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Air Transport Services Group (NASDAQ:ATSG)

Q2 2014 Earnings Call

August 06, 2014 10:00 am ET

Executives

Joseph C. Hete - Chief Executive Officer, President, Director, Member of Executive Committee and Chief Executive Officer of ABX Air Inc

Quint O. Turner - Chief Financial Officer and Principal Accounting Officer

Richard F. Corrado - Chief Commercial Officer, President of Cargo Aircraft Management Inc and President of Airborne Global Solutions Inc

Analysts

Helane R. Becker - Cowen and Company, LLC, Research Division

Arthur K. Rowe - BB&T Capital Markets, Research Division

Adam Ritzer

Bob McAdoo - Imperial Capital, LLC, Research Division

Seth Crystall - R.W. Pressprich & Co.

Michael Henderson-Cohen

Operator

Welcome to the Second Quarter 2014 Air Transport Services Group, Inc. Earnings Conference Call. My name is Dawn, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded.

I will now turn the call over to Mr. Joe Hete, President and Chief Executive Officer. You may begin, sir.

Joseph C. Hete

Thank you, Dawn. Good morning, and welcome to our second quarter 2014 earnings conference call. With me today are Quint Turner, our Chief Financial Officer; Rich Corrado, our Chief Commercial Officer; and Joe Payne, our Senior Vice President and Corporate General Counsel.

Yesterday, we issued our second quarter earnings release along with 2 other important news items. Our Board of Directors has authorized a discretionary flexibility to make opportunistic ATSG share repurchases of up to $50 million, and we have agreed to purchase 2 767-300ER freighters that are already in our fleet as leased-in aircraft. You can find all those announcements on our website, which is atsginc.com.

All 3 of these announcements are good news for shareholders, following on the new dry lease co-agreements with Cargojet and Amerijet and the more favorable credit agreement terms we announced in May.

Our second quarter results were very good, including increases in revenues, earnings and adjusted EBITDA, which increased 26% to $45 million. The quarter also marked the return of our ACMI Services business to profitability.

The board's action is consistent with the message that we have been sharing for months. We think a repurchase authority is a good tool to have when you anticipate significant cash flow and have minimal CapEx requirements. But just like any other tool, there's an optimal time to use it. We are going to keep that principle in mind in the months to come.

We also think that buying the 2 leased 767-300s that we have operated for several years is good news. Customer interest in the 300 is strong, and we believe that net of the lease payments we have avoided, the acquisition of these aircraft is an excellent value.

And it affirms what we have said about focusing our 767 freighter fleet development on the 300 series and about market demand for aircraft type in a strengthening economy. I have more to tell you about, including an update on our improving outlook for the year, and I know you have questions for Quint and I.

I'll be back to cover the details in a few minutes after Quint summarizes our results for the second quarter. Quint?

Quint O. Turner

Thanks, Joe, and good morning, everyone. Let me begin by advising you that during the course of this call, we will make projections or 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, and 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 include, but aren't limited to, changes in the demand -- market demand for assets and services, the number and timing of deployments of our aircraft, our operating airline's ability to maintain on-time service and control costs and other factors, as contained from time to time in our filings with the SEC, including our second quarter Form 10-Q.

We will also refer to non-GAAP financial measures from continuing operations, including adjusted EBITDA and adjusted pretax earnings, which management believes 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, and we advise you to refer to the reconciliations to GAAP measures, which are included in our earnings release and also on our website.

Joe described our June quarter as a very good one, and I don't disagree. We're always hesitant to use superlatives when we know we can do better. I think that's where we stand today, particularly as we look toward the fourth quarter and into 2015.

The big news of our second quarter, of course, was the new business we signed with Amerijet and Cargojet. But given the lead times of our business, there is always a lag between the announcement and the benefit and often, some significant prep cost in between.

That was certainly the case for us this time. We made a profit in our ACMI Services segment and got a strong performance from our AMES aircraft maintenance business. But we also had lower margins at CAM. Some of those results stem directly from the process of shifting aircraft out of our airline fleet where they were generating revenues for CAM and lease cost for the airlines and turning them over to AMES, our MRO, to prepare them for new customers. The net of all of these internal events, however, was still plenty of growth in all of our key consolidated financial metrics.

For the second quarter, revenues were $149.6 million, up nearly $11 million from the second quarter last year and $6 million better than the first quarter of this year. Excluding revenues from reimbursable expenses, revenues for the quarter increased $4.8 million or 4% from a year ago. Much of that net gain came from external customers of our aircraft maintenance business, AMES.

