Air Transport Services Group, Inc. (NASDAQ:ATSG) Q4 2022 Earnings Call Transcript

Air Transport Services Group, Inc. (NASDAQ:ATSG) Q4 2022 Earnings Call Transcript February 24, 2023

Operator: Good day, and thank you for standing by. Welcome to the Air Transport Services Group Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question and answer session. Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Joe Payne, Chief Legal Officer. Please go ahead.

Joe Payne: Good morning, and welcome to our fourth quarter 2022 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 describe 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; factors relating to the COVID-19 pandemic, including that the pandemic may continue for a longer period or its effect on commercial and military passenger flying may be more substantial than we currently expect; disruptions in our workforce and staffing capability; disruptions in our ability to access airports and maintenance facilities or adversely impact our customers’ creditworthiness and the continuing ability of our vendors and third-party service providers to maintain customary service levels; and other factors as contained from time to time in our filings with the SEC, including the Form 10-K 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 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 Rich Corrado, our President and CEO, for his opening comments.

Rich Corrado: Thanks, Joe. Good morning, everyone. 2022 was an exceptional year for ATSG. Even with rapid inflation and delays at our 767 freighter conversion vendor, your company still exceeded its 2022 financial goals of $640 million in adjusted EBITDA and $2 in adjusted EPS. We also began to invest in new freighter platforms from the Airbus family while maintaining our leadership in Boeing 767 freighter leasing. I am very proud of the excellent planning and execution throughout the company that drove our considerable success. Many of those efforts are playing into our outlook for 2023. Despite some headwinds, we expect more adjusted EBITDA growth and accelerated growth in 2024 and later years. I’ll be back to share more of that perspective after Quint reviews our financial results for 2022. Quint?

Quint Turner: Thanks, Rich, and welcome to everyone on the call this morning. The next slide in our deck summarizes the strong 2022 results that Rich highlighted. Our consolidated revenues for 2022 grew $311 million to $2 billion, another all-time high for revenues at ATSG. Our adjusted EPS increased by more than 40% to $2.28 compared with $1.61 in 2021. That was well above the $2 target we set a year ago. Adjusted pretax earnings increased 51% and adjusted EBITDA rose 18%. Earnings from our airline businesses, along with the momentum of our leasing returns from CAM, produced most of the EPS gain above our target. We are projecting lower EPS for 2023, as Rich will discuss in his remarks, mainly because of increased interest expense on our current fleet additions and inflation effects, particularly in our ACMI Services segment.

On the next slide, you can see that versus the 12 months ended in December 2021, our adjusted EBITDA grew a record $100 million or 18% in 2022. That improvement includes a full year of cash flows from the 15 newly converted 767 freighters we deployed in 2021 and more than doubling our earnings from ACMI Services. For adjusted EBITDA, we exclude, among other items, the changes in values of our financial instruments and the benefits of federal pandemic release assistance for our passenger operations under the payroll support programs for the 2021 period. On the next slide, you’ll see that our capital spending finished the year at just under $600 million, $25 million less than we projected last quarter. We separate what we call sustaining CapEx, mainly for airframe and engine maintenance, technology and other equipment from the spending we allocate to fleet expansion.

Sustaining CapEx was $187 million for the year, up $4 million. Growth CapEx was $412 million, up $90 million from the prior year, both to convert existing aircraft to freighters and to buy more feedstock passenger aircraft. In 2022, those purchases included 8 Boeing 767s and 6 Airbus A321s. We deployed and leased 6 newly converted 767 freighters last year. Turnaround times at many passenger-to-freighter aircraft conversion houses remain well above pre-pandemic levels despite their efforts to increase throughput. We expect those bottlenecks to lessen this year. The next slide updates our adjusted free cash flow as measured by our operating cash flow, net of our sustaining CapEx. Adjusted free cash flow of $285 million last year was down $115 million from the year-earlier period and down $88 million for the 12 months ended last September.

Cash flows from federal grants in 2021 were $83 million. All of that cash was received in the first half. Our full year 2022 results reflect the impact of the temporary fourth quarter increase in working capital related to reimbursement of fuel costs from Omni’s federal government customers. We project our growth capital investments to exceed adjusted free cash flows until 2025 when we expect that trend to reverse. Through 2024, we expect our debt leverage ratio to remain under 3 times and begin to decline in 2025. You may have already seen the 2023 guidance we provided in the earnings release we issued yesterday. Rich will cover some of the factors that will affect our earnings and cash flow in his remarks. I wanted to provide some color around the significant increase in our CapEx budget of $850 million this year and the strategic decisions and steps that prepare the way for our growth investments in 2023 and 2024.

