Air Transport Services (ATSG) - 2018 Q4 - Annual Report

Part I Business Air Transport Services Group provides aircraft leasing and air cargo services, with 2018 marked by the Omni Air acquisition and expanded Amazon agreements Company Overview ATSG offers a comprehensive suite of services including aircraft leasing, airline operations, and various support functions to the air logistics industry - The company's core services are aircraft leasing (CAM), airline operations (ABX, ATI, OAI), and support services (ground services, aircraft maintenance, flight support)[4] - CAM's business model focuses on acquiring passenger aircraft (typically 15-20 years old), converting them to freighters, and leasing them under multi-year agreements, which is more economical than leasing newly built freighters[4] Business Development Key 2018 developments include the acquisition of passenger airline Omni Air, a significant expansion of agreements with Amazon, and the purchase of twenty Boeing 767-300ER aircraft for future conversion - Acquired Omni Air International (OAI) on November 9, 2018, a leading provider of passenger airlift for the U.S. Department of Defense (DoD), expanding customer offerings and adding Boeing 777 operating authority[5] - Amended agreements with Amazon in December 2018 to lease and operate 10 additional Boeing 767-300s, extend terms on 20 existing aircraft leases, and extend the Air Transportation Services Agreement (ATSA) through March 2026[5] - In conjunction with the expanded Amazon agreement, Amazon will be issued warrants that could increase its potential ownership from 19.9% to approximately 33.2%, with the potential to reach 39.9% by leasing up to 17 more aircraft before January 2026[5][7] - Entered an agreement in December 2018 to acquire twenty Boeing 767-300 extended-range passenger aircraft from American Airlines over the next three years for freighter conversion[7] Revenue Information In 2018, revenues were primarily driven by the ACMI Services segment, with Amazon, DHL, and the U.S. DoD representing the company's largest customers 2018 External Revenues by Segment (in thousands) | Segment | CAM | ACMI Services | MRO Services | Other Support Services | | :--- | :--- | :--- | :--- | :--- | | External revenues | $156,516 | $548,804 | $117,832 | $69,193 | 2018 Revenue by Major Customer | Customer | Percent of Consolidated Revenues | | :--- | :--- | | DHL | 26% | | Amazon | 27% | | DoD | 15% | | Other | 32% | Description of Business The company's business is structured around aircraft leasing (CAM), airline operations (ACMI Services), and a vertically integrated support services division - CAM's fleet consisted of 91 serviceable Boeing 777, 767, 757, and 737 aircraft as of December 31, 2018[11] - ACMI Services offers customized airlift operations through three models: ACMI (company provides aircraft, crew, maintenance, insurance), CMI (customer provides aircraft), and Charter (full service, all-inclusive price)[12] - The company has limited exposure to aviation fuel price fluctuations, as customers like DHL and Amazon procure their own fuel, and military charter agreements include fuel price true-ups[17] - The company provides aircraft maintenance and modification services through its AMES and Pemco subsidiaries, holding numerous Supplemental Type Certificates (STCs) for aircraft alterations[18][19][21] Competitive Conditions and Employees ATSG faces competition across all segments based on cost and reliability, and a significant portion of its flight crews are represented by unions - The company competes with other cargo airlines like Atlas Air and Kalitta Air, and in the leasing market with firms like GE Capital Aviation Services[24] - Total full-time and part-time employees increased to approximately 3,830 at year-end 2018, up from 3,010 at year-end 2017[30][31] Union Representation of Flight Crewmembers (as of Dec 31, 2018) | Airline | Labor Union | Contract Amendable Date | % of Company Employees | | :--- | :--- | :--- | :--- | | ABX | International Brotherhood of Teamsters | 12/31/2014 | 6.5% | | ATI | Air Line Pilots Association | 11/14/2023 | 6.7% | | Omni | International Brotherhood of Teamsters | 4/1/2021 | 6.9% | | ATI | Association of Flight Attendants | 11/14/2023 | 1.0% | | Omni | Association of Flight Attendants | 12/1/2021 | 8.2% | Regulation The company's airline operations are heavily regulated by domestic and international bodies governing safety, economic authority, security, and environmental standards - The company is subject to environmental regulations, including the European Union Emissions Trading Scheme (ETS) for intra-EU flights and the upcoming Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), which will increase operating costs[40] - The DOT requires the company's airlines to be U.S. citizens, meaning no more than 25% of voting interest is foreign-owned or controlled[45] - The FAA mandates compliance with airworthiness directives and aging aircraft programs, which may require costly inspections and modifications; the oldest aircraft are estimated to reach their flight cycle limits in at least 20 years[46][48] - The company is subject to increasing data protection regulations, such as the EU's General Data Protection Regulation (GDPR), which imposes significant requirements