Our after-tax earnings from continuing operations were $9.3 million or $0.14 per share, a 34% increase from $6.9 million or 11% per share a year ago and also up from $6.5 million or $0.10 a share from the first quarter.

Adjusted EBITDA, which excludes gains or losses on our derivative instruments, was $45.3 million, up 26% from $35.9 million in the second quarter a year ago and up 17% compared with last quarter. Last year's second quarter adjusted EBITDA was negatively impacted by factors related to our combi transition.

We have continued to reduce personnel expenses wherever possible since our fleet transitions led to temporary overlaps and significant crew retraining activity last year. Airline headcount has decreased 13%, and pension expense is down, leading to a $1.3 million reduction in the salary, wage and benefit line year-over-year.

Direct aircraft operating costs, such as fuel, travel and landing and ramp fees, were down from a year ago, reflecting fewer international flights and lower fuel burns in the 757s compared with the DC-8 combis. These savings were partially offset by higher depreciation costs, with new aircraft entering the fleet, and higher aircraft maintenance expenses, especially engine costs.

Turning to our segments. Pretax earnings from our leasing business, CAM, were down $6.5 million over last year's second quarter, reflecting a $5.5 million increase in depreciation cost for the 5 Boeing 767s and 75s added to CAM's roster since June of 2013. CAM placed 1 767-300 freighter aircraft and 3 757 combis under leases with internal customers since June of 2013. It continues to market 1 unassigned 767-300 freighter.

As of June 30, CAM owned 51 freighter aircraft. 26 of them are leased to our airlines, and 21 are leased to external customers, including the first of 2 767s we're providing to Cargojet. 3 were being prepped for lease, the other 767 Cargojet freighter and 2 767s that will go to Amerijet.

The 2 767s that Joe said CAM will buy have been under operating lease from Guggenheim to ABX Air, with terms set to expire during 2015 and 2017. Buying the 2 aircraft at the end of September will eliminate $12.4 million in future operating lease payments.

CAM will initially lease them back to ABX. Both are extended-range 767-300 freighters, which will give us 9 of that aircraft type. We will finance the purchase from operating cash and funds from our revolver facility. The Guggenheim deal also includes an option to purchase the third 767-300 freighter next year.

ACMI Services had its first profitable quarter since 2011, with a pretax gain of $309,000 as compared to a $9 million loss a year ago and a $7 million loss in the first quarter.

The keys to that turnaround were lower personnel costs, including benefit and pension expenses; fewer expense to maintenance shifts than a year ago; reduced aircraft lease payments; and stronger results from our military combi operation, with a full complement of 757 combis and service throughout the second quarter.

Revenues and block hours were lower, primarily because DHL discontinued our role in its Mideast network. Excluding those Mideast flights, block hours increased 4%. We picked up additional hours for DHL's U.S. and Latin American network under our CMI agreement, and our combi hours flown for the U.S. military in the second quarter increased 10% from second quarter of 2013.

As I mentioned earlier, we were short combi aircraft for a time during the second quarter last year as we transitioned out of the DC-8, which resulted in a decline in our billable hours to the military.

We continued to cut costs in our airlines, with operating expenses declining $10.7 million compared to second quarter last year and lower wages and benefit costs, fuel costs and other airline expenses. These savings were partially offset by depreciation, maintenance and carrying costs for underutilized aircraft.

Pretax earnings from our other business activities, driven largely by AMES, our maintenance MRO, and our postal operations, were $4.1 million for the quarter, up from $2.6 million for the second quarter last year.

AMES had a great second quarter, but as we have said in the past, AMES results can vary depending on the timing of completion of airframe inspections. And I would not expect a strong contribution from AMES in the third quarter due to completion dates of scheduled work.

Before I discuss our cash flow and liquidity, I'll remind you again that our deferred tax position offsets our federal income tax liability. As a result, we don't expect to pay any significant cash federal income taxes until 2016 or later.

Net cash flow from operations in the first half was $55.4 million versus $48 million for the first 6 months of 2013. We told you earlier that favorable rates have significantly reduced our pension funding requirements for 2014. Cash deposits for pension declined to $1 million from $9.7 million a year ago. That drop was offset by lower payments from DHL, increased inventory cost and more work in progress.

Capital expenditures for the first half are on track with our original $45 million projection. We spent $23.5 million versus $72.8 million for the first half of 2013. The bulk of the capital was for heavy maintenance, including preparing freighters for redeployment to external lease customers and $5.3 million to complete the new hangar. We have raised our CapEx budget for the year to $95 million to reflect the 2 767s we're buying from Guggenheim.

