Air Transport Services Group, Inc. (NASDAQ:ATSG) Q3 2023 Earnings Call Transcript
Air Transport Services Group, Inc. (NASDAQ:ATSG) Q3 2023 Earnings Call Transcript November 7, 2023
Operator: Good day, and thank you for standing by. Welcome to the Q3 2023 Air Transport Services Group, Inc. Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to turn the conference over to your first speaker today, Joe Payne, Chief Legal Officer. You can now go ahead.
Joe Payne: Good morning, and welcome to our third quarter 2023 earnings conference call. We issued our earnings release yesterday after the market closed. It's on our website, atsginc.com. Let me begin by advising you that during the course of this call, we will make projections and other forward-looking statements that involve risks and uncertainties. Our actual results and other future events may differ materially from those we described here. These forward-looking statements are based on information, plans and estimates as of the date of this call. Air Transport Services Group undertakes no obligation to update any forward-looking statements to reflect changes in underlying assumptions, factors, new information or other changes.
These factors include, but are not limited to, unplanned changes in the market demand for our assets and services; our operating airline's ability to maintain on-time service and control costs; the cost and timing with respect to which we are able to purchase and modify aircraft to a cargo configuration; fluctuations in ATSG's traded share price and in interest rates, which may result in mark-to-market charges on certain financial instruments; the number, timing and scheduled routes of our aircraft deployments to customers; our ability to remain in compliance with key agreements with customers, lenders and government agencies; the impact of current supply chain constraints, both within and outside the U.S., which may be more severe or persist longer than we currently expect; the impact of the current competitive labor market; changes in general economic and/or industry-specific conditions, including inflation; the impact of geographical events and other factors as contained from time-to-time in our filings with the SEC, including the Form 10-Q we will file next week.
We will also refer to non-GAAP financial measures from continuing operations, including adjusted earnings, adjusted earnings per share, adjusted pretax earnings, adjusted EBITDA and adjusted free cash flow. Management believes these metrics are useful to investors in assessing ATSG's financial position and results. These non-GAAP measures are not meant to be a substitute for our GAAP financials. We advise you to refer to the reconciliations to GAAP measures, which are included in our earnings release and on our website. And now I'll turn the call over to Joe Hete, our CEO, for his opening comments.
Joe Hete: Thank you, Joe. Good morning, everyone. We appreciate you all joining us. Before we discuss our third quarter results, I would like to address the leadership transition we announced yesterday. This change is the result of careful and thoughtful deliberation by the Board of Directors. On behalf of the Board, I want to express our sincere gratitude to Rich for his contributions to the company. We wish him all the best. I am honored and energized to be stepping back into the CEO role. Having served as ATSG's CEO from August 2003 to May 2020 and continuing as a Board member after that, I believe I bring a unique perspective and skill set to the position. That aside, we are operating in an incredibly dynamic and challenging market environment.
There are certain issues that are within our control and others that are not. But we recognize that our recent financial results need to improve. There's more work to be done. And I'm committed to working collaboratively with the entire team to position our business for the future. Despite the challenging macroeconomic headwinds, ATSG is an incredibly resilient organization. With our differentiated business model, diverse customer base and unique competitive position, I believe we are poised to capitalize on the long-term opportunities ahead. I look forward to continuing to build on our strong foundation to deliver value for our shareholders. With that, I will now turn the call over to Quint Turner to discuss our financial results for the quarter.
And I will return to close our prepared remarks. Quint?
Quint Turner: Thanks, Joe, and welcome to everyone joining us this morning. While July started out in line with our expectations, our results were impacted by macro and operational challenges later in the third quarter. The next slide, Slide 4 summarizes our financial results for the third quarter. Our revenues grew $6 million or 1% versus a year ago to $523 million. This was driven by higher revenue in the ACMI Services and partially offset by a decrease in revenue in the leasing segment. Our GAAP pretax earnings were down $41 million and diluted earnings per share were $0.24 versus $0.57 in the third quarter of 2022. On an adjusted basis, pretax earnings fell $36 million to $31 million and EPS was down $0.28 to $0.32. In our aircraft leasing segment, CAM, pretax earnings were down $14 million compared to a year ago at $23 million.
