laws, contract negotiations, flight crew availability, and arranging resources for aircraft handling.
ATI currently operates four DC-8 combi aircraft for the U.S. Military. In July 2012, the U.S. Military's Air Mobility Command notified ATI that it was awarded a two-year agreement to continue the combi aircraft flights through September of 2014. ATI intends to service the award with its DC-8 combi aircraft and phase-in more modern Boeing 757 combi aircraft starting in the fourth quarter of 2012, replacing the DC-8 combi aircraft in conjunction with the U.S. Military's preference.
Other Activities
The Company sells aircraft parts and provides aircraft maintenance and modification services to other airlines. The Company also operates five U.S. Postal Service (“USPS”) sorting facilities and provides ground equipment leasing and facility maintenance services, including fuel services. Other activities also include the management of workers' compensation claims under an agreement with DHL and gains from the reduction in employee post-retirement obligations.
External customer revenues from all other activities were $13.5 million and $26.5 million for the three and six month periods ending June 30, 2012, compared to $12.6 million and $27.3 million for the three and six months periods ending June 30, 2011.
The pre-tax earnings from other activities were $3.2 million and $5.2 million for the three and six month periods ending June 30, 2012, respectively. Pre-tax earnings from other activities increased $1.6 and $1.9 million for the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011, primarily reflecting process streamlining initiatives at the sorting facilities and higher aircraft maintenance revenues. The Company's contracts with the USPS generated $10.3 million of revenue during the first half of 2012. While these contracts expire in 2012, we expect to renew them under similar terms.
Discontinued Operations
Pre-tax losses related to the former hub services operations were $0.6 million for the first six months of 2012 compared to $0.2 million during the first six months of 2011. The results of discontinued operations primarily contain pension expense for former employees that supported sort operations under a hub services agreement with DHL and expenses for certain legal matters associated with those former sorting operations.
Expenses from Continuing Operations
Salaries, wages and benefits expense decreased $0.8 million during the quarter ended June 30, 2012 and did not change for the six month period ended June 30, 2012, when compared to the corresponding periods of 2011. Reductions in the number of Boeing 727 and DC-8 crew members since June 30, 2011 were offset by costs of additional crew members for the expanded number of Boeing 767 aircraft operated by the Company and by increased pension expense compared to 2011. Pension expense for continuing operations increased $1.4 million and $2.8 million during the three and six month periods ended June 30, 2012, respectively, when compared to the corresponding periods of 2011 due to the affects of lower discount rates used to actuarially calculate the Company's annual pension expense.
Fuel expense decreased by $34.6 million and $60.4 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. The decrease occurred in conjunction with BAX/Schenker's discontinuation of its North American air network in the fourth quarter of 2011. During 2011, while under contract with BAX/Schenker, ATI provided aviation fuel for the BAX/Schenker air network and was reimbursed by BAX/Schenker for the costs of fuel. The Company is no longer incurring aviation fuel expenses or recording a related reimbursable revenue for the BAX/Schenker network. Fuel expense during 2012 primarily reflects the costs of fuel to operate U.S. Military charters, position aircraft for service and for maintenance purposes.
Maintenance, materials and repairs expense increased by $2.9 million and $4.7 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. During the first six months of 2012, maintenance expense reductions stemming from the discontinuation of Boeing 727 aircraft and DC-8 freighter aircraft since the fourth quarter of 2011 were offset by higher maintenance expenses to support the larger fleet of Boeing 767 and 757 aircraft.
Depreciation and amortization expense decreased $2.4 million and $4.4 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. The decline in depreciation expense reflects the removal of seven Boeing 727 aircraft and eight DC-8 freighter aircraft from service offset by incremental depreciation expense for seven Boeing 767 aircraft and one Boeing 757 aircraft added to the fleet since June 2011. The Boeing 727 aircraft and DC-8 freighter aircraft were removed from service in conjunction with BAX/Schenker's discontinuation of its North American air network in the fourth quarter of 2011.
Travel expense decreased by $1.4 million and $1.7 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. The decrease is a result of the discontinuation of the BAX/Schenker North American air network in the fourth quarter of 2011.