Photo by John McArthur on Unsplash

The bulk of our CapEx this year and in 2024 will continue to fund the expansion of our leased 767 fleet. The other major driver of our stepped-up growth in spending over the next several years is our decision to begin offering our lease customers to other freighter types, the Airbus A321, a narrow-body midsize trader designed to replace retiring Boeing 757s, and the A330, a wide-body midsize freighter that will complement our still expanding fleet of 767s. We started this freighter platform expansion from a strong financial position. Through 2022, our debt-to-adjusted EBITDA ratio as calculated under our bank agreement was below 2 times and well below our average over the last several years. We also acted in 2020 and 2021 to lock in favorable fixed rates by issuing 7-year unsecured notes at a 4.75% coupon rate and amended our senior credit facility to increase our borrowing capacity, free of some collateral, and accommodate the resumption of our stock repurchase program.

Available credit under our revolver was $365 million at the end of 2022, with an option for additional capacity subject to bank approvals. To coincide with our increased business with airlines in Europe and Asia, we intend to establish a similar $100 million credit facility in Ireland in the next few days. When our fleet development program is at its peak in 2024 and lease revenues from Airbus fleet additions are just beginning, we project that our leverage ratio will still remain less than 3 times. After that, we expect to begin delevering in 2025. I also want to note that even with higher CapEx spending, we have the liquidity and cash flow visibility to continue to accommodate opportunistic share repurchases under the $150 million facility the Board created last fall.

As we noted in our release, we repurchased 2 million shares or about 3% of those outstanding during the fourth quarter after pandemic grant restrictions on our repurchases expired. With that summary of our financial and operating results, I’ll turn it back to Rich for some comments on our operations and outlook. Rich?

Rich Corrado: Thanks, Quint. The earnings release we issued yesterday listed some key 2022 operating accomplishments that contributed to the financial results that Quint just reviewed. Let me highlight them and share some additional color to give you more insight about how well we performed last year. Overall, we added 13767 freighters in 2022, 6 of which were CAM owned and leased to third-party customers. CAM also re-leased 1767-200 and extended leases on 4 other 200s. Two of the 6 newly converted 767-300 freighters leased last year are also being operated by ATSG’s airlines under crew, maintenance and insurance agreements. We also added 7 other 767-300s to our fleet under asset-light CMI arrangements. Those were assigned to our airlines by customers who obtained them elsewhere but shows our airlines, ABX Air and ATI to fly them.

They joined 6 others we were already operating on the same basis. We expect our customers to assign us 3 more in 2023. These decisions by our customers attest to their confidence in the airline services that we provide. Our original 2022 plan called for more freighter leases, but both vendor and regulatory issues prevented us from reaching our targets. Our principal 767 conversion vendor, IAI, continues to add conversion capacity but throughput times remain well behind pre-pandemic levels. Anticipating delays, we decided to book several conversion slots with Boeing in 2021 and added more in 2022. Boeing will convert 4 of the 767-300s we expect to deploy this year. We believe that a combination of additional slots and faster throughput will allow us to meet our 2023 fleet expansion goals.

Another challenge is gaining approvals from the regulatory agencies to put our converted A321-200 freighters into service. Three of the 6 A321s that CAM intends to lease this year, including CAM’s first 2 to ASL Aviation in Ireland, are ready to go with regulatory approval. We expect that to happen by midyear. To prepare for our step-up in fleet investments starting this year, CAM was active in the feedstock market in 2022. Through purchases and other commitments, CAM now controls all of the passenger aircraft it requires for our anticipated 20 freighter leases in 2023 and nearly all of those that were leased in 2024. Please go to the next slide. Quint noted that the scale of our fleet investments will be much larger over the next few years and then we have the financial backing to complete them.

To those who might be concerned about whether customers will be ready to make long-term lease commitments for those aircraft as they complete conversion, it’s important to understand that the surge in U.S. e-commerce activity that preceded and soared during the pandemic is only now beginning to surge in other parts of the world. The e-commerce portion for retail sales is still growing rapidly elsewhere, including Eastern Europe, Asia, Africa and Latin America as air networks expand. Accordingly, more than 80% of CAM’s leased freighter deployments over the next several years will be to airlines operating outside North America. And many of them will operate in networks established by DHL and other integrators who lease our freighters themselves but where rules limit where they can operate directly.

Turning to our airlines. Some of the continuing growth in e-commerce fulfillment in the U.S. last year led to expansions of their fleets and more operating block hours. ABX Air and ATI added 9 767 freighters, including 7 assigned to them. Block hours of flying for all 3 airlines increased 8%, with a 9% increase in cargo operations and a 4% gain in passenger operations. Even with 1 fewer 767 in its fleet, Omni still completed a strong schedule of passenger airline missions for government customers. Also, the Department of Defense restored our full combi schedule, including our longest route in the fourth quarter. We are also proud to note that a year ago, DHL agreed, once again, to extend and expand the long-standing commercial relationship we’ve enjoyed with them since the inception of ATSG as an independent public company in 2003.

The agreement extended our airline service in support of DHL’s U.S. Express network for 6 years and included the lease of 3 more 767-300 freighters from CAM. Our deployment schedules include still more 767s plus some A330s for DHL’s global network. Please go on to the next slide. Those were a few of the operating and commercial successes that helped us generate record revenues, adjusted EBITDA and adjusted EPS in 2022 and will contribute to our results for several years to come. In 2023, ATSG expects to generate between $650 million and $660 million in adjusted EBITDA and between $1.85 and $2 in adjusted earnings per share. Those targets reflect a record pace of 20 freighter lease deployments I mentioned a moment ago and which we announced to the market on February 6.