Through June, we have drawn $173 million against our revolving credit facility. As you recall in May, we executed another amendment to our senior credit facility with our bank group, which extended the maturity to May of 2019 from July of 2017, with annual 1-year extension options. It also reduced our interest expense pricing, lowered our collateral requirement and relaxed the threshold needed to allow for stock buybacks or dividends.

That return of capital to shareholders is now permitted when our debt-to-EBITDA ratio is below 2.5x after giving effect to any such distribution. Our current debt-to-EBITDA ratio of just over 2x qualifies us for a 2.16% rate on our unhedged debt through the third quarter.

During the first 6 months, we drew $15 million from the revolver to fund the 25% interest we took in West Atlantic and for capital spending, including heavy maintenance for aircraft and the completion of our hangar in Wilmington. We made debt principal payments of $44.3 million, and $3.1 million of the remaining principal balance of our DHL note was extinguished. Even with the Guggenheim purchase, we still expect to finish 2014 with a ratio close to 2x EBITDA.

The share repurchase flexibility Joe described is for up to $50 million in common shares with no plan expiration date. We have a discretion without any minimum requirement to buy back stock, either in the open market or privately. Of course, the timing, price and volume of the transactions would be based on market conditions, relevant security laws and other factors.

Joe will talk more about that in a moment. But just as a reminder, the 20% premium requirement on any cash returns to shareholders contained in our DHL note agreement remains in effect through next March. Joe will now guide you through the events of the quarter and discuss the capital allocation news we announced yesterday. Joe?

Joseph C. Hete

Thanks, Quint. ATSG is clearly in its best position for growth and profitability in several years. We're in the middle of deploying 5 of our 767s with dry lease customers from June through late September this year. That's the largest subset of lease deployments in 3 months since our DHL agreement in early 2010 when we dry leased the first 7 of what would eventually be 13 of our 767 freighters to DHL.

Our ACMI Services segment turned profitable in the second quarter, a reflection of more than a year's worth of work to reorganize our airline businesses, streamline our flight crews and find customers for underutilized aircraft.

In our other businesses, including MRO unit, AMES, also had a strong quarter. Those results were also on target with our guidance comments last quarter when we said we would reach and could possibly exceed the upper end of the $165 million to $170 million target for adjusted EBITDA that we had first set in March.

That upgrade reflected the second half benefits from 4 additional dry leases we signed in May and expect to fully implement by the end of September. The first of the 2 additional 767s we're leasing to Cargojet entered service in June. Amerijet got its first of 2 this month, and both will get their second aircraft before the end of the quarter.

We also expect to complete arrangements with West Atlantic for its first 767 lease this quarter. That completes all the new business arrangements I'm prepared to discuss at the moment, although Rich Corrado and his sales teams have been very busy all summer.

We also said in May that DHL was in the process of adjusting its U.S. air network to better match capacity to volume. And as a result, they would be returning some 767s deployed under special lease arrangements. One was returned in the second quarter and then another last month. We expect that a third may come back this fall.

Our airlines have 2 underutilized 767s today. CAM has one more that is unassigned. Based on our outlook for the fourth quarter, I expect that any spare aircraft we have now that would be active with ad hoc assignments in the holiday season while we continue to pursue longer-term arrangements.

With that additional cash flow from new deployments and a good fourth quarter, I'm now confident we will exceed $170 million in adjusted EBITDA for the year.

But I don't want to get more specific than that at this point. Our outlook for the third quarter looks a lot like the second. CAM's margins will improve as incremental dry lease revenues grow. But ACMI Services will fall back a bit due in part to resumption of airframe checks on our 767-200s.

In the fourth quarter, we will be taking depreciation on those 2 additional 767s we're buying. We'll get an additional $2 million benefit in EBITDA from the loss of the lease payment. And after giving effect to depreciation, earnings per share will improve by about $0.01.

Final results for 2014 will depend on our holiday flying, which will be resolved in about a month or so. But it's certainly positive that we were able to redeploy underutilized aircraft from our airlines to external dry lease customers. By the time of our third quarter call, I hope to be able to give you an even better fix on where our 2014 numbers will end up.

Our management team spent several days with the board last week, briefing them on our financial outlook and other issues and listening to their points of view. We reviewed the options we have discussed with many of you about how best to allocate our future cash flow, both this year and into 2015.