Rent expense increased by $0.8 million and $0.9 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. Rent expense was not significantly affected by the discontinuation of the BAX/Schenker North American air network because the Company did not lease the aircraft used in that network.
Landing and ramp expense, which includes the cost of deicing chemicals, decreased by $2.2 million and $4.5 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. The decrease during 2012 reflects the discontinuation of the BAX/Schenker North American air network in the fourth quarter of 2011.
Insurance expenses decreased by $0.6 million and $0.9 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011, primarily due to the reduction in Boeing 727 and DC-8 aircraft during the fourth quarter of 2011 and the first quarter of 2012.
Other operating expenses include professional fees, navigational services, employee training, utilities, and the cost of parts sold to customers. Other operating expenses decreased by $0.3 million and $0.0 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. During 2012, increased expenses for international aircraft operations were offset by lower costs stemming from the discontinuation of the BAX/Schenker North American air network.
Interest expense increased by $0.1 million and decreased by $0.4 million during the three and six month periods ending June 30, 2012, respectively, compared to the corresponding periods of 2011. Interest expense was higher for the three months ending June 30, 2012 compared to the corresponding 2011 period primarily due to an increase in the amount of borrowings under the revolving credit loan and an increase in the interest rates. The decline in interest expense for the first six months of 2012 compared to 2011 reflects the payoff of an aircraft loan in 2011 and an increase in capitalized interest for the aircraft undergoing freighter modification. Interest rates on the Company’s variable interest, unsubordinated term loan increased to 2.72% at June 30, 2012 from 2.25% at June 30, 2011. We expect interest expense to increase during the remainder of 2012 due to a higher level of debt which is being used to expand the Company's aircraft fleet.
During the three and six month period ending June 30, 2012, the Company recorded pre-tax net gains on derivatives of $0.2 million and $0.7 million , reflecting the impact of higher market interest rates since December 31, 2011 on the interest rate swaps held by the Company at June 30, 2012.
In 2011, the Company executed a new credit facility replacing its previous credit agreement. During the first six months of 2011, the Company wrote off $2.9 million of unamortized debt issuance costs associated with the former credit agreement. During the first six months of 2011, in conjunction with the termination of the former credit agreement, the Company terminated its hedge accounting of interest rate swaps related to the former term loan, which resulted in the recognition of $3.9 million of pre-tax losses which had previously been reflected in other comprehensive income.
Income tax expenses recorded through June 30, 2012, have been estimated based on year-to-date income and projected results for the full year, excluding discrete items. The effective tax rate for the full year 2012 is projected to be approximately 38.2%. The effective tax rate from continuing operations for the three and six months ended June 30, 2012 was 38.3% and 38.2% compared to 37.5% for the corresponding periods in 2011. The effective tax rate increased for 2012 due to having more earnings in certain taxing districts with higher tax rates as compared to 2011.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Net cash generated from operating activities totaled $64.6 million for the first six months of 2012 compared to $78.5 million for the first six months of 2011. Cash flows generated from operating activities decreased for the first six months of 2012 compared to 2011 primarily reflecting payments to vendors associated with the wind-down of the BAX/Schenker operations, partially offset by customer collections.
Capital spending levels were primarily the result of aircraft modification costs and the acquisition of aircraft for freighter modification. Cash payments for capital expenditures were $69.5 million in the first six months of 2012 compared to $102.7 million in the first six months of 2011. Capital expenditures in 2012 included $59.9 million for the acquisition of two Boeing 767-300 aircraft and the modification of aircraft, $5.3 million for required heavy maintenance and $2.8 million for other equipment costs. Capital expenditures for the first six months of 2011 included $84.2 million for the acquisition and modification of aircraft, $17.1 million for required heavy maintenance and $1.4 million for other equipment costs.
Proceeds of $2.5 million were received during the first six months of 2012 for the sale of aircraft engines and parts.
Net cash provided by financing activities was $19.4 million in the first six months of 2012 compared to $13.6 million used in the corresponding period in 2011. During the first six months of 2012, we drew $25.0 million from the revolver under the Senior Credit Agreement to fund capital spending and we made debt principal payments of $5.6 million . Additionally, $3.1 million of the principal balance of the DHL promissory note was extinguished during the first six months of 2012, pursuant to the CMI agreement with DHL.