Four of the international companies we will lease freighters to in 2023 and 2024 are new customers, supporting Air Express networks in other regions. Several years ago, we began to expand our sales and marketing outreach to customers where e-commerce is just beginning to take hold, and those efforts are paying off in record demand for our freighters today. Later in the year, CAM will begin the passenger-to-freighter conversions of our first A330-300 for lease delivery in 2024. CAM expects to convert and lease 30 such aircraft by 2028, two-thirds of which are already backed by customer commitments. CAM will also begin conversion of a projected 16 767-300 freighters it expects to lease in 2024, most of which have customers awaiting them. ATSG’s 2023 outlook also includes the return of 8 of the 12 767-200 freighters that ATSG leased to Amazon in 2016.

The remaining 8 will be re-leased, sold or harvested, with their engine added to the power by cycle pool for 767-200 lease customers. ATSG also expects inflationary and schedule reduction impacts on our airlines in 2023, when we expect fewer hours of flying for our ACMI and CMI customers. We remain positive on ATSG’s long-term growth opportunities with our major U.S. air network customers and expect to add 3 customer-provided aircraft this year. We expect that 2024 and 2025 will bring the resumption of strong earnings and cash flow growth from today’s investments, with year-over-year growth of about 10% in adjusted EBITDA and even stronger growth in our leasing segment. Few companies have customers committed to long-term agreements that will generate the kind of cash flow visibility that ATSG enjoys.

We have a strong balance sheet, a leadership position in the midsized freighter leasing market and the strong backing of investors in our credit facility and debt securities, who regard the feedstock aircraft we are acquiring as prime assets. Our employees are also prepared to execute all of our 2023 plans with a goal to turn exciting opportunities into long-term superior returns for shareholders. That concludes our prepared remarks. Quint and I, along with Mike Berger, our Chief Strategy Officer, are ready to answer questions. May we have the first question, operator?

See also 11 Best Energy Dividend Stocks to Invest In and 12 High Growth NASDAQ Stocks That are Profitable.

Q&A Session

Operator: Our first question comes from Jack Atkins with Stephens. Your line is open.

Grant Smith: This is Grant on for Jack. I just wanted to dig in a little bit on the 2023 guidance really on the ACMI side and kind of how you’re expecting that to play out maybe first half versus second half. And you mentioned in your fleet update that the first half would see a year-over-year decrease in block hours with your larger customers. And today, you talked about a full year block hour decrease year-over-year in cargo and passenger. Just maybe any color on how you’re thinking about ACMI over the course of the full year would be great.

Quint Turner: Yes. Thanks for the question. In terms of ACMI, the block hour decrease that we talked about, remember, we had the resumption for ATI of a combi route in the fourth quarter of ’21, so we’ll have that for the full year in — or excuse me, fourth quarter ’22, and we’ll have it for the full year of ’23. And we consider that as passenger, but of course, the other passenger hours being flown by Omni primarily for its governmental and the DoD and governmental customers. We expect passenger and cargo hours to be down. They’ll be down less than 5%, we would anticipate, year-over-year for the full year. And I think really in terms of differentiating, it’s — we do expect perhaps in the second half to see, as we typically do, and you see a lot of the forecast, some recovery, particularly on the cargo side, where hours may pick up seasonally.

But on the pack side, it’s more of — we expect sort of a steady environment. Those are sometimes a little tougher to forecast. As you know, some of those hours, you don’t have as much notice on. We’ve had events happen in the world that can affect the demand particularly for Omni on the military side. We do anticipate, I believe, in the — based on what we’ve seen in the first quarter, we may see some reduced hours in flying for Omni on the governmental side, if that helps. But basically, that part, the tax line, we’re assuming pretty much steady state in the absence of having any specific information about the second half.

Grant Smith: And if I could just follow up 1 more thing. So you mentioned the strength internationally in e-commerce and what you’re hearing for your customers. Maybe if you could just talk a little bit on your U.S. customers. And maybe is there any more negative commentary you’ve heard from them? Any calls for concern as you maybe think about trying to re-lease those 767-200s as you mentioned?

Mike Berger: Yes. No, thanks, Grant, for the call. It’s Mike Berger. From a U.S. perspective, as Rich mentioned, just to go back to Rich’s remarks, our order book for the next couple of years, ’23 and ’24, has really been dominant, over 80% leased outside the U.S. from an international perspective. So our strategy to move forward further globally that we started several years ago now really is taking hold and will continue to. So we — while we continue to look for opportunities within the U.S. and we’ll continue to support our customers’ growth where needed, our opportunities have really been greater outside the U.S. and we continue to push that way.

Operator: Our next question comes from Helen Becker with Cowen. Your line is open.