The consensus was that there are good arguments for growth investments to create long-term value, for paying down our debt and for share repurchases. And of course, those options are not mutually exclusive.

After spending the last 5 years on fleet modernization, restructuring and business development, I'm looking forward to 2015 when our cash flow will fully reflect those improvements in our business.

Buying the 2 767-300s from Guggenheim is a symbol of that confidence, as well as the financing option that just makes good sense. Both aircraft have been important parts of ABX Air's fleet for the past several years, and the 300 series will be our preferred fleet growth platform for the foreseeable future.

As we look to the expiration of those leases next year and in 2017 and the challenge we would have to find comparable aircraft at such an attractive price, we thought it was the right move to buy them now. When we see our near-term demand for more fleet capacity and aircraft available that meet our rate of return requirements, we will enter the market to acquire them rather than let potential competitors jump in ahead of us.

You can't survive in this business for long if you aren't ready to serve new customers when they call. But we're also unlikely to make any major fleet expansion commitments without a very clear understanding that we have customers willing to make a long-term commitment.

Meanwhile, we will continue to make progress against our operating goals to build new customer relationships, provide the best and most reliable air cargo service in our midsized niche and fit those services to customer requirements in ways that other operators cannot.

We will use all the resources you have hired us to manage with full regard for the interest of our shareholders, mindful that other investments also offer the combination of growth, financial strength and maximize returns for shareholders that we intend to provide.

That concludes our prepared remarks, Dawn. We are ready to take the first question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jack Atkins from Stephens.

Unknown Analyst

This is actually Andrew [ph] on for Jack. I guess I'll start with a question for you, Rich. Could you speak to the current market demand for your assets? Looks like things have been improving given the lease announcements in the first quarter. How have customer inquiries been throughout this quarter? And can you give us a sense for which geographies and customer verticals are the most interested in putting these assets under lease?

Richard F. Corrado

Sure. Thanks, Andrew, for the question. The air cargo market seems to stay in growth over the last 3 quarters, and that's really created a bit more market optimism from buyers than we've seen in the 2 years prior when there was negative growth in the market. We've actually seen some pent-up demand in some areas, Europe in particular, where customers are looking to add lift, both for the fourth quarter and beyond. We've got some good growth opportunities in the Americas, in the E.U., as I said, and in the Mideast in the near term. And this includes both dry lease opportunities, as well as ACMI opportunities. We've got a real good chance of implementing a few of these opportunities in the fourth quarter. So would impact this year as well. Peak is also looking good. It should meet or exceed last year's peak from a deployment standpoint. I think Joe mentioned that in his prepared remarks as well.

Unknown Analyst

All right, that definitely helps. And then I know you guys touched on the increased military operations in the quarter. Can you provide some color around sort of kind of like what an impact or how much of an impact that had on the results this quarter and kind of what levels you're anticipating for the rest of the year?

Joseph C. Hete

Yes. Andrew [ph], from our standpoint, remember, our niche in the military flying is with our combi operations. We weren't tied into any of the flying that went on in the Middle East. As you recall, last year in the second quarter, as we were doing the transition from the DC-8 to the 757, we ended up missing out on about $3 million worth of revenue from the military because we couldn't cover all the flights due to a shortage of aircraft at that point in time. So when you look on a year-over-year basis, the number should be relatively consistent quarter-to-quarter for our military flying. It's just that we missed out on that one piece of revenue last year because of the transition involved.

Unknown Analyst

Okay, okay. That makes sense. And I guess my last question would be for you, Quint. As we kind of run through the quick math on the 767 purchase from Guggenheim, we're kind of getting about $0.03 accretive for EPS in '15 and about $0.02 in FY '16. Is that kind of the right way to think about the impact?

Quint O. Turner

Yes. I think in the earlier remarks, Andrew, we noted that from an EBITDA standpoint, it's a couple of million dollars a quarter that you're looking at in improvement in EBITDA. And then on a quarterly basis, it's a $0.01 to $0.015 kind of number from an EPS quarterly improvement basis. And that -- really, that's just the difference between the operating lease expense we were paying and what the depreciation will be from owning the aircraft.

Operator

Our next question comes from Helane Becker from Cowen.

Helane R. Becker - Cowen and Company, LLC, Research Division

So, Quint, why don't you raise the guidance given the accretion from -- just on the Guggenheim deal and the comments you made about the peak, doesn't it make more sense to raise the guidance a little bit?