Commitments
Through CAM, the Company continues to make investments in Boeing 767 and 757 aircraft. As these aircraft are modified, we will place them into service under dry leasing arrangements to external customers or ACMI operations using our airlines, depending on which alternative provides the best long term return and considering other factors, including geographical placement and customer diversification.
In August 2010, the Company entered into an agreement with M&B Conversions Limited and Israel Aerospace Industries Ltd. ("IAI"), for the conversion by IAI of up to ten Boeing 767-300 series passenger aircraft to a standard freighter configuration during the 10-year term of the agreement. As of June 30, 2012, four such aircraft have completed the modification process, two Boeing 767-300 aircraft were undergoing modification to a standard freighter configuration and one Boeing 767-300 aircraft was awaiting modification. If the Company were to cancel the conversion program as of June 30, 2012, it would owe IAI approximately $18.9 million associated with non-recurring engineering efforts, conversion part kits and to complete the modification.
In October 2010, the Company entered into an agreement with Precision Conversions, LLC (“Precision”) for the design, engineering and certification of a Boeing 757 "combi" aircraft variant. The Boeing 757 combi variant to be developed by Precision will incorporate 10 full cargo pallet positions along with seating for up to 58 passengers. As of June 30, 2012, one Boeing 757 had completed the modification process from a passenger to a standard freighter configuration and two other Boeing 757 aircraft were respectively in the process of undergoing modification from a passenger to a standard freighter configuration and from a passenger to a combi configuration. If the Company were to cancel the conversion program as of June 30, 2012, it would owe Precision approximately $10.2 million associated with engineering efforts, conversion part kits which have been ordered and to complete the modifications.
We estimate that total capital expenditures for 2012 could total $180 million to $200 million primarily for aircraft acquisitions and related modification costs involving Boeing 767-300 and Boeing 757 aircraft. Actual capital spending for any future period will be impacted by the progress in the aircraft modification process. We expect to finance the aircraft purchases and modifications from current cash balances, future operating cash flow and the Senior Credit Agreement.
CONF CALL
Joe Hete - President, Chief Executive Officer
Welcome to all of your joining us today for our fourth quarter conference call. I’m Joe Hete, President and Chief Executive Officer of Air Transport Services Group. With me today are Quint Turner, our Chief Financial Officer, Joe Payne, our Senior Vice President and Corporate General Council, John Graber who is President of ABX Air and Rich Corrado who joins us officially today as Chief Commercial Officer.
You may have seen the release we issued this morning announcing Rich’s return to the company. It’s great to have him with us and I’ll say more about that later about what we’ll be working on.
This is a big week for us, and for you as our shareholders. We and DHL have announced a new set of agreements that form the basis of a transformational change in our working relationship. Taken together, these agreements reinforce DHL’s long-term commitment to the international service strategy it adopted here in the U.S. more than a year ago and also signified the collective commitment of all the ATSG businesses to serving DHL’s customers not only here in the U.S., but anywhere in the world.
The agreements represent a brand new approach to the way we do business with DHL and bring to an end the lingering issues over the termination of our old agreements. With all of our 767 freighters now either deployed on an ACMI basis or dry leased under multi-year agreements and with more becoming available through our conversion investments, we are also poised to serve more new customers with these very attractive aircraft backed up by the most complete array of support services of any cargo operator in the world.
We know you have many questions about these agreements as well as our 2009 results. To help you better understand both, we are supplementing our remarks today with some graphics that help illustrate our results and the new agreements. You can follow along via webcast or download them later from our website atsginc.com.
Naturally, I have much more to tell you about these agreements and we want to allow plenty of time for your questions, so I’m going to stop here for now and let Quint Turner cover our year-end results.
Quint Turner - Chief Executive Officer
Good morning everyone. As always, I need to begin by advising everyone that during the course of this call, either in our comments or in our slide presentation, we may make projections or other forward-looking statements that involve risks and uncertainties and our actual results and other future events may differ materially from those we may describe here.