for handling personal data[50] Risk Factors The company faces significant risks from its dependence on key customers, economic downturns, union negotiations, and the dilutive effect of Amazon's warrants - The business is highly dependent on a few key customers (DHL, Amazon, DoD), and the loss or non-renewal of their contracts could have a material adverse effect[56] - The collective bargaining agreement with ABX's flight crewmembers (IBT) is currently amendable and under renegotiation, which could lead to higher operating costs or service disruptions[59] - Airline operating agreements contain on-time reliability thresholds; failure to meet them can result in monetary penalties and, in cases of prolonged failure, contract default and termination[62] - The stock warrants issuable to Amazon will dilute the ownership of existing stockholders and cause fluctuations in reported earnings due to fair value re-measurements[66] - The Senior Credit Agreement contains covenants, including a requirement to maintain aircraft collateral coverage of 110% of the outstanding term loan and revolving credit facility[73][74] - Evolving environmental regulations, such as the EU ETS and ICAO's CORSIA, are expected to increase operating costs related to greenhouse gas emissions[79] Unresolved Staff Comments The company reports that there are no unresolved staff comments - None[82] Properties The company's primary facilities are leased, and its in-service fleet consisted of 90 aircraft as of year-end 2018, the majority of which are owned - Key leased properties include maintenance hangars and offices in Wilmington, Ohio, and a two-hangar maintenance complex in Tampa, Florida[82] In-service Aircraft Fleet as of December 31, 2018 | Aircraft Type | Total | Owned | Operating Lease | | :--- | :--- | :--- | :--- | | 767-200 SF | 34 | 34 | 0 | | 767-200 Passenger | 3 | 2 | 1 | | 767-300 SF | 33 | 33 | 0 | | 767-300 Passenger | 7 | 6 | 1 | | 777-200 Passenger | 3 | 3 | 0 | | 757-200 PCF | 4 | 4 | 0 | | 757-200 Combi | 4 | 4 | 0 | | 737-400 SF | 2 | 2 | 0 | | Total in-service | 90 | 88 | 2 | - As of year-end 2018, CAM owned five Boeing 767-300 aircraft undergoing or awaiting freighter modification and one Boeing 767-200 being prepped for future leasing[86] Legal Proceedings The company is involved in various legal proceedings but does not expect the outcomes to materially impact its financial condition or results - The company is party to various legal proceedings but does not expect the outcomes to be material to its financial condition or results[87] Mine Safety Disclosures This item is not applicable to the company - Not applicable[88] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's stock trades on NASDAQ, with a repurchase program in place and no dividends paid, while its five-year performance has outpaced key indices - The company's common stock is traded on the NASDAQ under the symbol ATSG[88] - The Board of Directors authorized a stock repurchase program of up to $150 million, with $61.3 million remaining available for repurchases as of December 31, 2018[89] Comparison of 5-Year Cumulative Total Return | | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | 12/31/2018 | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Air Transport Services Group, Inc. | $100.00 | $105.81 | $124.60 | $197.28 | $286.03 | $281.95 | | NASDAQ Composite Index | $100.00 | $114.62 | $122.81 | $133.19 | $172.11 | $165.84 | | NASDAQ Transportation Index | $100.00 | $144.06 | $124.46 | $149.57 | $185.07 | $169.26 | Selected Consolidated Financial Data This section provides a five-year summary of key financial data, reflecting the impact of the Omni acquisition and the re-measurement of Amazon warrants Selected Consolidated Financial Data (Years Ended December 31, In thousands, except per share data) | | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Revenues from continuing operations | $892,345 | $1,068,200 | $768,870 | | Earnings (loss) from continuing operations | $67,883 | $21,740 | $21,060 | | Consolidated net earnings (loss) | $69,285 | $18,495 | $23,488 | | Diluted EPS from continuing operations | $0.89 | $0.36 | $0.33 | | Total assets | $2,470,585 | $1,548,844 | $1,259,330 | | Long term debt and current maturities | $1,401,252 | $515,758 | $458,721 | | Stockholders' equity | $436,438 | $395,279 | $311,902 | - 2018 revenues reflect the adoption of the new revenue standard (Topic 606), which nets certain reimbursed expenses, making direct comparison to prior years' gross revenues misleading[95] - Financial results were significantly impacted by non-operating items, including a $7.3 million gain in 2018 and a $79.8 million loss in 2017 from the re-measurement of Amazon warrants, and a $59.9 million tax benefit in 2017 from the Tax Cuts and Jobs Act[95] Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) Adjusted pre-tax earnings grew 8.5% in 2018, driven by new leases and the Omni acquisition, while reported revenue decreased due to an accounting change Overview The company operates through three segments, with major customers DHL, Amazon, and the DoD driving revenues, and the Amazon warrant re-measurement significantly impacting earnings - The company's three reportable segments are CAM (leasing), ACMI Services (airlines), and MRO Services (maintenance)[98] - In 2018, DHL, Amazon, and the DoD accounted for 26%, 27%, and 15% of consolidated revenues (excluding reimbursed revenues), respectively[98][100] - The fair value of outstanding Amazon warrants is re-measured each reporting period, resulting in a non-operating gain of $7.4 million in 2018 compared to an $81.8 million loss in 2017[100] Results of Operations Adjusted pre-tax earnings increased in 2018 due to fleet expansion and the Omni acquisition, with strong performance in the CAM and ACMI segments - The CAM-owned operating aircraft fleet increased by 29 aircraft since the end of 2016, driven by demand for converted 767-300 freighters and the acquisition of 11 passenger aircraft with Omni[101] Adjusted Pre-Tax Earnings from Continuing Operations (Non-GAAP, in thousands) | | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Pre-Tax Earnings (Loss) from Continuing Operations | $87,478 | $(6,536) | $34,454 | | Adjustments (warrant re-measurement, amortization, etc.) | $17,160 | $102,015 | $30,657 | | Adjusted Pre-Tax Earnings from Continuing Operations | $104,638 | $96,479 | $65,111 | Pre-Tax Earnings by Segment (in thousands) | Segment | 2018 | 2017 | | :--- | :--- | :--- | | CAM | $65,576 | $61,510 | | ACMI Services | $17,717 | $8,557 | | MRO Services | $14,499 | $19,741 | | Other Activities | $9,107 | $5,590 | - The adoption of revenue standard Topic 606 in 2018 resulted in netting certain reimbursed revenues against expenses; in 2017, these reimbursed revenues totaled $289.4 million[110] Financial Condition, Liquidity and Capital Resources Liquidity remains strong with increased operating cash flow, while the Omni acquisition was financed through new debt, and significant capital expenditures are planned for 2019 Cash Flow Summary (in millions) | Cash Flow Activity | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net Cash from Operating Activities | $298.0 | $235.0 | $193.1 | | Net Cash (Used in) Investing Activities | $(1,141.9) | $(298.4) | $(269.5) | | Net Cash from Financing Activities | $870.5 | $79.7 | $75.1 | - Capital expenditures were $292.9 million in 2018, mainly for acquiring eight Boeing 767-300 aircraft and related freighter modification costs[141] - Financing activities in 2018 were dominated by debt taken on for the Omni acquisition, including a new $675.0 million term loan and $180.0 million drawn from the revolving credit facility[141] - The company estimates capital expenditures for 2019 will total $400 million, primarily for aircraft purchases and freighter modifications[145] - As of Dec 31, 2018, the company had $59.3 million in cash and $57.9 million available under its revolving credit facility[148] Critical Accounting Policies and Estimates Critical accounting policies involve significant judgment, particularly in goodwill impairment testing, valuation of long-lived assets, and the fair value measurement of stock warrants - Goodwill impairment testing requires significant judgment, using market and income approaches (discounted cash flows) to estimate the fair value of reporting units like CAM, OAI, and Pemco[154] - Accounting for post-retirement obligations is highly sensitive to assumptions; a hypothetical 100 basis point decrease in the rate of return on pension assets would have increased 2018 pension expense by approximately $6.1 million[164][165] - Stock warrants issued to a lessee are accounted for as a lease incentive asset and amortized against revenue, while unexercised warrants are classified as a liability and re-measured to fair value each period, causing non-operating gains or losses[162] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk exposure is to interest rate changes affecting its $1.2 billion in variable-rate debt, with limited exposure to fuel prices - The company has significant exposure to interest rate risk with $1.2 billion of variable interest rate debt outstanding as of December 31, 2018[169] - A hypothetical 20% increase or decrease in interest rates would have changed interest expense by approximately $5.1 million for the year ended December 31, 2018[169] - The fair value of the 14.83 million stock warrants issued to a customer is re-measured quarterly and is dependent on the company's stock price, volatility, and interest rates[169] - Risk from jet fuel price changes is largely mitigated by customer agreements that pass through fuel costs[169] Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for 2018, which received an unqualified opinion from the independent auditor Report of Independent Registered Public Accounting Firm Deloitte & Touche LLP issued an unqualified opinion on the financial statements, highlighting the change in revenue recognition and dependence on key customers - The auditor, Deloitte & Touche LLP, issued an unqualified opinion on the financial statements[173] - The report emphasizes the company's dependence on its three principal customers (DHL, Amazon, DoD) and notes the change in accounting for revenue due to the adoption of a new standard[175][176] Consolidated Financial Statements The financial statements show total assets of $2.47 billion and net earnings of $69.3 million for 2018, reflecting the impact of the Omni acquisition Consolidated Balance Sheet Highlights (in thousands) | | Dec 31, 2018 | Dec 