11 767-200 freighters have been returned as scheduled since September 2022, including 2 in the third quarter. Power-by-cycle engine revenue was also reduced due to fewer 767-200s in service as well as fewer cycles flown by those 200s still in service. Additionally, the lack of aircraft sales during the quarter versus two in the prior year period negatively impacted our year-over-year comparison. Taken together, the effect of these items, all related to our 767-200 fleet, reduced pretax earnings from the prior year quarter by $13 million. Interest expense was $4.7 million higher than the prior year quarter. Those items offset $7.3 million in additional lease revenue from 10 more freighters added to service. In our ACMI Services segment, pretax earnings were $12 million, down $13 million compared to the third quarter of 2022.
This was driven by a mix with more military and less commercial flying, fewer hours over long-haul international routes for cargo customers, the effects of inflation and payroll costs and service challenges in our passenger operations. Earnings from cargo operations together were down $6 million and passenger operations pretax was down $7 million. Total airline block hours were down 1% versus the prior year quarter as increased passenger hours were unable to fully offset a drop in cargo hours. Cargo hours decreased 4% and passenger block hours, including combi flying for the military, were up 14%. Our 757 combi operations resumed services over a transpacific route last fall. Turning to the next slide. Our third quarter adjusted EBITDA was $137 million, down 16% compared to the prior year period.
On a trailing 12-month basis, adjusted EBITDA was down $39 million to $594 million. As you can see, even with the year-over-year decrease, CAM still makes up the bulk of our EBITDA, and we still consider this to be our core business. We project 16 freighter lease deployments in 2023, including 12 767-300s and our first 4 A321-200s. Since September 2022, our in-service fleet increased by 6 aircraft. The next slide details our capital spending. Total CapEx for the quarter was $168 million, comprising $120 million in growth CapEx and $48 million in sustaining CapEx. As you may recall, we lowered our capital expenditures outlook for the year last quarter. We continue to expect total capital spend of $785 million for 2023, $240 million of that will be sustaining CapEx and $545 million will be for growth.
The next slide covers our updates to adjusted free cash flow as measured by our operating cash flow, net of our sustaining CapEx. Operating cash flows decreased $30 million to $118 million for the quarter and were $600 million for the trailing 12 months. Adjusted free cash flow was $400 million over the last 12 months. That equates to approximately $6 per share based on our outstanding shares as of September 30. On the next slide, you can see that available credit under our revolver facilities in the U.S. and abroad was $428 million at the end of the third quarter. This table reflects the recent convertible note refinancing transaction we completed as well as the subsequent share repurchases we made. Combined, we bought back 9.4 million shares over the past year with 5.4 million of those purchased in the third quarter alone.
Our balance sheet remained strong with net leverage under 3x, putting us in a strong position to complete this year's investment plans. Now I'm going to turn the call over to Mike Berger, our President, who will summarize the issues that have developed since September and how they have affected our outlook for the rest of the year. Mike?
Mike Berger: Thanks, Quint. Most of you are aware that at our Investor Day event in September, we reaffirmed our 2023 adjusted EBITDA guidance of $610 million to $620 million. At the $615 million midpoint of that range, that implies $320 million in the second half on top of the $295 million we delivered in the first half. We reviewed the latest results from each of our businesses before the event. And while we told you then about the risk around CAM's second half lease deployments and second half outlook for our airlines, we thought our plan was still attainable. But since then, a great deal has changed in the macro environment for air cargo capacity as most of you are aware and are hearing on earnings calls and reading the trade press and the performance of our passenger airline, Omni Air.
To illustrate how those changes have affected our outlook, I'm going to focus on adjusted EBITDA and show you why we are reducing our guidance by about $45 million to a range of $560 million to $580 million. This slide shows that our prior guidance for the second half on the left, the midpoint of our new guidance of $270 million on the right and some key factors behind the changes. The vast majority of that $45 million reduction, about $43 million, stems from 2 pieces of our business: freighter leasing at CAM and Omni's passenger flying. It's important to note that our cargo airlines, ABX Air and ATI, are on track to meet their adjusted EBITDA targets for the year. Quint told you about the service delays and related higher costs that affect Omni's results for the third quarter.