These forward-looking statements are based on information, plans and estimates as of the date of this call and Air Transport Services Group undertakes no obligation to update any forward-looking statements to reflect changes in the underlying assumptions or factors, new information or future or other changes.
These factors include but aren’t limited to changes in market demand for our assets and services, the timely completion of 767 freighter modifications as anticipated under ABX Air’s new operating agreement with DHL and ABX Air’s ability to maintain on time service and control costs.
There are also other factors that are contained from time to time in ATSG’s filings with the U.S. Securities and Exchange Commission including its annual report on Form 10-K which we filed last evening.
We may also refer to a non-GAAP financial measure, EBITDA and adjusted EBITDA which management believes is helpful to the investor in assessing ATSG’s financial position and results. This non-GAAP measure is not meant as a substitute for the GAAP financials and we advise you to refer to the reconciliation to the GAAP measure, which we have included in our slide presentation.
Challenging, but successful best describes 2009 for ATSG as we worked with our largest customer to phase out its U.S. domestic Air Express business while building our other businesses in a very tough economy.
The good news is that we finished the year in a much stronger financial position than we started it with a new collective bargaining agreement with AVX air pilots that will make us much more competitive in global markets and with a framework in place that led to the new multi-year agreements we have completed with DHL which Joe will cover in detail shortly.
Revenues from continuing operations for the year were $823.5million, down 13% from 2008 when we were still supporting a full-scale domestic package network for DHL. Our block hours of flying for DHL were down 78% last year. That, along with the scale backs in other services we provide them accounted for approximately $76.4 million of the reduction in revenues.
Lower aviation fuel prices were a big contributor to a $56.3 million decline in our ACMI services revenues. The average price for a gallon of fuel was 42% lower in 2009 than it was in ’08. On the other hand, revenues from our DHL agreements included $121.4 million related to the reimbursement of severance and other benefits to ABX employees primarily pilots.
These are largely non recurring although we expect to record some revenues from termination of the ACMI agreement this year.
Pre-tax earnings from continuing operations for the year were $45.4 million versus a loss in 2008 of $56.6 million. In ’08, we took a pre-tax impairment charge of $91.2 million on write-downs of goodwill and customer relationship intangibles of our ATI and CCI Airlines, the subsidiaries of Cargo Holdings International that we acquired in 2007.
Excluding the impairment charge, pre-tax earnings from continuing operations were $34.6 million in 2008. Net income for 2009 was $34.4 million, of which $6.2 million was generated by discontinued operations.
Fourth quarter revenues from continuing operations were $250.5 million in 2009, down slightly from $257 million in 2008. Revenues included $72.5 million and $22.7 million respectively in severance and other benefits paid to ABX employees.
Pre-tax earnings from continuing operations for the fourth quarter were $17.6 million versus an ’08 loss of $65.7 million largely due to the impairment charge. Excluding the impairment charge, 2008 pre-tax earnings were $25.6 million. Net income for the quarter was $11.5 million with $1.2 million from discontinued operations.
Two factors accounted for most of the change in our fourth quarter results. In 2008, we booked the entire year of annual markup benefits from DHL during the fourth quarter as we had in prior years, but in ’09 the annual markups were earned and recognized each quarter. In addition, we had a significant loss in the ABX Air portion of our ACMI services segment, primarily due to the trans-Atlantic scheduled service 767. This slight transition to a conventional ACMI service affected in February and will be profitable going forward.
In the third quarter of 2009, ATSG adopted reporting for discontinued operations primarily consisting of ABX Air support for DHL’s ground and package-sorting operations under the Hub and Line haul services agreement, which expired last August. It also includes ABX Air’s former aircraft fuel service operations, which DHL took over in July when they transferred their hub from Wilmington to the Cincinnati and Northern Kentucky airport.
Net earnings for discontinued operations contributed $6.2 million or $0.10 per diluted share for the year versus $6.9 million or $0.11 in 2008. Consolidated net earnings for the year were $34.4 million or $0.54 per diluted share. That compares with a consolidated net loss including the impairment of $56 million or $0.90 per diluted share in 2008.