31, 2017 | | :--- | :--- | :--- | | Total Current Assets | $259,221 | $184,503 | | Property and equipment, net | $1,555,005 | $1,159,962 | | Goodwill and acquired intangibles | $535,359 | $44,577 | | Total Assets | $2,470,585 | $1,548,844 | | Total Current Liabilities | $229,134 | $184,672 | | Long term debt | $1,371,598 | $497,246 | | Stock warrant obligations | $203,782 | $211,136 | | Total Liabilities | $2,034,147 | $1,153,565 | | Total Stockholders' Equity | $436,438 | $395,279 | Consolidated Statement of Operations Highlights (in thousands) | | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Revenues | $892,345 | $1,068,200 | $768,870 | | Operating Income | $111,018 | $99,400 | $70,563 | | Earnings from Continuing Operations | $67,883 | $21,740 | $21,060 | | Net Earnings | $69,285 | $18,495 | $23,488 | Notes to Consolidated Financial Statements The notes detail the adoption of Topic 606, the $867.7 million Omni acquisition, significant customer relationships, and the substantial increase in debt - Effective Jan 1, 2018, the company adopted revenue standard Topic 606, which requires netting of certain reimbursed costs (e.g., fuel) against revenue and recognizing MRO revenue over time[216] - The acquisition of Omni on Nov 9, 2018, for $867.7 million in cash resulted in the recording of $353.5 million in goodwill and $140.0 million in intangible assets[220][222] - In December 2018, new agreements with Amazon provided for the issuance of warrants for 14.8 million shares at an exercise price of $21.53, which will vest as new leases are executed and existing leases are extended[236] - Total debt obligations increased from $515.8 million in 2017 to $1.4 billion in 2018, primarily due to a new $675.0 million term loan and revolver draws to finance the Omni acquisition[244][246] - The company's defined benefit pension plans were underfunded by $65.1 million as of December 31, 2018, an increase from the $59.2 million underfunded status at year-end 2017[264][265] Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure matters - None[314] Controls and Procedures Management concluded that disclosure controls and procedures were effective, though the assessment of internal controls excluded the recently acquired Omni - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of December 31, 2018[314] - Management's assessment of internal control over financial reporting excluded the internal controls of Omni, which was acquired on November 9, 2018[316] - The independent registered public accounting firm issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2018[318] Other Information The company reports no other information for this item - None[327] Part III Directors, Executive Officers and Corporate Governance This section identifies the company's executive officers and incorporates other governance details by reference from the 2019 Proxy Statement - Information regarding directors, Section 16(a) compliance, and corporate governance is incorporated by reference from the definitive Proxy Statement for the 2019 Annual Meeting of Stockholders[328] Executive Officers | Name | Age | Title | | :--- | :--- | :--- | | Joseph C. Hete | 64 | President and Chief Executive Officer | | Quint O. Turner | 56 | Chief Financial Officer | | Richard F. Corrado | 59 | Chief Operating Officer | | W. Joseph Payne | 55 | Chief Legal Officer & Secretary | | Michael L. Berger | 57 | Chief Commercial Officer | Executive Compensation Information regarding executive and director compensation is incorporated by reference from the company's 2019 Proxy Statement - The response to this item is incorporated by reference from the definitive Proxy Statement for the 2019 Annual Meeting of Stockholders under the captions "Executive Compensation" and "Director Compensation"[330] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information regarding security ownership and equity compensation plans is incorporated by reference from the company's 2019 Proxy Statement - The response to this item is incorporated by reference from the definitive Proxy Statement for the 2019 Annual Meeting of Stockholders[330] Certain Relationships and Related Transactions, and Director Independence Information regarding related person transactions and director independence is incorporated by reference from the company's 2019 Proxy Statement - The response to this item is incorporated by reference from the definitive Proxy Statement for the 2019 Annual Meeting of Stockholders[331] Principal Accounting Fees and Services Information regarding fees paid to the independent accounting firm is incorporated by reference from the company's 2019 Proxy Statement - The response to this item is incorporated by reference from the definitive Proxy Statement for the 2019 Annual Meeting of Stockholders[331] Part IV Exhibits and Financial Statement Schedules This section lists all financial statements, schedules, and exhibits filed with the report, including key agreements with Amazon and lenders - This section lists all financial statements, schedules, and exhibits filed with the report[332] - Key exhibits filed include the Second Amended and Restated Credit Agreement (10.62), the new Investment Agreement with Amazon (10.65), and the related Warrant to Purchase Common Stock (10.66)[342][345][346]