Quint O. Turner

Well, I think we kind of are raising the guidance, Helane, insofar as now we're saying we will exceed the upper end of the range. Now we did not provide you a new range, and I think that's where you're zeroing in on. I think part of it is, as Rich said, we're in the process of finalizing our view of what the peak demand -- what's going to get booked for peak demand. And I think, again, we're -- I don't mean to leave anybody hanging out there, but I think we are confident about exceeding the $170 million. I think that where we fall above that is going to depend upon how that plays out, and certainly, we'll give you more color on that when we next speak to you. Obviously, that's going to be unknown at that point.

Helane R. Becker - Cowen and Company, LLC, Research Division

Okay. And then can you just -- how many of the aircraft now are on lease to DHL?

Joseph C. Hete

In terms of the -- I mean, if you look at the DHL business that we have today, Helane, you've got 13, which are the original long-term dry leases. And then we have ones that are on shorter-duration arrangements with DHL that consist right now of 3 767-200s and 1 767-300 that they have and...

Helane R. Becker - Cowen and Company, LLC, Research Division

Okay, okay. And those are just like 4 -- like 1 quarter kind of things, 3, 4 month kind of things? Is that what you mean by short-term lease?

Joseph C. Hete

That list gives us the ability to get out of those and call it a 90-day notice period.

Helane R. Becker - Cowen and Company, LLC, Research Division

Got you, okay. And then on...

Joseph C. Hete

And that does not include the 757s, of which we have 4 757s in their network as well.

Helane R. Becker - Cowen and Company, LLC, Research Division

Okay. And then how many of your pilots retire annually over the next couple of years?

Joseph C. Hete

It's not a really large number, Helane. If you look at it, I think if you look out over the next 2 years, it's probably depending on, of course, obviously, they can get -- retire as soon as they hit 60, but you have people hanging in there. So it's tough to gauge exactly where they would be. But if you said how many were actually going to hit that 65 mark, where they have -- absolutely had to have been a relatively small number.

Operator

Our next question comes from Kevin Sterling from BB&T Capital Markets.

Arthur K. Rowe - BB&T Capital Markets, Research Division

This is Chip on for Kevin. Joe, you mentioned you still had 2 underutilized assets. But then you also said you had 1 returned in Q2, 1 this month and possibly another. Could you just kind of run through, on a 200 and 300 basis, what actually is underutilized at this point?

Joseph C. Hete

Yes, Chip. Basically, in terms of aircraft that are on an operating certificate with one of our airline affiliates, we have 2 aircraft that fall into that category. So the difference there being that if something pops up on a relatively short timeframe in terms of an ACMI operation or for ad hoc business here or there, those aircraft are ready to go because they are on operating certificates. And then in addition to that, we have 1 767-300, which is the last one that we put through modification that came out in the first quarter. That aircraft is not on anyone's operating certificate at this point in time. It's held by CAM. So when you look at it from the standpoint of when we came into this year, we said we had 600 utilized aircraft. And based on the current commitments that we have from customers, that number is now down to 3.

Arthur K. Rowe - BB&T Capital Markets, Research Division

Okay, does that include the one at West Atlantic?

Joseph C. Hete

Yes.

Arthur K. Rowe - BB&T Capital Markets, Research Division

Okay, okay. And then kind of along the same lines, and I realize it may be a bit early, but with demand picking up and you have 300 utilized assets, just trying to gauge where you think your CapEx requirements may be for next year. I know you have the option to buy that other 300 from Guggenheim. I'm just trying to get a sense of how much demand that you have to get to exceed the 300 utilized that you have now.

Joseph C. Hete

Well, essentially, Chip, from our standpoint, as you may have noted in our prepared remarks, that you have to have assets available. When a customer calls requiring one, you can't tell them, "Well, wait 6 months while I go source an aircraft and put it through a 4-month modification process." So that -- what we would spend in 2015 for growth CapEx would largely be dependent upon where we end up this year as far as the -- our ability to deploy the 3 underutilized aircraft at this point in time. If you look at the CapEx requirement for next year, I mean our maintenance CapEx numbers in the -- call it, the $30 million to $40 million range on an annualized basis. So if we were to acquire any additional aircraft, you've got to be thinking in terms of something on the order of magnitude of, call it, ballpark $25 million per tail for a 767-300.

Arthur K. Rowe - BB&T Capital Markets, Research Division

Okay. And then at AMES, you've seen some improved results there with the new maintenance hangar and then the A320 approval. What sort of growth or contribution could AMES eventually add?