We achieved a strong positive turn around in our balance sheet during the year, significantly de-leveraging the company. We reduced debt by $135.1 million or 26.4%. That included principal payments on our credit facilities of $43.1 million, a $46.3 million debt extinguishment related to the DHL promissory note and a $45.7 million reduction in our aircraft capital lease obligations as we transferred those leases to DHL.
Our debt to equity ratio improved dramatically year over year from 6.4 at the end of 2008 to 1.5 by the end of last year, as shareholder equity more than tripled to $246 million from $80.4 million in 2008.
In addition to debt reductions, our post retirement liabilities fell by $144.6 million or 48.6%. That included $83.2 million from company cash contributions, $75.8 million on gains on asset values as the market improved, $57.3 million gain as a result of the company’s scaling down its work force and freezing the employee pension plan, and $71.7 million of benefit costs and actuarial adjustments.
$37.8 million of the cash contributions we made was added to the ABX Air pilot pension trust in December of 2009, as a result of negotiations with the pilots to finally settle the $75 million severance fund available under the severance and retention agreement.
That’s a summary of our overall financial highlights for the quarter and year. I’m going to give you just a few brief comments on our segments this time to allow more time for Joe to cover our new agreements and to answer your questions. You can find the rest of the segment data in our earnings release and our 10-K.
Our DHL segment revenues from the ACMI agreement were down 37.4% for the year and down 50.4% for the quarter due to DHL’s transition to an international only domestic network as I discussed a moment ago.
Employee severance and retention revenues were $121.4 million for the year and $72.5 million for the quarter. Pre-tax earnings from the DHL segment were $27.9 million including $16.7 million stemming from the severance and retention agreement.
The fourth quarter pre-tax earnings of $14.1 million included $12.2 million related to a negotiated settlement of the $75 million severance fund provided for ABX Air pilot issues. A portion of the fund was directed to the retirement security of ABX Air flight crewmembers.
ACMI services had essentially flat revenues for the quarter and year excluding fuel and other reimbursed expenses. Block hours for this segment increased 11% in 2009 as we added both 767s and 757s to the fleets of our three airlines.
Segment pre-tax earnings were $541,000 in 2009, primarily as a result of losses on ABX Air’s operations including its trans-Atlantic scheduled services.
CAM revenues mainly from our other airlines were up 27.8% for the year and up 22.9% for the quarter. Pre-tax earnings were up 24.1% for the quarter and 25.8% for the year. CAM currently leases 43 aircraft, seven more than a year ago. 2009 results included $10.3 million in allocated interest expense, down from $12.4 million in ’08 on lower rates.
Three of our 767-200 cargo freighters were being leased to third party customers at year-end. A fourth was leased to AmeriJet in February with a fifth due to be delivered to them later this spring. Three 767 full freighter conversions were completed during 2009 and a fourth in early January, and a fifth in March. We expect to complete all 14 conversions by the end of 2011.
That’s a summary of our segment performance. Switching now to our cash flow, cash from operations for 2009 was $103 million, down from $161.7 million in 2008. A combination of the reduction of our DHL business and reimbursement payments from DHL for employee severance and retention not yet paid were the main factors.
Non-reimbursed interest expenses decreased $2.8 million year over year. Interest rates on the company’s variable interest unsubordinated term loan decreased from 4.5% in the fourth quarter 2008 to 2.9% in 2009 in part due to our improving EBITDA coverage ratio.
EBITA, which of course is earnings before interest, taxes, depreciation and amortization from continuing operations was $155.8 million in 2009 versus adjusted EBITDA of $163 million in 2008. Last year’s EBITDA excludes the $91.2 million impairment charge we spoke about earlier.
For the fourth quarter, EBITDA from continuing operations was $45 million versus adjusted EBITDA of $59.9 million in 2008, again, excluding the impairment charge.
Please note the reconciliation of earnings from continuing operations to adjusted EBITDA in our earnings release published yesterday, which is available on the ATSG website.
Our 2009 capital expenditures were $101.2 million, including $69.6 million for modification of ten 767s and the purchase of one extended range Boeing 767 aircraft in the fourth quarter, completing a purchase commitment made in 2007 when the company acquired Cargo Holdings International.