Some of those higher costs are continuing. But the main reason for Omni's new fourth quarter outlook is the conflict in the Middle East, which began on October 7. Events in that part of the world have affected Omni's normal fourth quarter requirements for its government customers, which typically peak in October each year. Also, Omni's outlook for higher-margin commercial flying in the fourth quarter is lower than before. Omni's third quarter results include a good July and an August that was close to plan. Obviously, the disruptions in the Middle East were not part of our plan when we spoke to many of you in late September. We are closely monitoring Omni's progress and the global factors that drive its demand. Of the $45 million guidance reduction overall for the second half, more than 1/3 of it is attributable to Omni.
Moving to CAM. Our new second half guidance reflects issues in three key areas: freighter and related engine leasing through the end of the year; planned changes in the 767-200 fleet, including sales of those aircraft types; and our current assessment of the new information we're receiving from some of our current 767-300 lease customers outside the U.S. CAM had a strong July for freight release deployments, although some were delayed from earlier in-service projections. We now expect to deliver 16 newly converted freighters by the end of the year, which is 3 fewer than we mentioned before. Leases of engines for 767-300s, which have been a significant contributor in the first half, have decreased. Quint mentioned in his remarks that CAM had intended to sell 767-200s in the second half at prices that would yield significant returns on those fully depreciated assets.
We expect to sell a couple this quarter and others in 2024. Additionally, in mid-October, we were contacted by certain airline customers of CAM expressing that they were experiencing lower customer demand, which is negatively impacting their financial results and outlook. Our guidance reflects appropriate adjustments to address the potential effect of that new information. I think I speak for the entire management team in saying that we are probably even more unhappy to have to give you these dues as you are to receive it. The air cargo industry is undergoing rapid changes this fall as you are hearing everywhere else. Unfortunately, we are not immune to that. We still believe that our strategic direction to serve the airlines who will remain in the express package fulfillment business will eventually yield great results.
Now I'll turn the call back to Joe Hete for some closing remarks.
Joe Hete: Thanks, Mike. To echo Mike and Quint's words, I want to add that the Board believes just as strongly in the long-term goals of the company to grow and achieved strong returns from leasing and operating mid-sized freighters and passenger aircraft. The growth capital we have spent over the last several years plus what we will spend in the next several years made sense to us even before the pandemic, when freighters were the hottest commodity in the aircraft business. I regard our foundational assets, mid-sized freighters, and the foundational customers we lease to and fly for, DHL, Amazon and the military, has a strong platform that will sustain the company through challenges and support continued long-term cash flow.
I hope to bring back what I was probably best known for when I was CEO, leveraging my decades of experience in this industry to assess all of our options to deploy our capital for greater shareholder return and best-in-class customer service. One of Rich Corrado's many talents, which is a key part of why we chose him to run the company, was his insights about the markets we serve and where our range of capabilities fit best. That insight has served us well for several years, but those market conditions have changed. Our new reality is that growth will be more difficult to achieve than before. We faced similar periods before. And I'm confident we can maintain the resilience that has been a hallmark of the company and keep it moving ahead in any climate.
The Board's view and mine is that we need to take a more conservative view of when and where we can best invest for the greatest shareholder return and sharply reduce our capital spending program in 2024 and beyond. We now plan to spend $505 million in 2024. That's down $100 million in capital spending compared to the 2024 plan provided at the end of September and down $280 million from this year's projected spend. That new 2024 outlook is driven by fewer conversions and only essential feedstock purchases. That includes purchases of Airbus A330 aircraft we will begin leasing next year. 2024 planned projected lease deployments of 14 converted freighters, including 6 767-300s, 5 A321s and 3 A330s. We are introducing no additional 767-300s for conversion beyond the 7 currently in process.
As I've said in the past, we always have the flexibility to not convert some of the aircraft we own until market conditions improve. It's too early to estimate our 2024 adjusted EBITDA. But with these capital spending reductions and the items that Mike mentioned earlier, we plan to provide new adjusted EBITDA guidance for 2024 during our fourth quarter earnings call in February. I can make one positive prediction about 2024, however, cutting our growth CapEx spending means our free cash generation will be higher than it would have been under the prior plan through 2024 and 2025. That concludes our prepared remarks. Quint and I, along with Mike Berger, our President; and Paul Chase, our Chief Commercial Officer, are ready to answer questions.
May we have the first question?
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