Joseph C. Hete

When you look at the number of man-hours that they could generate, they can add -- basically, it's 100,000 square foot facility. We can add a couple of lines. So it could be, call it, in the range of 30% increase in the overall level of volume that AMES could pump through their facility. Obviously, the key is finding the customers to keep those lines full on a regular basis. As we noted, our -- the AMES standpoint from a quarter-to-quarter basis, it can be, as Quint would characterize it, lumpy from 1 quarter to the next. We did have a very strong second quarter. There were some maintenance events that lagged over from the first into the second. And we do revenue recognition in the AMES sector based on when the asset is redelivered to the customer, not on a -- as a work-in-process basis. So they'll probably see a little bit of a falloff in the second quarter of this year versus where AMES -- or the third quarter this year versus where AMES finished in the second.

Arthur K. Rowe - BB&T Capital Markets, Research Division

And what was the breakdown of customers versus preparing your internal aircraft at AMES this quarter?

Joseph C. Hete

As far as the revenue side?

Arthur K. Rowe - BB&T Capital Markets, Research Division

Right. The $5.8 million growth?

Joseph C. Hete

Yes, a very small portion of it was prepping the aircraft for new customers, Chip. That wasn't a big driver.

Operator

[Operator Instructions] Our next question comes from Adam Ritzer from Pressprich.

Adam Ritzer

I guess the question I had, I just had a few questions just to follow up with some people. Can you -- just in terms of the planes that you have empty, I was a little bit confused. I know you talked the last caller through it, you said you had 2 now with operating certificates, 1 more coming at a mod, for a total of 3. But you also said you have, I think, 3 more coming from DHL. So is it 3 or 6?

Joseph C. Hete

No, what we said was -- is the -- if you look at what we consider to be underutilized, 2 of them have come back already, all right? Then we've redeployed those assets. So what we have and currently don't have regular customers for is 2 767-200s and 1 767-300. And then we also said that we may get a third one back from DHL later this year. But that hasn't occurred at this point in time. So there could be potentially 4.

Adam Ritzer

Okay. So the 3 include 2 from DHL, and it could be 1 more. So it's not a maximum of 6. It's a max of 4?

Joseph C. Hete

As things stand today, yes.

Adam Ritzer

Got it. Not including anything that could come up, okay. The other question I had is I think Quinn mentioned that the DHL note balance was extinguished. Did I hear that right or wrong?

Quint O. Turner

No. Adam, that's -- I just -- I think in the prepared remarks, we mentioned that the 20% premium -- cash premium that would be applied to any capital returns would -- is still out there until March, which coincides with the expiration of the DHL note. The DHL note, at its current to amortization pace, is extinguished at the end of March of next year.

Adam Ritzer

Okay. So that's what you meant? You didn't meant -- you didn't mean you paid it off. It's until March, okay.

Quint O. Turner

Correct, correct.

Adam Ritzer

Got it. Can you talk a little bit about AMES? I know you now have the hangar. It's all built. Looks like you're starting to get some business. Have you ever mentioned to anybody or is there something you could share about how much a business can be done here, how much EBITDA this potentially could generate? Because you invested a decent amount of money there.

Joseph C. Hete

No. We haven't given any guidance along the lines of what actually could be generated by the addition of the hangar space itself. Obviously, the key there is to -- what kind of customer base do you get to fill it up? I mean the MRO business can be feast or famine to a certain degree where 1 quarter you have the hangar absolutely full, and then the next quarter you may be only 50% full. It's kind of gauged, as I said, based on the number of manhours you can generate as well. And so we're in the ramp-up process on that. We did just complete the third of a -- of 3 737 aircraft or a passenger carrier, which could be a recurring customer. And of course, we're out there beating the bushes today, looking for additional customers that can now utilize that space. One of our Achilles' heels before on the MRO side is we couldn't dedicate specific lines to customers. And they want to be able to bring an aircraft on a nose-to-tail basis consistently, and then this gives us that flexibility to do that now.

Quint O. Turner

I mean having AMES down is a great benefit to, for example, DHL just because it gives us a lot of flexibility. We have a lot more control over dealing with nonroutine maintenance issues that come up. We can sub an aircraft, we can prioritize, and so forth. But at the same time, AMES has run as an independent business, and it looks at its external customers all independently. But certainly, having it here at our home base gives us a lot of flexibility. It is a -- it's sort of a single-digit type margin business. The MRO business is competitive. But the expanded capacity we have, we believe will improve the margins just because you're spreading the fixed cost over more potential lines of direct labor. And so AMES has been a consistent contributor, as Joe said. It's kind of lumpy from quarter-to-quarter, but it's been a -- I think a really good investment for us to have the MRO thus far.