We also spent $25.6 million for capitalized airframe and engine overhauls and other equipment costs. Capital expenditures for 2008 were $111.9 million mainly to modify nine aircraft. We currently project $102 million in total CapEx spending in 2010 including approximately $30 million of maintenance CapEx.
Our effective tax rate for the quarter was 38%, roughly the same as in 2008 after adjusting for the impairment charge deductions. Looking ahead, due to our tax carry forward position, and our continuing investment in aircraft assets, we don’t expect to pay federal income taxes until 2013.
Now, I’ll turn the call back to Joe for his review.
Joe Hete - President, Chief Executive Officer
As I said at the beginning our new DHL agreements represent a new day for us. Under the old cost plus contract there was always the security of having your fixed costs largely covered, but very little opportunity to earn an acceptable return on investment.
Like DHL, we found that type of relationship too restrictive and not in the best interests of our customer. We’re both pleased that we can now get back to focusing on what’s important, which is delivering great service to all our customers and rewarding the shareholders that have stuck by us through a tough transition.
These new agreements improve on the ACMI agreement in several ways. They resolve all the issues of interest to our current and former employees, unlock the value of our aircraft assets, and trigger the full implementation of our new collective bargaining agreement.
Let’s review each of the segments beginning at the end of our former ACMI agreement. We terminated that agreement ahead of its expiration date in August, and are winding up the matters addressed in the Severance and Retention Agreement.
Several elements of the termination agreement resolve matters that we have been discussing with DHL for more than a year including our aircraft put values. The amounts we have agreed upon involve compromises and tradeoffs, but measured against the scope and scale of the leases from CMI, these are good outcomes and will improve our 2010 results.
As we have said before, we agreed to prepay $15 million against the note when we signed the option agreement with DHL last year. That will bring the note balance down to $31 million before it begins to amortize under the CMI.
The payments for settlement of remaining retention benefit items will clear up not only vacation pay reimbursements and other compensation items for former employees. The $11.2 million agreed additional payment related to vacation payout for severed employees includes $7.1 million we had booked in 2009. Severance and other issues related to the ABX Air pilots were resolved in December.
The termination agreement winds up the past. Now let’s look at the future with DHL, which starts today.
Prior to today, ABX Air had an ACMI agreement with DHL that bundled the rent on the aircraft with the cost of operating them. That rent was based on depreciation plus the 1.75% markup. The new agreements pull out the aircraft element, thereby unlocking their true value.
CAM, our leasing entity, will provide DHL with up to 13 dedicated 767 freighters for up to seven years at rates that reflect the scope and scale of DHL’s commitment. The lease rate cover our carrying costs including interest and will earn us a much-improved return.
All 13 of the DHL aircraft will be full freighters with standard cargo doors. Freighters currently outside the DHL network will replace on an interim basis some of the PCs that have not been converted. We’re about half way through that process, and our conversion partner IAI is running ahead of schedule. We will blend the rest into the DHL network as IAI completes them between now and the first quarter of 2011.
DHL has told us they may want to lease more aircraft from us over the next seven years either for the U.S. network or elsewhere, and our agreement lays out terms for those as well.
DHL is responsible for routine heavy maintenance of the 767 aircraft as a term of the leases, but our AMES subsidiary will do that work for the next three years as a reimbursable expense under the CMI agreement.
We negotiated these terms while fully aware of DHL’s air transport decisions in other parts of the world. We’re also aware that our 767s represent the best replacements for some of the aircraft they operate. That’s why we’re confident that these leases will prove to be great deals for both of us over the next seven years.
Moving on to the CMI agreement, you see that we will remain the backbone of DHL’s U.S. air network, a role that ABX has played since 2003, and replaced what had been seven year agreement with one that could with mutual agreement, extend up to 10 years. It gives DHL very competitive fixed rates with pre-determined annual escalators, which are based on the more competitive rates and work rules in our new collective bargaining agreement.