Joseph C. Hete

Just as a point of clarification, Adam, actually, the hangar itself is owned by the port authority. It's only capitalized because of the accounting requirements for the lease. So it was actually not our cash that we utilized to fund that facility.

Adam Ritzer

Right, right. I get it. Okay, it sounds like a good one. So -- and last but not least, obviously, I've asked you, I don't know for how many years, about a buyback. I appreciate that you guys are finally doing this. I guess the real question I had is I know, Quint, you and I have talked multiple times in the past. I mean you guys seemed to indicate you wanted to wait until the DHL balance was extinguished to avoid the 20% premium. And it seems like you're kind of caveating a buyback in terms of optimal time to use it. So maybe you can talk a little bit about more why you decided to do that now, maybe why not pay DHL off and maybe why not be a little more aggressive with the free cash yield on the stock and the cash building from here on.

Richard F. Corrado

Well, Adam, I think the flexibility and making the tool of a buyback available speaks pretty loudly that we see the value in that. And in terms of the DHL note, I think what we've said is that certainly, the decision to buy back stock, when you're not paying a 20% premium in cash to the current price, becomes more accretive at the point in time that's no longer required. And luckily for all, I mean that isn't a very long horizon to note. It's fully amortized in March. And so it's not -- we're not saying -- again, it's an opportunistic decision to buy back shares. We're not saying that we absolutely would not do that while the note's outstanding. But what we are pointing out is that it's less -- it's a little less attractive obviously to do it if you're going to have to pay a 20% cash premium that otherwise, you would not pay.

Adam Ritzer

Right. Okay, I understand. So what you're saying is, "Look, we still have a 20% premium. So we want to have this out there in case it becomes more attractive with that 20% premium." Is that kind of what you mean?

Richard F. Corrado

That is correct.

Adam Ritzer

Okay. Why not just go to DHL? I know you want to save money. I appreciate it as a shareholder. Why not just give them their $3 million so you could buy it now without worrying about that?

Richard F. Corrado

But I think that's the point I was making about the cash premium. It just -- again, if it was just to -- paying it off, it does -- the premium does not preclude us from buying back stock. So there's no reason to pay the note off entirely. It's just -- it makes the cash price to buy back stock 20% higher so long as the principal balance is still there. So I'm not quite sure your question -- I think we've been pretty clear with that.

Adam Ritzer

My question is why not just give them the $3 million so you don't have to pay a 20% premium and then you could be more aggressive on the buyback?

Quint O. Turner

But Adam, it goes back to being opportunistic. I mean it's like, why would I stroke somebody a check for $3 million? I mean if I wait long enough, I could actually apply those same dollars to buying back more shares. I mean it's just a matter of...

Adam Ritzer

I know.

Quint O. Turner

We can go on and on and on about this discussion, which we have done in the past. But the reality of it is, we will be opportunistic if the case presents itself to where it makes good economic sense to do that buyback with the premium in place. And it goes down by $550,000 a month, and right now, it is more than $3 million of that outstanding balance of that note.

Adam Ritzer

I know. I appreciate your trying to save the $3 million, and I appreciate your putting a buyback in place.

Operator

Our next question comes from Bob McAdoo from Imperial Capital.

Bob McAdoo - Imperial Capital, LLC, Research Division

Yes. Most of my questions have been answered. But could you just go into a little more detail with why you say you have a lower -- what happens that causes the lower personnel cost in the ACMI situation?

Joseph C. Hete

Bob, that's on a year-over-year basis basically. When we merged the 2 air carriers, ATI and CCIA last year, we had to go through a whole cycle of...

Bob McAdoo - Imperial Capital, LLC, Research Division

That was still inflated a little bit last year, is what it is.

Joseph C. Hete

Yes. And now the final flushing, so to speak, of everybody that -- from a retraining standpoint occurred in the first quarter of this year. So now we'll see the benefit of having everything rightsized going forward.

Bob McAdoo - Imperial Capital, LLC, Research Division

And then one kind of educational question for me on the military contract. The way that's structured, if you're providing the SMs [ph] with a relatively less economic DC-8 versus the 757, do they reimburse you a different rate or you get a certain amount for ASM? Or how does that work in terms of -- if you put a more economic airplane out there for you, the 757, do you get to keep the benefit of that economics? Or does part of that flow back to the government?

Joseph C. Hete

No. It's basically kind of a fixed rate and primarily driven by a look back in terms of what your costs have been in the past. So when we upgraded from the DC-8 to the 757, obviously, the 757 had a higher investment cost than what the old DC-8s did. But consequently, our -- and the converse of that was that the fuel burn of the 757 was significantly less than the DC-8. So what dollars we saved on buying fuel got applied toward the asset. So the revenue is fixed. Just the cost pieces have changed, and that changes on an annual basis.

Bob McAdoo - Imperial Capital, LLC, Research Division

Okay. So the revenue is kind of fixed on a per trip basis or something?

Joseph C. Hete

It's on an annualized basis essentially.

Bob McAdoo - Imperial Capital, LLC, Research Division

Yes. And so you do get the -- if there are -- if, in fact, the fuel savings and whatever else and maintenance on that airplane are less, then you get to harvest that yourself as opposed to having to share it?

Joseph C. Hete

Right. But keep in mind, we went for a higher-priced asset with no change in the revenue and save back on the...

Bob McAdoo - Imperial Capital, LLC, Research Division

Sure. No, I understand that.

Operator

Our next question comes from Seth Crystall from R.W. Pressprich.

Seth Crystall - R.W. Pressprich & Co.

I just had a quick question or actually 2 quick questions on the Guggenheim transaction for the aircraft. The interest rate on that -- on the revolver is approximately like 2%, 2.5%. Is that what it is now?

Richard F. Corrado

It's about 2.16%, I think, at the current leverage ratio, Seth.

Seth Crystall - R.W. Pressprich & Co.

And the expectation would be that most of the $50 million would be borrowed at that rate?

Richard F. Corrado

No. I mean it's out of a -- it's a mix of our operating cash flow as well as what we would pull down from the revolver.

Seth Crystall - R.W. Pressprich & Co.

Okay. And then you said the maintenance CapEx runs $30 million to $40 million. And next year, you have another option, I guess, on another plane, which is through -- I expect that would run about $25 million also, if you were to take that option.

Joseph C. Hete

That one would be actually a little bit less because you buy 2, get a third one for a little bit less money, so to speak. And it's an enticement for us to exercise that option, but we have the flexibility not to have to buy it.

Operator

Our next question comes from Michael Henderson-Cohen from Andalusian.

Michael Henderson-Cohen

I had just 1 quick question or 2 on the buyback, the share repurchase. And first, just going back to the previous caller, and I just want to make sure that I'm not getting myself confused here, the outstanding DHL balance and the 20% premium, that would really only matter for the first $15 million of a potential repurchase, right, because you've got that 20% premium and then you basically would have paid it off. And then for the -- if you were to do the full $50 million for the remaining $35 million, there would actually be no penalties. Is that the right way to think about it?

Quint O. Turner

Except the note balance is more than $3 million at this point in time. It's a little over $4 million.

Joseph C. Hete

Yes. It would -- it currently wouldn't matter for the first, what, 22 -- $21 million, $22 million.

Michael Henderson-Cohen

Okay, okay. Got it, got it. And then just in -- maybe if you could just elaborate on how the repurchase would actually work in practice. I'm just trying to understand, is it now just at your discretion to do that? Or is it going to involve the board? Have you guys established sort of a target price? Can you just maybe talk a little bit more about that?

Quint O. Turner

At this time, we -- as we said, purchase can be made on the open market or in privately negotiated situations, and they would be done opportunistically. But I don't think we're -- we want to get into the details of what price or with what frequency or -- at this stage.

Michael Henderson-Cohen

Okay, okay. I mean I guess would you kind of foresee that being a decision that would be made with the board's involvement as well or really just sort of a, "Here's the situation. Let's just pull the trigger and move forward."

Quint O. Turner

No, I think it's -- obviously, we consult very closely with the board on decisions that affect the allocations of capital.

Operator

At this time, we have no additional questions. I'd like to turn the call back to Mr. Joe Hete for closing remarks.

Joseph C. Hete

I hope you now have a clearer picture about the financial and operational progress we're making and about the principles that will govern our capital allocation decisions. We will be focused on optimizing returns over the long term with all options and combination thereof on the table. We welcome your feedback, and we hope to see many of you when we're out on the road this fall. Thank you, and have a quality day.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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Source: Air Transport Services Group's (ATSG) CEO Joseph Hete on Q2 2014 Results - Earnings Call Transcript
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