The agreement makes clear that the ABX air pilots have the exclusive right to operate up to 13 767-200s deployed by DHL in its US network or elsewhere in the world before they can engage the services of another 767-200 operator in the U.S. network. Any additional 767-200s they might operate in the U.S. could be operated by other air carriers.
The CMI also anticipates pricing for flight crews, additional aircraft leases and other services if DHL opts to expand our role in their network.
A key factor to keep in mind is that the balance of the new CBA provisions take effect on the commencement date of the CMI agreement. That means that ABX Air is today much more competitive as either an ACMI or charter services provider than it was before.
The CMI has fixed incentive rewards for ABX Air if it continues to deliver great service as it has all along, under benchmarks that we and DHL have agreed on as challenging, but achievable.
We have proven over the years the outstanding level of service that our people an aircraft can provide. The goals apply only to delays subject to our control and there are dis-incentives if we should fail to measure up.
As I said a moment ago, DHL has agreed to use our AMES operation for heavy maintenance on the 767s for at least three years. The restructuring we completed last spring to create AMES by pulling it out of ABX and establishing a leaner cost structure was a big reason we have been able to keep this business, given greater competition from offshore vendors.
With our ownership of these aircraft assets and our role in operating them, we intend to work hard to retain the maintenance fees after the three-year commitment is up. The principal advantage to us of this agreement however, is it directly incents us to continue to work harder to reduce overhead and other costs that don’t involve safety or performance.
We will be looking even harder at re-working procedures that have added to our costs in the past and created nothing of value for the customer. That could over time include changes that might require extra flexibility from some of our employees and vendors. We will pursue those savings where we find them and always seek a fair and reasonable solution.
The CMI agreement may also serve as a model of relationships we could pursue with other customers or as a means for other carriers to smoothly add our aircraft and capabilities into their networks. We think it just makes good sense to be open toward as many different combination of ATSG’s capabilities as customers might envision to meet their business objectives.
That means being more customer centric and building relationships with them that may begin with one type of service but might lead into others as their needs and confidence in us evolves. Pursuing those options is very much at the forefront of our planning and development efforts.
As I mentioned at the outset, we have brought Rich Corrado back to the company as Chief Commercial Officer. Rich was here during the Airborne years and briefly was with DHL. He has been instrumental in building our marketing strategy as a consultant over the last several months. I’m pleased to have him here to help me chart our new integrated growth strategy.
Our experience with AmeriJet shows how we can marshal all of our resources to meet a particular set of customer requirements in one package and what that could mean to customers. We were able to handle nearly all the arrangements to lease and gain certification for our aircraft, train pilots, establish maintenance support and put it all together in a turnkey package with contributions from several of our ATSG companies.
Our flexibility and the benefits of our CBA are also in evidence in our new restructured relationship with TNT. It became clear to both of us last year that Transatlantic shared space charter service we launched wasn’t working out.
Trying to build revenue in the face of a global recession and the cost to position and schedule our crews, proved to be too much of a challenge and our losses in this service were significant. We have learned a tough lesson, but I’m happy to say the new CBA together with great cooperation from TNT now makes this service work better as an ACMI arrangement. That new ACMI service that began with one aircraft 767 in February was expanded with a second aircraft that started flying for TNT this week.
There are many other elements to our DHL agreements and our new integrated marketing approach that I could talk about, but I know you have a lot of questions already about what we’ve announced and we’ll get to them in just a moment.
While it’s nice to be able to say that our stock was one of the best performers on Wall Street last year, that says a lot more about where we started than where we are today, even with yesterday’s 45% gain. From our low point last year, when our market value was less than the value of one of our 767’s, to our closing price yesterday of $3.35, the market is still saying that we’re only worth about ten of them.
Given the size of the fleet including our 767s, 757s, DC-8 combis, and 727s, we are clearly worth much more on both an absolute and relative basis than even a conservative assessment of our size, multiple year DHL agreements, other prospects, cash generating potential and stronger balance sheet would dictate.
I know that you will be watching as I will for the markets to take note as the dramatic changes in our business over the last six months. By the time of our next call in May, I very much hope to be able to share the news that we have begun to move rapidly in that direction.
With that, we’ll take questions.
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Fund Letters
